Category: Closing a business

Tax is always changing, and entrepreneur’s relief is no exception. The £10 million lifetime limit is to be reduced to £1m for disposals on or after 11 March 2020 – read the latest update here.

ER but not as we know it

The Spring Budget 2020 announced a significant restriction on future availability of entrepreneurs’ relief (ER) for individuals who dispose of all or part of their business, individuals who dispose of shares in their personal company, and trustees who dispose of business assets.

 

Broadly, the lifetime limit of £10m is to be reduced to £1m for disposals on or after 11 March 2020. The measure also provides that the lifetime limit must take into account the value of ER claimed in respect of qualifying gains in the past. The relevant legislation is included in Finance Bill 2019-21, so is currently subject to enactment.

 

Qualifying gains within the lifetime allowance are charged at the rate of 10%. Gains in excess of this limit are charged at the rate of 20% rate. For disposals between 6 April 2011 and 10 March 2020, the lifetime limit on gains qualifying for ER is £10 million. The £10 million limit is a lifetime threshold and claims may be made against it on more than one occasion. Finance Bill 2019-21 also includes provisions to rename ER as ‘business asset disposal relief’ from 2020-21 onwards.

 

Selling all or part of a business

To qualify for business asset disposals relief, both of the following must apply:

  • the individual must be a sole trader or business partner
  • the individual must have owned the business for at least two years before the date they sell it

The same conditions apply if the business is closing rather than being sold. The business assets must be disposed of within three years to qualify for relief.

 

Selling shares or securities

To qualify, both of the following must apply for at least two years before the shares are sold:

  • the individual is an employee or office holder of the company (or one in the same group)
  • the company’s main activities are in trading (rather than non-trading activities like investment) or it’s the holding company of a trading group.

 

There are other rules depending on whether or not the shares are from an Enterprise Management Incentive (EMI). Broadly, if the shares are from an EMI, the investor must have both:

  • bought the shares after 5 April 2013
  • been given the option to buy them at least one year before selling them

 

If the shares are not from an EMI, for at least two years before the shares are sold, the business must be a “personal company”. This means that the investor has at least 5% of both the shares and the voting rights in the company. The investor must also be entitled to at least 5% of either:

  • profits that are available for distribution and assets on winding up the company
  • disposal proceeds if the company is sold

 

If the number of shares held falls below 5% because the company has issued more shares, the investor may still be able to claim business asset disposals relief. The investor should elect to be treated as if they had sold and re-bought the shares immediately before the new shares were issued. This will create a gain on which ER can be claimed.

 

The investor can also elect to postpone paying tax on that gain until they come to sell the shares. This is usually done via the self-assessment tax return. If the company stops being a trading company, ER can still be claimed if the shares are sold within three years.

 

Selling assets previously lent to the business

To qualify, both of the following must apply:

  • the investor sold at least 5% of their part of a business partnership or their shares in a personal company
  • they owned the assets but let their business partnership or personal company use them for at least one year up to the date they sold the business or shares – or the date the business closed.

 

Partner Note:  TCGA 1992, ss 169H to 169V; Finance Bill 2019-21, cl. 22 and Sch 2

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Closing a business can be a difficult time. Be tax efficient with this beneficial liquidation strategy.

Closing a business – when a member’s voluntary liquidation is beneficial

Although it is possible to strike off a company and for distributions made prior to dissolution to be treated as capital rather than as a dividend, this is not an option where the amount of the distributions exceeds £25,000.

Where the taxpayer’s personal circumstances are such that it is beneficial for the remaining funds to be taxed as capital (and liable to capital gains tax), rather than as a dividend, a member’s voluntary liquidation (MVL) can be an attractive option, as depending upon the level of funds to be extracted the costs of the liquidation may be more than covered by the tax savings that can be achieved.

What is an MVL?

An MVL is a process that allows the shareholders to put the company into liquidation. This route is only an option if the company is solvent (i.e. its assets are greater than its liabilities). The directors must sign a declaration of solvency confirming that the company is able to pay its debts in full within the next 12 months and 75% of the members must agree to place the company into liquidation. The shareholders must pass a special resolution to wind up the company. They will also need to pass an ordinary resolution to appoint liquidators. The liquidator must be a licenced insolvency practitioner.

What are the tax implications?

Under an MVL the capital extracted from the company is treated as a capital distribution and is liable to capital gains tax, rather than being taxed as a dividend. Where entrepreneurs’ relief is in point, the rate of tax will only be 10%, assuming enough of the entrepreneurs’ relief lifetime limit remains available. If significant funds are available for distribution, this can generate considerable tax savings.

Example

Edward and Oliver are directors of a company in which they both own 50% of the shares and 50% of the voting rights. Each is entitled to 50% of the profits available for distribution and 50% of the assets on a winding up.

They wish to wind the company up, but as they have cash and assets of £10 million to distribute, they opt for an MVL, to allow them to take advantage of the capital gains tax treatment. Both are additional rate taxpayers, and both meet the qualifying conditions for entrepreneurs’ relief.

Edward and Oliver each receive £5 million on the winding up of the company. They both have the full amount of the entrepreneurs’ relief lifetime limit (£10 million) unused, and it is assumed for simplicity that the annual exempt amount has been used elsewhere. The gain is therefore taxed at 10% and each will pay tax of £500,000 on their distribution of £5 million.

Had they not opted for an MVL and the extracted funds taxed as a dividend, they would have each paid £1,905,000 in tax on the £5 million distribution (£5m @ 38.1%).

Anti-avoidance

Anti-avoidance provisions apply which are designed to target ‘moneyboxing’ (where the company retains more funds than it needs in order to extract them as capital when the company is liquidated) and ‘pheonixism’ (where the company is liquidated, the value extracted as capital and a new company is set up to carry on what is essentially the same business). Liquidation distributions which are caught by the rules are treated as income rather than capital.

Partner note: Insolvency Act 1986, Pt. IV, Ch. III.

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