Entrepreneurs’ Relief – Dodging the Pitfalls

Entrepreneurs’ Relief – Dodging the Pitfalls
Does the business qualify?

Surely if you’re running a business you’re an entrepreneur, so why wouldn’t you get entrepreneurs’ relief? The answer is that, although HMRC may talk of a ‘business’, the tax legislation (TCGA 1992, s 169S) defines a business as a ‘trade, profession or vocation’ carried on with a view to profit. The key word there is ‘trade’, which excludes activities that depend on exploiting assets as investments. 

What this primarily hits is property letting. Property development is accepted as a trade, but letting is not unless it falls within the specific category of furnished holiday letting.

Property developers take care

Many developers rent out properties that they have developed but cannot sell. So long as you have always intended to sell the property and make sure that it is still held as stock in your accounts the business should still qualify for entrepreneurs’ relief. The fact that property is rented may not prevent entrepreneurs’ relief applying to the business. 

The catch here is that profits on property held as stock will be taxed as trading income when they are sold. This means that a shareholder in a property development company can sell shares and get entrepreneurs’ relief if the tests of 5% ownership and employment for one year are met, but a sole trader or partner who sells the properties, even on a cessation that qualifies for entrepreneurs’ relief, will end up paying income tax instead of CGT on the profits on sale of the properties.

Property developers, incorporate your business

Transferring a property development business to a company means that if the business is sold the whole sale should obtain entrepreneurs’ relief. Transferring an established business to a company can be costly in stamp duty land tax and even income tax, whereas a business that was started as a company or transferred early can avoid those costs. Another advantage to using a company for property development is the difference in tax rates: 20% or 23% corporation tax rather than income tax at up to 45% on significant profits even if they are reinvested in further properties.

Entrepreneurs’ relief applies to businesses, not assets

Selling part of a business should attract entrepreneurs’ relief, but be careful what you are selling. 

Example - Arkwright gets it wrong

Arkwright owns two convenience stores in different areas and wants to sell one. One would–be buyer only wants the premises and offers more, giving a gain of £100,000; the other wants to continue the shop and his offer gives a gain of £90,000.

Arkwright takes the bigger offer but cannot claim entrepreneurs’ relief because all he has sold is a shop, a single asset without a business, and because he still owns and runs the other shop he cannot claim entrepreneurs’ relief on the basis of a business cessation either. As a result, assuming he’s used his annual exemption against other gains, Arkwright pays 28% CGT on a gain of £100,000, which is £28,000, and ends up with £72,000 net whereas if he’d accepted the lower offer he would have been able to sell the shop as a going concern, i.e. part of his business, paying only 10% CGT and netting £81,000.

Practical Tip : 

Changing ownership can bring entrepreneurs’ relief for asset sales. Arkwright might have been able to get the best of both worlds by doing one of two things. If he’d transferred the continuing business to a company he would have ceased to own the business personally.  Similarly, if he transferred a share in the business to his wife, that would enable him to claim entrepreneurs’ relief on selling the unwanted shop, even if not as a going concern.

Chris Williams