Judging by the number of calls I’m receiving on this issue, changes to entrepreneurs’ relief are continuing to cause much confusion, with many shareholders unsure as to whether their transaction still qualifies.
Before former Chancellor Philip Hammond moved the goal posts last year, the situation was quite straightforward. Most people with shares in a trading company could expect to pay capital gains tax at the much more palatable rate of 10% rather than 20% when they sold their shares.
To be eligible they simply had to show that their shares were in a company that traded (i.e. not in an investment business), they were an officer or employee of that company and they held at least 5% of the shares (giving them at least 5% of the voting rights), all for at least a year before the sale.
But, in the 2018 Autumn Budget, a new “test” of what defines “personal company” was announced, with shareholders now needing to have the right to 5% or more of the dividends as well as to 5% or more of the proceeds if the company is wound up or, alternatively, to 5% of the proceeds if it is sold. And all the qualifying tests must now be satisfied for two years, not one.
Some worried business owners are unsure whether their transaction qualifies for capital gains tax at all. Their concerns relate to the anti-Phoenix rules which affect people who wind up their company but then carry on the same or similar business either in another company or in some other form. In such cases the proceeds of the winding up might be treated as income from dividends, not as a capital gain, so the business owner pays tax at up to 38.1%, the highest rate of income tax on dividends.
This scenario is most likely to apply where somebody has sold the trade from the company, or simply run the trade down, and is now winding up the company to get the proceeds out. Because of the uncertainty introduced by the new rules, I am frequently asked to write reports on whether those rules will apply.
To guarantee receiving entrepreneurs’ relief, some people have started selling their company when it is no longer trading. In response to this practice, HMRC has recently published its Spotlight 47 guidance (https://www.gov.uk/guidance/attempts-to-avoid-an-income-tax-charge-when-a-company-is-wound-up-spotlight-47), which suggests that some of these arrangements might be sufficiently artificial or contrived for HMRC to apply the wide ranging general anti-abuse rule (GAAR).
To be frank, my personal view is that HMRC is being ridiculous here. While there may be some extreme cases that might be caught, I would not expect a sale of a money-box company that has ceased to trade to be caught by the anti-Phoenix rule, far less by the GAAR. This is just scare-mongering and I do not consider it acceptable behaviour from a public authority!
This issue – and my thoughts on it – are covered in my recent article in Taxation magazine: https://www.taxation.co.uk/Articles/why-selling-a-company-is-not-tax-avoidance
Another common issue on which I’m increasingly being asked to advise relates to whether a company is a trading company. Defining a company’s status can be a problem for businesses that have accumulated large amounts of cash which they haven’t distributed to shareholders, or where profits have been used to buy investment properties, as investment activities are not trading activities. I do not generally believe that large cash holdings should cause a problem, although I have had to argue the point with HMRC a couple of times (successfully, of course!) And a large and active investment portfolio certainly could taint the status of the company so that it no longer qualifies as a trading company and its shareholders would not, therefore, be entitled to entrepreneurs’ relief.
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