It is a ‘well known fact’ that when you sell your business you will only pay Capital Gains Tax at 10%.
This is the so called Entrepreneurs’ Relief. Unfortunately, like all well known facts, there is more to this story. The tax rules are complex, and not entirely logical, so let’s take a look at the areas where you might be at risk of paying tax at the full rate of 28%.
Probably the most important feature of the Entrepreneurs’ Relief is that it only applies to trading companies. Unfortunately, there is no definition of what constitutes a trade and the decisions of the courts over the past 160 years have not always been helpful.
In most cases it is clear that you have a trade if, for example, yours is a retail operation or a manufacturing business, so it’s perhaps easier to discuss what does not qualify for the relief.
In general terms, concerns such as property investment businesses or, indeed, any other business which relies solely on passive investment income, would be exempt. Cases on the margins would include enterprises such as caravan parks, which HMRC generally considers to be investment businesses, even where the owners carry out related activities, such as providing utilities or other facilities.
If you’re a sole trader or carry out your trade through a partnership, then when you sell your trade or the partnership rights you should qualify for Entrepreneurs’ Relief.
The situation gets more complicated, however, if you trade through a company.
To be eligible for the relief, firstly you must own at least 5% of the company’s ordinary shares and hold at least 5% of the voting power in the company. Secondly you must be an employee or officer (director) of the company, or of a company within the group, if you have more than one company. As long as these conditions have been satisfied for a full year immediately before the sale, selling the shares, or any proportion of them, you should qualify for the 10 per cent tax rate.
However, problems can arise in instances where employees receive shares that were not voting shares, or where the company is co-owned by both husband and wife but where the wife has never been a director or employee of the company.
Another pitfall can emerge when accepting a loan document rather than an immediate cash payment from the purchaser of your business. This type of “share exchange”, can lead to difficulties, as any cash you receive when you sell the shares may qualify for the Entrepreneurs’ Relief, but the later redemption of the loan notes will not – so you might end up paying tax at 28% every time you redeem a loan note.