The government is keen to encourage entrepreneurs to create wealth and employment, and it has repeatedly used the tax system to try to do so. All the focus is now on Entrepreneurs’ Relief but before that it was on retirement relief, and business taper relief. Entrepreneurs’ Relief began its life as a relatively minor effort – a maximum of £80,000 of tax saving for an individual over a lifetime – much much less attractive than it is now.
The relief is now much more attractive and it would seem that every entrepreneur believes that when you sell your business you will only pay Capital Gains Tax at 10%. Which of course means that most people are assuming they’ll qualify for Entrepreneurs’ Relief. Alas its not quite so simple. The tax rules are complex, and if you get it wrong you’ll pay the full rate of 28%.
There are quite a few ways in which it can go wrong. Entrepreneurs’ Relief only applies to trading companies but alas there is no definition of what constitutes a trade and court decisions over the past 160 years are not altogether helpful.
In many businesses its pretty clear that there is a trade. So what doesn’t qualify for the relief? Generally speaking property investment businesses or other business relying on passive investment income, would be exempt. Less clear cut would be businesses such as caravan parks, which the tax man generally considers to be investment businesses, even where the owners carry out related activities, such as providing utilities or other facilities. So before you go ahead and appoint an M&A advisor to help you to sell your business give thought to the trading status of your company.
If you’re a sole trader or partnership you should qualify for Entrepreneurs’ Relief, but its more complicated if you trade through a company. 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 of the company. And you must satisfy these conditions for a full year immediately before a sale of the company. I've often met people who had sufficient shares to qualify but hadn't met the officer or employee criteria for a full year. That's fine if you have time to plan, but if a strategic buyer knocks on your door with a great offer you may not have the time for that.
Where it can also start to go wrong is situations where employees get non voting shares, or where husband and wife own the company but one spouse has never been a director or employee of the company.
There can also be problems associated with the type of deal you do with the purchaser of your business. If you were to provide some Vendor Finance for the deal, ie you accepted a loan document rather than an immediate cash payment from the purchaser of your business, such a “share exchange” can be problematical. If you go down this route the upfront cash you get when you sell may qualify for the Entrepreneurs’ Relief but the later loan note redemptions will not – so you might end up paying tax at 28% every time you redeem a loan note.
The key, as ever with tax, is to plan ahead. And of course if you do have some of the issues above such as husband and wife ownership, skewed voting rights, or issues around the trading status - there are always planning options.