Entrepreneurs’ Relief

In just three years Entrepreneurs’ Relief has moved from the quiet backwaters of the tax relief world to centre stage. In an act of remarkable generosity, the Government doubled the limit to £10 million in the last Budget. For a successful entrepreneur, Entrepreneurs Relief (ER) offers the chance to pay Capital Gains Tax on the sale of a business at just 10% on up to £10 million of gain. Compared to the standard 28% CGT rate, that offers a tax saving of up to £1.8 million. No longer is ER merely a tax relief for small-business owners; it is now a huge tax incentive for entrepreneurs at every level. But as with all things tax, the devil’s in the detail. That’s why it’s more important than ever for entrepreneurs to review their ER position to check that they qualify.

On the face of it the qualifying criteria are straightforward and not particularly onerous. You must have owned the business for at least one year. You have to work in the business. If it’s a company you should own at least 5% of the ordinary share capital. And it needs to be a trading business. The danger is if any one of these conditions is not met, you lose the relief. Not just some but all of it.

There are many traps. For example, a company funded by venture capitalists will often have different share classes for the founder, management and the VCs. Even if the founder retains voting control, his ordinary shareholding may be diluted to below 5% if the VCs hold significant non-voting preferred ordinary shares. Another trap is where shares are held in the entrepreneur’s family trust rather than personally. Or the entrepreneur’s spouse or children may own significant shares but not work in the business. Where a business is sold for loan notes rather than cash, that presents its own difficulties.

There are also opportunities. For example, ER is available separately to married couples and to other family members, potentially multiplying the tax saving several times over. Unconnected senior employees each with less than 5% may be able to pool their shareholdings through a management company so that the management company holds over 5% and the employees each qualify for ER. Stripping out surplus cash before a sale can ensure the company is treated as a qualifying trading business. Re-arranging family trusts may allow the trustees to qualify for ER.

The key for entrepreneurs is to plan early. That will involve a review and possibly a restructuring but it will be time and money well spent. A sale of the business can come around unexpectedly and very quickly. If the company and the entrepreneur are both “ER-ready” then there’s less risk of a late scramble to ensure ER applies. The ultimate risk is that a last-minute restructuring is required and the purchaser is asked to come back in 12 months. By then the market may have changed and the purchaser may have moved on.

For further advice on Entrepreneurs' Relief, please contact Andrew Goldstone on +44 20 7440 7205 or by e-mail.