In the second of his four-part article, Peter Rayney covers the latest Finance (No. 3) Bill 2018-19 changes to the entrepreneurs’ relief rules.
Last month, we looked at the new 5% economic ownership tests that must now generally be satisfied by shareholders to secure entrepreneurs’ relief (ER) on the sale of their shares.
Furthermore, for post-5 April 2019 disposals, ER is only available where all the relevant qualifying conditions have been satisfied throughout the two-year period before the disposal.
Incorporation of existing trades
A special ‘tracing’ rule now applies to the sale of shares in a recently incorporated trading company. Under the previous ER regime, where an existing sole trader or partnership trade incorporated, the shareholders’ ER qualification ‘clock’ commenced when they acquired their shares in the newly incorporated company (or, if later, when the company started trading).
This meant that where a company was sold shortly after incorporation, the shareholders were unable to make competent ER claims (furthermore, they could not normally obtain any ER on the prior sale of goodwill to the (connected) company, since this was prohibited by the rule in TCGA 1992, s 169LA).
However, for share sales occurring after 5 April 2019, it is possible to include the qualifying period for ER before the trade was transferred to the company. Thus, for the purposes of the two-year ownership test, a shareholder can now include the period they carried on the trade as a sole trader or in partnership together with the qualifying shareholding period post-incorporation.
It must be stressed that this ‘aggregation’ rule only applies where the sole trader or partnership has incorporated under the capital gains tax ‘incorporation relief’ rules in TCGA 1992, s 162 (see proposed TCGA 1992, s 169I(7ZA)). This means that all the assets of the trade (possibly apart from cash) must be transferred as a going concern wholly or partly in consideration for the issue of the relevant shares by the company.
Thus, where companies have been incorporated by gifting the goodwill (using hold-over relief under TCGA 1992, s 165) or selling the goodwill at market value (with the proceeds being left outstanding on loan account), it will not be possible to use this ‘aggregation’ rule.
Example: Claiming ER shortly after a business incorporation
Buzz has carried on his electronics repair and installation business as a sole trader for many years. On 1 May 2018, he transferred the trade and all its assets (including goodwill) to his new company, Aldrin Electronics Ltd, wholly in exchange for an issue of shares.
The net asset value of the assets transferred to the company (including goodwill valued at £500,000) was £850,000. The capital gain arising on the goodwill was £500,000, which was relieved under the section 162 incorporation relief.
In June 2019, he sold all his shares in Aldrin Electronics Ltd for £1.1 million (net of disposal costs).
Buzz has only held his shares in the company for some 14 months. However, since he incorporated the trade in consideration for an issue of shares, he is treated as satisfying the ‘two year’ ownership period since he can include his period as a sole trader.
His capital gain on the sale of the company would, therefore, be eligible for ER and is computed as follows:
£’000£’000
Net sale proceeds1,100
Less: Allowable base cost
Base cost of shares (= net value of business on incorporation)850
Less: s 162 relief(500)(350)
Capital gain (eligible for ER)750
Practical Tip:
If an existing business is likely to be sold shortly after it has been transferred to a company, it will normally be beneficial to incorporate in exchange for shares within TCGA 1992, s 162.
