Last week, I looked at some of the fundamentals of entrepreneurs’ relief and the main qualifying conditions.
This week, I would like to continue with a case study that might help to put some of those rules into context, especially in relation to the cumulative nature of the entrepreneurs’ relief limit. It is taken from our Techlink Professional Library.
Y is a higher-rate taxpayer and a serial entrepreneur. He used £1m of his lifetime entrepreneurs’ relief limit in relation to a disposal in 2009.
In July 2010, Y realised a chargeable gain of £6m on the disposal of a business. In December 2011, Y sells another business, realising further chargeable gains of £7m.
Both disposals qualify for entrepreneurs’ relief (subject to the lifetime limits). Y has no allowable losses to set against these gains, and has fully used his annual capital gains tax exemption on other gains.
The £6m gain realised in July 2010 is subject to the £5m lifetime limit for entrepreneurs’ relief (for qualifying disposals from June 23, 2010), of which Y has previously used £1m. A total of £4m (£5m – £1m) of the gain is fully within the overall limit of £5m and is charged to CGT at the single rate of 10 per cent. The balance of £2m is charged at 28 per cent.
The increase in the lifetime limit to £10m from April 6, 2011 means £5m of the £7m gain from December 2011 is chargeable at the 10 per cent rate of CGT, so the remaining £2m of chargeable gains are charged at the higher rate of 28 per cent.
Having looked at the cumulative nature of the relief, let us now take a look at how the rules apply to determine which individuals would qualify for the relief.
Entrepreneurs’ relief is available where there has been a qualifying business disposal, which occurs when there is a material disposal of business assets.
HM Revenue amp; Customs has indicated it will apply the old CGT retirement relief principles (TCGA 1992 ss163-164) to entrepreneurs’ relief with regard to material disposals. This means a disposal of business assets occurs when there is:
- a disposal of the whole or part of a business (this is more than a disposal of assets used in a business; it requires the disposal to be of all of a business or a clearly identifiable part of it); or
- a disposal of assets, or of interests in such assets, which were used for the purposes of a business that has now ceased, provided they were in use for those purposes at the time of cessation; or
- a disposal of shares in or securities of a company, or of an interest in such shares or securities.
Each of the three types of disposal described above constitutes a material disposal when:
(i) In the case of a disposal of the whole or part of a business, the business is owned by the individual making the disposal throughout the period of one year ending with the date of the disposal.
(ii) In the case of a disposal of assets, or of interests in such assets, used for the purposes of a business that has now ceased:
– the assets were in use for those purposes at the time of cessation;
– the business was owned by the individual making the disposal for a period of one year immediately prior to the cessation of the business; and
– the disposal takes place within three years of that cessation.
In the case of a disposal of shares in or securities of a company, or of an interest in such shares or securities, either of the following conditions are met:
1) that throughout the period of one year ending with the disposal:
– the company was the individual’s ’personal company’ (see below);
– the company was a trading company or the holding company of a trading group; and
– the individual was an officer or employee of the company or of one or more companies that are members of the group.
2) that where the company has, within the three years immediately preceding the disposal, ceased to be either a trading company or a member of a trading group, relief is available if condition 1) above was satisfied throughout the period of one year immediately preceding that cessation.
This does not apply where the company ceases to be a trading company but becomes a member of a trading group, or vice versa.
Entrepreneurs’ relief is also available where the individual carries on business as a member of a partnership. The legislation provides that:
- where an individual who carries on a business as a sole trader and then takes on a partner or partners in that business, any disposals of his interests in the business assets which he contributes to the partnership can be treated as disposals of a part of the business;
- where an individual, who carries on business as a member of a partnership, disposes of all or part of his interest in the assets of the partnership that disposal can be treated as a disposal of the whole or part of the partnership business; and
- each individual who is a partner in a business at any time is treated as owning the business carried on at that time by the partnership.
For sole traders and partners, the above means the individual must own the business or be a member of a partnership that owns the business.
For shares and securities in a trading company that company will be the owner’s personal company if the individual is an officer or employee of the company and owns at least 5 per cent of the ordinary share capital and 5 per cent of the voting rights.