Yet that is the capital gains tax rate under entrepreneurs’ relief. It was greatly criticised in the national press a couple of years ago for being less than the cleaner’s tax rate but even so it has survived the media onslaught and continues to this very day.
Entrepreneurs’ Relief Increased
In fact, the June 2010 Budget extended it to cover a much larger amount of capital gains. They increased the limit to £5 million with effect from 23 June 2010. This is, therefore, a relief well worth preserving if you have the chance to benefit from it but you must plan ahead well before a sale to ensure that you do not lose out. Some important points to watch are mentioned below.
What and Who Does it Apply To?
Entrepreneurs’ relief can apply to the sale of an unincorporated business but in the context of this article I am considering the disposal of shares in a trading company. It applies to those who have 5% or more of the ordinary share capital and voting rights in the company and are employees of it. Employees include directors, non-executive directors, a company secretary, and part-time staff.
Anyone hoping to benefit from entrepreneurs’ relief on a sale of shares in a company therefore needs to ensure that they have some form of employment with the company.
The relief can also apply to an asset, commonly a property, which is privately owned but is used by the company. But once again you must be careful. If the company pays full rent for the use of the asset, all relief will be lost in respect of that asset when the time comes to sell – it will be an investment asset and therefore outside the scope of entrepreneurs’ relief.
What If I Want to Sell?
Long before the time comes to sell the company, you need to be sure that it does not have any significant level of investment assets. HMRC regards a 20% level as significant based on a number of different tests. However, those with family companies do need to take advice at an early stage in order not to fall foul of the 20% test.
All sorts of deals are struck on the sale of shares in a trading company. There might be an immediate outright cash payment; that presents no particular difficulty for entrepreneurs’ relief. Very often, however, the purchaser will offer its own shares or loan notes together with a lower cash payment.
Usually when shares or loan notes are issued in exchange for the shares of another company, no capital gain arises at that stage but the old base cost of original shares is carried forward as the acquisition cost of the shares or loan notes received. The only exception to this rule is where the new loan notes are ‘qualifying corporate bonds’; with these the gain is realised on the exchange of the original shares, but the tax is not actually payable until the bonds are disposed of.
Following the June 2010 Budget, whenever shares are sold wholly or partly in exchange for shares in the purchaser or any kind of loan notes in the purchaser, including qualifying corporate bonds, an election should be made at that stage to pay the 10% entrepreneurs’ relief rate on the gain on the shares being sold. If this election is not made, entrepreneurs’ relief may be lost for the future when the shares or loan notes received in exchange are eventually disposed of. Relief on the securities received would all depend upon whether the conditions for entrepreneurs’ relief are satisfied on the eventual disposal of those shares or loan notes. Will you have 5% of the ordinary shares in the new company plus an employment with it?
There are many complications in this area and I have only given a brief outline of them here. In most cases, the best thing to do is to make sure that the purchaser offers some cash payment so that you can pay the 10% tax rate at the time of the takeover and not worry about whether it will be irretrievably lost after the takeover has gone through.
By Malcolm Gunn