Tax legislation has a reputation for being cyclical in nature. New legislation emerges, tax services professionals identify areas that can be worked to their clients’ benefit and then the legislation is changed and it all begins again. And so it has proved for entrepreneur’s relief (ER).
In a recent explanatory note to clients, the tax services department of leading national accountants, Baker Tilly, have highlighted those areas that have been tightened up.
Just to recap, ER is the favourable capital gains tax rate of 10% designed to reward entrepreneurs when they eventually sell trading businesses that they have owned and nurtured over several years. Up to £10 million of qualifying gains can be partly sheltered by entrepreneurs in this way during the course of a lifetime provided.
The first major amendment to the rules came at the end of last year. It was decided that sole traders and partnerships which sold assets and goodwill to a company effectively owned by them could no longer claim ER on the goodwill element. However this has been altered again since to exclude any partner actually retiring. According to specialists in tax services, the incorporation route had been commonly used for many years as a tax planning tool since goodwill (real or illusory) could be sold to a new company and the proceeds recouped from a loan account over a period of years.
Most recently, in the last Budget, two or three further target areas were closed off. Continuing the theme of bearing down on what HMRC likes to call “contrived ownership structures”, tax services experts say that corporate members of a trading partnership or LLP will no longer qualify for ER unless they are trading in their own right. Corporate membership of partnerships had been popular for many years, and tax services professionals insist this was very often for sound commercial reasons. However the amendments to this rule, and those relating to mixed partnerships, might make many revise the wisdom of maintaining corporate membership in the future.
Another so-called contrived structure to be affected is the use of “management feeder” companies. We know that to qualify for ER, one needs to own over 5% of the trading business being sold and providers of tax services tell us that those who didn’t own this requisite 5% would often circumvent the problem by pooling their holding with others in a company established to hold a collective holding of over 5%. The joint venture rules that applied prior to 18th March 2015 meant that, as long as the individual held over 5% of the actual management feeder company, he or she would enjoy ER regardless of the fact that it wasn’t trading. Specialists in tax services point out that the rules have now been changed to ensure that this is no longer the case unless the management feeder company itself is a trading, as opposed to a pure investment, entity.
Tax services professionals also highlight the change to the associated disposal rules in ER. These now stipulate that anyone selling assets utilised in a trading company or partnership business will only enjoy ER when there is a sale of interest that amounts to 5% of more. It is imperative that the exact definition of a 5% interest is verified beforehand in each particular case.
Tax services experts have identified several client categories that these changes might adversely affect:
- Smaller businesses who operate as sole traders or partnerships but who wish to become owned within a corporate structure
- Partnerships and LLPs that are trading but have corporate members
Clearly, these organisations need to seek appropriate advice and anyone who needs clarification on entrepreneur’s relief and how recent changes might impact on them may wish to contact Baker Tilly’s specialist tax services team.