This is a comparatively new relief that applies only to disposals after 5th April 2008 (subject to some transitional rules for gains before this date that have been deferred).
It was introduced following the uproar from business owners after the 18% CGT rate was introduced in 2008.
Under the pre-2008 rules most owners of trading businesses or companies could qualify for an effective 10% rate of CGT when they sold up. The new 18% rate therefore represented an 80% increase in their tax bills when they sold their businesses.
To smooth the waters, the Government introduced Entrepreneurs Relief, which allowed you to still be taxed at an effective rate of 10% -- subject to a whole host of conditions being satisfied.
It's important to note that, because it's a potentially complex relief, obtaining detailed professional advice is essential.
So How Does this New Relief Work?
For disposals after 22 June 2010 the rates of CGT have changed and the maximum rate has increased from 18% to 28%.
However, in the June 2010 Budget the Chancellor of the Exchequer stated that, where capital gains qualify for Entrepreneurs Relief, the 10% rate of CGT will still apply.
Where Entrepreneurs Relief can be claimed it now simply reduces the tax rate to 10%.
For disposals between 6 April 2008 and 22 June 2010, Entrepreneurs Relief applies by reducing any capital gain by the fraction 4/9, which gives rise to a 10% effective rate of CGT.
Example
Jack owned shares in his unquoted trading company which he purchased for £10,000 on 1st May 2000. He sold them at the end of May 2010 for £180,000. Assuming he has already used up his annual capital gains tax exemption, his CGT calculation is as follows:
Proceeds = £180,000
Cost = £10,000 Entrepreneurs Relief (4/9ths of £170,000) = £75,555
Capital Gain = £94,445
In this case the CGT payable would be £17,000 (18% of £94,445) which equates to 10% of the £170,000 gain.
Where you have a disposal after 22 June 2010, capital gains that qualify for Entrepreneurs Relief are simply taxed at 10%. It is not necessary to reduce the gain by the fraction 4/9ths.
The new way Entrepreneurs Relief is applied reduces the value of the annual exemption slightly.
This is best illustrated with an example.
Example
Jack realises a capital gain of £90,000. The gain qualifies for Entrepreneurs Relief.
If the disposal was before 23 June 2010, the £90,000 gain would be reduced by 4/9ths to £50,000. The annual exemption of £10,100 would then be deducted and the capital gain of £39,900 would be taxed at 18%. The CGT payable would be £7,182.
If the disposal was after 22 June 2010 (but before 6 April 2011), the £10,100 annual exemption would be offset directly against the £90,000 capital gain.
The capital gain of £79,900 would then be taxed at 10% giving a CGT charge of £7,990. The new rules therefore increase the amount of CGT payable by over £800.
If the disposal had been on or after 6 April 2011 the position would be the same except for the fact the annual CGT exemption has now increased to £10,600. (In other words, the £90,000 capital gain would be reduced by £10,600 before being taxed at 10%, leading to a CGT charge of £7,940).
Lifetime Limit
There is a lifetime limit that applies for Entrepreneurs Relief purposes.
This was doubled in the March 2010 Budget and significantly increased again in the June 2010 Budget and the March 2011 Budget.
Therefore we now have four limits, depending on the date of disposal:
• For disposals before 6th April 2010 -- £1 million.
• From 6th April 2010 to 22nd June 2010 -- £2 million.
• From 23rd June 2010 to 5th April 2011 -- £5 million.
• From 6th April 2011 -- £10 million.
These limits are lifetime limits.
It should be noted that "old" limits still apply for disposals within their respective periods. So, for instance, the £1 million limit still applies for disposals in tax years 2008/2009 and 2009/2010. Similarly, the £2 million limit applies for disposals between 6th April 2010 and 22nd June 2010 and the £5 million limit applies for disposals between 23rd June 2010 and 5th April 2011.
So, if you made a sale in October 2010, £5 million of gains would have qualified for Entrepreneurs Relief. However, you will now have an additional £5 million of relief that can be utilised for disposals taking place from 6th April 2011.
It's important to note that the lifetime limit is per individual, so each shareholder can have up to £10 million of gains taxed at 10%. This raises some interesting tax planning opportunities which we'll look at in another article.
In order to obtain Entrepreneurs Relief you have to make a claim. If your gains exceed £10 million the excess will be taxed at 28%.
You have to keep track of gains that have qualified for Entrepreneurs Relief and deduct them from your £10 million allowance for future disposals.
