How to protect your entitlement to entrepreneurs' relief
The lifetime limit on gains qualifying for entrepreneurs' relief was doubled from £5 million to £10 million with effect from 6 April 2011. This relief, now worth a maximum saving of £1.8 million per person, is extremely valuable. But, given the minimum 12-month qualifying period before a sale, it may take careful planning not to lose out.
Shares and securities
To qualify for entrepreneurs' relief you must be an officer or employee of the company in question but there is no minimum working hours requirement. As long as the employment has commercial substance, it will qualify. Non-executive directors and company secretaries qualify as officers or employees of the company for the purposes of entrepreneurs' relief.
Where shareholders own at least 5% of the share capital and voting rights but are not officers or employees of the company, it may be worth appointing them as such to enable them to qualify for the relief.
If a sale is imminent and a married couple holds shares in a company where one spouse will qualify for the relief and the other will not, they should consider a transfer of shares between spouses before the disposal.
Splitting shareholdings between family members may also provide an opportunity for a second £10 million lifetime allowance, providing the recipient also satisfies the conditions for relief.
Trading status
The company must be a trading company - any 'non-trading' activities must not be 'substantial'. You may want to consider restructuring the business to separate the non-trading and trading activities, or minimising non-trading activities in the final 12 months of ownership. If the company meets the trading conditions for entrepreneurs' relief, the shareholders will also qualify for other favourable CGT reliefs.
If the company has ceased to trade, the shareholders have three years from that date to effect a disposal and still qualify for entrepreneurs' relief.
Share capital
It's a good idea to carry out a fresh review of your entitlement to entrepreneurs' relief whenever the company's issued share capital increases or decreases. Be careful where share options are involved, as any future increase in share capital will dilute interests and could unknowingly compromise a shareholder's entitlement to relief.
Where a share option scheme exists, employees will often exercise their options immediately before a sale. But as they will not have held the shares for the minimum holding period of 12 months, they won't qualify for entrepreneurs' relief - even though they may hold 5% and be officers or employees of the company.
Deferred consideration
Often the sale of a company is structured in such a way that part of the consideration is deferred - either as a fixed sum agreed at the outset, or as an amount dependent on the future performance of the business. In the case of deferred consideration, loan notes are often issued to defer the CGT liability arising on the sale until the loan notes themselves are redeemed.
But beware; it's unlikely that the individual will satisfy the entrepreneurs' relief conditions in relation to the loan notes, so there's a danger of losing the right to entrepreneurs' relief on the sale. This situation can be avoided by disapplying the share reorganisation provisions and accepting a CGT charge at the time of the sale. This will preserve the relief but will mean the tax liability is paid earlier.
Link with other CGT deferral reliefs
Gains deferred in Enterprise Investment Scheme (EIS) shares will now only qualify for relief when the gain ultimately crystallises if the conditions are satisfied in relation to the EIS shares themselves.
Previously entrepreneurs' relief was calculated by reducing the qualifying capital gains that are chargeable to tax by 4/9ths. Now it is based on the net gains at a rate of 10%. This means that any gains previously deferred are now unlikely to benefit from the relief.
Personal assets used in a business
Assets owned personally by a shareholder, but used by the company, will generally qualify for entrepreneurs' relief under the associated disposal provisions. This relief can be lost if any rent has been charged in relation to the asset since 6 April 2008.
Entrepreneurs' relief and trusts
Entrepreneurs' relief is not available where shares, otherwise qualifying for the relief, are held on discretionary trust. The loss of the relief must therefore be weighed up against the benefits offered by these structures.
In the case of life interests, entrepreneurs' relief is available only if it is the beneficiary's personal company and he or she is also an officer or employee. This may mean advancing a sufficient number of shares to the life tenant to ensure these conditions are met.
For offshore trusts, if gains that would otherwise qualify for relief under the normal conditions are attributed to the settlor, entrepreneurs' relief should still be available. Deemed gains assessable on the beneficiary will, however, not be entitled to relief.
In conclusion
All this demonstrates the complexity of qualifying for entrepreneurs' relief - and the importance of planning well in advance of a sale so as not to miss out.
For further information and advice, please contact personal tax manager Zoe Hidden on 020 7516 2298 or by email zhidden@littlejohnllp.com
