What are the pitfalls to watch out for when claiming Entrepreneurs' relief? How can you avoid them?

This is day 4 of our Christmas Advent calendar as we analyse Christmas and tax and open a door to count down each working day until the Christmas holidays in the UK. 

Entrepreneurs’ Relief and selling a company

When you are selling shares in your company you should not assume that Entrepreneurs' Relief (ER)  applies simply because you hold more than 5% of the shares and are a company director. There are several pitfalls to look out for.

5% of what and for how long?

Prior to Budget 2018 you needed to hold 5% of ordinary share capital and voting rights for at least one year prior to the disposal for ER to apply.

From 29 October 2018 two changes apply and you must now hold:

  • Beneficial entitlement to at least 5% of the profits available for distribution to the equity holders of the company. 
  • At least 5% of the rights to assets in a winding up.

It is not yet clear how the requirement for an entitlement to 5% of the profits available for distribution will work where there are Alphabet shares and directors vote dividends to each share class on a discretionary basis. Until HMRC provide guidance on this advice should be taken before relying on ER where these types of shares are being sold.

From 6 April 2019 the one-year holding period is extended to two years. This also applies to the company's trading status (see below).

What can I do to make sure my shares qualify?

If you have shares with restricted or unusual rights you should review them; they may not currently qualify for relief.

  • The qualifying period clock will be restarted when the share rights change and you meet the 5% test.
  • Once you meet the test any other shares which fail the test still qualify; you do not need to do anything.

There are no transitional rules for the increase to two years (except where the company ceased trading by 29 October 2018);

  • If you will not have held your shares for two years on 6 April 2019 you must either sell before that date or wait. 
  • Consider Deferred consideration if a buyer will complete before April 2019 but does not have the funds in place.

Selling in stages

If you hold 5% of the share capital (and as above all parts of the test are met) ER can apply:

  • If you sell in stages only the first sale will qualify as this will take you below 5%.
  • Consider deferred consideration or Loan notes to ensure that the whole 5% is sold at once. 

Resigning as a director

You must be an officer or employee of the company throughout the requisite period (one or two years depending on the date of disposal.

  • You must not resign your position as director or employee until the share sale is complete or you risk jeopardising the relief.

Are you sure your company is a trading company?

The company must be a trading company or a member of a trading group throughout the one or two year period.

  • For ER the test is that non-trading or investment activities must not be more than 20%, looked at in the round.
    • This is different to business property relief (BPR) where only 50% of the business must be trading to qualify.
  • There are various factors to consider including:
    • Income from non-trading activities.
    • The asset base of the company.
    • Expenses incurred or time spent by officers and employees of the company.

Too much cash or investment property alone may not prevent a company from trading for ER but a combination of these and a decline in trading activity may tip the balance into non-trading status.

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