Example
Steve sells the shares in his wholly owned trading company on 1 July 2011 and makes a capital gain of £10,500,000 (before Entrepreneurs Relief). He has not made any previous claims for Entrepreneurs Relief and therefore will be entitled to the full £10,000,000 lifetime allowance.
Based on the current guidance, the £10,000,000 gain will suffer a 10% rate of CGT, with the remaining £500,000 gain taxed at 28%.
Assuming his annual exemption has already been used for other gains, his CGT charge would then be £1,140,000.
Effective Tax Rates with Entrepreneurs Relief
Even if you exceed the £10,000,000 limit your overall effective tax rate will probably still be very low.
In the previous example, a gain of £10.5 million was realised and the CGT charge was £1,140,000.
This equates to an effective tax rate of just 10.86% which is still very low.
Entrepreneurs Relief can result in a very low effective tax rate even on large gains. For example, a £12 million gain is taxed at 13%. A £14 million gain would suffer an effective CGT rate of 15.14%.
How to Qualify for Entrepreneurs Relief
The conditions to qualify for Entrepreneurs Relief are pretty strict.
You will only obtain the relief if the company whose shares you are selling is your 'personal company'.
This means:
These tests need to be met for a period of one year immediately before the disposal. In most cases, provided your company is a trading company (we'll look at this shortly), these conditions will be met.
It's also worth bearing in mind that there is no requirement that you work full time for the company.
There are also provisions allowing relief where a company is wound up within three years of ceasing to trade.
Split Ownership
The fact that there is a £10 million lifetime allowance per person means that it may be advantageous to split ownership of the shares to maximize your tax savings.
Ideally any change to the ownership structure should be put in place well before any disposal.
You could, for example, ensure that you and your spouse or civil partner both make use of your Entrepreneurs Relief allowance.
On a wider level, children and other family members could also be used to hold shares to increase the total amount of Entrepreneurs Relief.
Crucially, they would need to hold more than 5% of the shares and also be officers or employees of the company. The fact that they don't need to be full-time employees makes this easier to achieve in practice.
As the company secretary and non-executive directors are both regarded as officers of the company, it should be relatively easy to satisfy the employment requirement.
Example
Harriet is setting up a new trading company, CheapasChips Ltd. She anticipates fast growth and splits the shares on incorporation between her husband, Ethan, and her sisters, Mae and Chloe. The total share capital is £100 and they each own 25%.
If she sells the company 15 years later for £40 million they would each realise a gain of around £10 million.
Each shareholder would therefore pay CGT of £1,000,000 (ignoring the annual CGT exemption), for a total tax bill of £4 million.
If the shares had not been split between the family members, Harriet would have suffered a CGT charge of:
Gain = £40 million Less: Entrepreneurs Relief = £10 million x 10% = £1 million Remaining Gain = £30 million x 28% = £8.4 million Total CGT = £9.4 million
The split ownership therefore produces a tax saving of £5.4 million.
Points to Watch For
If you're planning on this kind of strategy you should take detailed advice before you act.
Firstly, if you include your minor children as shareholders any income from the shares (over £100) would be taxed in your hands. In other words, when the company declares dividends you'll pay tax on your children's dividends.
Secondly, and in a similar vein, the Government may at some point look to introduce new income-shifting rules. Neither these, nor the rules for minors outlined above, would impact on the CGT position on disposal but they could result in dividends being taxed in your hands.
The income-shifting rules were planned to apply from 6th April 2008. They were then deferred until 2009 and have now been suspended completely. However, it's likely that some form of income-splitting legislation will be introduced at some point in the future.
There are also, of course, non-tax factors to consider. Splitting ownership of your company among family members could create problems (for example, if your children become divorced).
As stated above, this is a complex area and should be looked at in detail.
You will probably have noticed from this discussion that most disposals of shares in regular trading companies will qualify for
Entrepreneurs Relief. This means that for most business owners selling their company shares will be a very tax-efficient way of
increasing their wealth.
About the Author
The Author of this article is our site Editor, Lee Hadnum. Lee is a rarity among tax advisers having both legal and chartered accountant qualifications. After qualifying a prize winner in the Institute of Chartered Accountants exams, he also went on to become a chartered tax adviser (CTA).
He worked in Ernst & Youngs Entrepreneurial Services department for a number of years before setting up his own tax planning practice. He is now a full time tax author.
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