An overview of Entrepreneurs Relief
Business Asset Disposal Relief (BADR), formerly known as Entrepreneurs' Relief, is a valuable tax relief available to individuals disposing of all or part of their business. This relief allows eligible individuals to pay a reduced rate of Capital Gains Tax (CGT) on qualifying business disposals. The aim is to encourage entrepreneurship by making it more financially attractive for business owners to sell their businesses or business assets.
Under BADR, the Capital Gains Tax rate is reduced to 10% on qualifying gains, compared to the standard CGT rates of 10% or 20%, depending on the individual's income level. The relief applies to a lifetime limit of £1 million of qualifying gains. This means that the total gains eligible for the 10% tax rate under BADR can be up to £1 million throughout the individual's lifetime. Any gains exceeding this limit will be taxed at the standard CGT rates.
Eligibility Criteria for BADR
To benefit from BADR, certain conditions must be met. These include:
1. Qualifying Business Asset:
The asset must be part of a trading business, not an investment business.
Qualifying assets include shares in a personal company, assets used in a business at the time of disposal, and certain shares acquired under the Enterprise Management Incentive (EMI) scheme.
2. Ownership and Employment:
The individual must have owned the asset for at least two years.
For shares, the individual must have been an officer or employee of the company and have at least 5% of the company’s shares and voting rights.
3. Personal Company Definition:
A personal company is one in which the individual holds at least 5% of the company’s ordinary share capital and voting rights, and is entitled to at least 5% of the distributable profits and net assets.
Calculating the Relief
When eligible for BADR, the Capital Gains Tax rate on qualifying disposals is reduced to 10%, compared to the standard rates of 10% or 20% (depending on the income level). The lifetime limit for BADR is £1 million of qualifying gains.
Example Calculation:
1. Scenario:
An individual sells their entire shareholding in a personal company for £2 million.
The cost of the shares was £500,000.
The individual has no other gains or reliefs.
2. Calculation:
Total Gain: £2,000,000 - £500,000 = £1,500,000
Qualifying for BADR: The gain is within the £1 million lifetime limit.
Tax Due: 10% of £1,000,000 (BADR limit) = £100,000
Remaining Gain: £1,500,000 - £1,000,000 = £500,000 (taxed at the standard rate, assuming 20%)
Tax on Remaining Gain: 20% of £500,000 = £100,000
Total CGT: £100,000 (BADR) + £100,000 (standard rate) = £200,000
Detailed Requirements for BADR
1. Ownership Period:
The minimum ownership period is two years for all assets disposed of on or after 6 April 2019. For disposals made before this date, the period was one year.
2. Employment Condition:
The individual must have been an officer or employee of the company or group at the time of the disposal or during the qualifying ownership period.
3. Company Requirements:
The company must be a trading company, not engaged in non-trading activities to a substantial extent (generally accepted as more than 20%).
4. Associated Disposals:
If an individual disposes of an asset used in the business when they retire or reduce their participation in the business, they may qualify for BADR.
Changes from Entrepreneurs' Relief to BADR
1. Name Change:
The rebranding from Entrepreneurs' Relief to Business Asset Disposal Relief occurred in the 2020 Budget, reflecting a shift in focus.
2. Lifetime Limit Reduction:
The lifetime limit was reduced from £10 million to £1 million. This change applies to qualifying disposals made on or after 11 March 2020.
Practical Considerations
1. Planning the Disposal:
To maximise the benefit of BADR, careful planning is essential. This includes timing the sale, understanding the ownership period, and ensuring the business qualifies as a trading company.
2. Record-Keeping:
Maintain detailed records of the acquisition, ownership, and disposal of assets to substantiate claims for BADR. This includes employment records, company shareholding details, and any changes in the business structure.
3. Professional Advice:
Given the complexities involved, seeking professional advice from a tax advisor or accountant is crucial. They can help navigate the requirements and ensure all criteria are met to claim BADR.
Common Pitfalls and How to Avoid Them
1. Non-Qualifying Shares:
Ensure the shares disposed of meet the definition of qualifying shares. Shares in investment companies or companies that do not meet the trading criteria will not qualify.
2. Insufficient Ownership Period:
Be mindful of the two-year ownership rule. Disposing of assets too soon can result in losing the relief.
3. Changes in Legislation:
Stay updated with any changes in tax legislation that may affect eligibility for BADR. Changes can impact the lifetime limit, qualifying conditions, and tax rates.
Conclusion
Business Asset Disposal Relief offers significant tax savings for business owners planning to sell their business or business assets. Understanding the eligibility criteria, planning the disposal, and maintaining accurate records are crucial to maximising this relief. By doing so, business owners can ensure they take full advantage of this valuable tax relief, making their entrepreneurial ventures more rewarding.