In the current political climate, business owners are facing extraordinary levels of uncertainty. With this in mind, many are likely to consider reducing their risk by taking money from their businesses, but one of the key ways of doing this tax-efficiently could be under threat.
Entrepreneurs’ Relief was introduced in 2008 to encourage entrepreneurship and reduces the tax rate of a capital gain from selling a business to just 10%, instead of the usual capital gains tax rate of 20% for higher and additional rate taxpayers. The relief applies to an individual’s lifetime limit of £10m, but recent comments by politicians and others have sparked fears that it could be removed or watered down in future.
Some changes have already been implemented that will increase the amount of time shares must be held to be eligible for the relief and strengthen the ownership criteria to include sharing profits and sale proceeds. With the continuing uncertainty, seeking advice about Entrepreneurs’ Relief planning may be a good first step for those who want to ensure they benefit from its tax advantages.
If you are planning to exit you should talk to an accountant about Entrepreneurs’ Relief, which is granted on the assumption that your business is a trading company. While the obvious example is that a business which only owns investments and rental properties is not a trading company, HMRC may reject an Entrepreneurs' Relief claim for a business holding too much cash, as this may be considered a non-trading asset.
HMRC will potentially challenge Entrepreneurs' Relief if the company holds substantial non-trading assets. Generally, substantial is taken to mean more than 20%. HMRC will look at the whole business and consider the non-trading assets in relation to:
• Asset Base
• Where time is spent
Technical Connection Consultant Simon Martin explains: “Let’s assume you have got a marketing agency that’s clearly trading because you sell marketing services. However, you’ve been so successful that you’ve built up £1m in cash, which is held in your business account. HMRC could challenge the relief if there is no clear trading purpose for the £1m.
“It might well be that the funds do have a trading purpose because you want to expand, move to new premises or buy another company. But if there’s no good explanation they may decide that as the business has a relatively low turnover and you have £1m in cash, there is unlikely to be a trading purpose for these funds.
“They could therefore jeopardise the claim for Entrepreneurs’ Relief because it looks as though you have excessive non-trading assets.”
Control the controllable
Martin Brown, CEO of business growth advisor Elephants Child, says: “I would encourage any entrepreneur with an eye on exiting within a few years to take control of the situation as far as they can.”
He says a sensible first step would be to conduct a thorough and brutally honest audit to determine how potential buyers might view and value your business, and how ready it is to undergo a due diligence process.
If there are only small ‘gaps’ between the current positioning of your business and what a buyer might find attractive, and if there is an attractive market for that type of business, then it is worth giving serious consideration to resolving these issues. You can then start the process of creating exit options to take advantage of the current Entrepreneurs’ Relief situation.
An important analysis will be to compare the net proceeds likely to be received if a sale is executed now, compared to waiting a few years. You will need to form your own opinion on the likelihood of Entrepreneurs’ Relief being scrapped, and take tax advice to ascertain the difference between ‘with ER’ and ‘without ER’ scenarios. You should also be taking a view on the potential impact of Brexit and the economic cycle on the value you might achieve now compared to what might be achieved in a few years’ time.
However, Martin stresses, if the audit establishes that the entrepreneur or the business are far from ready for a sale process, then the loss of the relief isn’t something they should be worrying about. He says: “In that scenario, you should be considering a longer-term exit horizon and start preparing for that.”
But there’s no need to exit your business altogether to take advantage of Entrepreneurs' Relief. Instead, selling part of the company to an investor can release some cash and reduce the risk posed by difficult trading conditions. This approach would also allow you to take advantage of the relief before any possible changes are made to the benefits it offers.
Entrepreneurs’ Relief is complex and it’s important to take professional advice before deciding on a course of action.
The levels and bases of taxation, and reliefs from taxation, can change at any time. Tax reliefs are dependent on individual circumstances.
Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place.