Entrepreneurs’ Relief – The New Anti-Avoidance Rules

Of all the tax reliefs available to business, entrepreneurs’ relief (ER) has proved to be one of the more expensive for any government. A relief that had been expected to cost the Treasury £900 million in 2013/14 has instead cost £2.9 billion (National Audit Office). 

In the 2014 autumn statement, the Chancellor of the Exchequer announced a ‘strengthening’ of the relief, by which he meant the introduction of specific anti-avoidance rules in an effort to at least partly reduce the cost of providing the relief. 

ER was introduced from 6 April 2008 (by FA2008, s 7, Sch 3). The legislation can be found in TCGA 1992 (at ss 169H-169S). The relief from capital gains tax (CGT) is available for gains realised by individuals and trustees of certain settlements on the disposal of qualifying business assets. Gains which fall within the lifetime limit (currently £10 million) are taxed at 10% after deduction of the annual CGT allowance, rather than the standard CGT rate of 18% for basic rate taxpayers or 28% for higher rate taxpayers. The tax savings are therefore potentially very large for those taxpayers who can claim. 

The chancellor should not be surprised at the popularity of the relief, given the increase in lifetime limit over the past five years. The lifetime limit is currently £10 million – prior to 6 April 2010 the limit was only £1 million.

ER is available for gains on what is termed in the legislation as a ‘material disposal of business assets’ (TCGA 1992 s169I), which is broadly either:

Trustees can claim ER on the disposal of settlement business assets in limited circumstances, being available to trustees of settlements in which there is an individual who is a ‘qualifying beneficiary’. This is broadly an individual with an interest in possession in the trust property, or the part of the trust property that includes the business assets (TCGA 1992 s 169J). ER is not available to trustees of discretionary settlements, or to personal representatives of deceased persons. 

ER can generally be claimed on any gain made on a material disposal of business assets into a company owned by that same individual. This has produced a tax saving opportunity should any ’goodwill’ be transferred along with any other business assets. 

The planning was based on the premise that the company would be unlikely to have sufficient cash funding to enable payment for the goodwill transferred. In the individual’s CGT calculation, the annual exemption would be deducted from the value of the goodwill and ER would be claimed, resulting in a 10% CGT charge on any balance. The company accounts would show the seller as being a creditor. The (seller) shareholder would gradually extract funds equal to that balance as tax-free and NI-free payments from the company. In addition, the company was previously able to claim tax relief on the cost of the goodwill under the corporate intangible assets regime (CTA 2009, Pt 8). 

George Osborne has put a stop to such tax planning by inserting a new s 169LA into TCGA 1992 (via FA 2015 s 42), with the effect that for business disposals on or after 3 December 2014, ER cannot apply on any gain arising on the transfer of goodwill to a close company, where that company is a ’related party’ to the seller, i.e. the seller has control of or an interest in the company (as defined in CTA 2009, s 835(5)). There is a restricted exception permitting retiring partner(s) to claim ER on the transfer of a partnership’s business to such a company.

When considering an ER claim on the disposal of shares, the conditions state that the company must be a ’trading company’ (or the holding company of a trading group) rather than being an investment company. 

The company must also be a ‘personal company’ (TCGA 1992, s 169S(3)), meaning that the shareholder must broadly comply with all of the following:

This meant, for example, that if a majority shareholder owned 85% of the shares in a trading company and five managers held the remaining 15% equally, their individual 3% shareholdings would not qualify for the relief because they would have failed the 5% test.

An arrangement to circumvent these rules was for the shareholders to invest in a ’management company’. That company would own at least 10% of the trading company’s nominal share capital and thus comply with the special rules relating to ’joint venture’ companies (TCGA 1992, s 165A). These rules could result in a company being deemed to be a trading company if it owned or proposed to acquire an interest of between 10% and 50% of the ordinary share capital of an actual trading company (or the holding company of a trading group) which is at least 75% owned by five or fewer people. Thus a single company with no assets apart from its ’joint venture’ holding could potentially be regarded as a trading company although actually not trading in practice. 

The anti-avoidance provisions in FA 2015 put an end to such tax planning schemes so that, with immediate effect, the management companies will be required to establish their trading status separately in order to secure ER. 

Partnerships that are structured to include a corporate member of a trading partnership or limited liability partnership are no longer able to rely on the corporate partner being treated as a trading entity unless trading in its own right and not owning substantial non-trading assets.

The National Audit Office’s cost figures prove that ER is a valuable relief. Despite the new anti- avoidance rules, it is unlikely that ER will be abolished, but there always remains the possibility that the ER lifetime limit might be reduced back to £5 million or even £1 million in future Finance Acts.