TXF6 UK
Syllabus C. Chargable Gains For Individuals C5. Entrepreneur's relief

C5b. Entrepreneur's relief

Syllabus C5b)

Explain and apply entrepreneurs’ relief.

Entrepreneurs’ relief

covers the first £10,000,000 of qualifying chargeable gains that a person makes in their lifetime.

  • It operates by charging CGT at 10% for the disposals on which it is claimed regardless of an individual’s taxable income.

Conditions to get the relief:

  1. The asset must have been owned for at least one year prior to the disposal.

  2. The election for the relief must be made by the anniversary of the 31/01 following the tax year of the disposal. 

    Therefore, if the tax year of disposal is 18/19, then the election must be made by 31/01/21.

    (It is not the 31/01 immediately after the tax year, it is the one following the tax year of the disposal.)

  3. It must be a disposal of a qualifying asset.

Qualifying assets include:

  1. The disposal of a whole business run by a sole trader or by partners in a partnership. 

    The assets must have been used in the trade to qualify for the relief. 

    Also, the entire business must be disposed of, if a single trading asset is disposed of it, it will not qualify for the relief.

  2. Individual business assets of the individual’s or partnership’s trading business that has now ceased. 

    Note the disposal of assets must take place within three years of cessation of trade. 

    The difference here is that the entire business is not being sold, it is being shut down. 

    Therefore, no trading activity will continue and this is why the assets can be disposed of within 3 years of cessation

  3. The disposal of shares in a trading company, where the individual has 5% shareholding and is also an employee of the company, for 12 months prior to the disposal. 

    Entrepreneurs’ relief will be available on the entire disposal, regardless of whether the trading company owns assets for investment or not.

Illustration

On 14 October 2018, a shareholder of Numbers Ltd, an unquoted trading company, sold his entire shareholding in the company.

He had been the advertising director of Numbers Ltd since the company’s incorporation on 1 December 2017.

He had 40% shares in the company since its 1 December 2017.

Will this disposal qualify for entrepreneurs’ relief?

Solution

This disposal will not qualify for entrepreneurs’ relief because:

  • The shares were owned for less than one year.

Illustration:

Sunder disposed of his business to an unconnected person. The business he had the following asset values:

  • Goodwill £150,000

    Freehold office £200,000

    Inventory stock £20,000

    Debtors £30,000

    Investment property   £100,000

    Cash £50,000

  • Which of the assets will qualify for entrepreneur’s relief on disposal of the entire business?

Solution:

The investment property does not qualify for entrepreneur's relief as only assets that are used in the trade can qualify. 

An investment property is just held for investment, not used in the trade.

Asset Market Values Capital gains tax treatment
Goodwill £150,000  Entrepreneurs’ relief available. Taxed at 10%
Freehold office £200,000  Entrepreneurs’ relief available. Taxed at 10%
Inventory stock £20,000 Exempt
Debtors   £30,000 Exempt
Cash £50,000 Exempt
Investment property £100,000 Taxed normally at 10% or 20%.

Illustration:

In March 2019, Sunder also disposed of a 20% shareholding in Cow Ltd.

He had been an employee of Cow Ltd. since June 2017, when he acquired the shares.

The gain arising on disposal was £200,000.

  • Will this gain be eligible for entrepreneurs’ relief?

Solution:

Yes it will be. 

This is because he has owned the shares and worked in the company for more than one year.

Illustration

On 30 October 2018, Bhumi sold a business that she had run as a sole trader since 1 February 2011 to an unconnected person. The disposal resulted in the following chargeable gains:

£
Goodwill 150,000
Freehold office building 400,000
Freehold warehouse 180,000
730,000

The warehouse had never been used by Bhumi for business purposes.

Bhumi has taxable income of £6,000 for the tax year 2018–19.

She has unused capital losses of £30,000 brought forward from the tax year 2017–18.

What is Bhumi's capital gains tax liability for the year?

Solution

Gains qualifying for entrepreneurs’ relief £
Goodwill 150,000
Freehold office building 400,000
550,000
Other gains
Freehold warehouse           180,000
Capital losses brought forward (30,000)
150,000
Annual exempt amount (11,700)
138,300
Capital gains tax:
550,000 at 10%
55,000
138,300 at 20% 27,660
Tax liability 82,660
 

Explanation

  • The capital losses and the annual exemption is set against the gains that do not qualify for entrepreneur’s relief. 

    This is because it saves more tax to set the losses and exemptions against gains that are taxed at a higher rate of 20%.

  • £28,500 (34,500 – 6,000) of Bhumi's basic rate tax band is unused, but this remaining band limit is first set against the gains qualifying for entrepreneurs’ relief of £550,000 even though this has no effect on the 10% tax rate. 

    If there is any basic rate band remaining, then it will be used for gains that do not qualify for entrepreneurs’ relief.

Things to note:

  • a) Gains that qualify for entrepreneurs’ relief will take priority in using up the basic rate band limit first. 

    Therefore, it is likely that other capital gains will normally fall into the higher band and pay CGT at 20%.

  • b) The annual exemption and relief for losses is not automatically given to the gains which qualify for entrepreneur’s relief. 

    Therefore 2 separate calculations should be made and gains which do not qualify should be given the annual exemption and losses carried forward first, in order to save CGT at a higher rate.