The UK capital gains tax laws have undergone various changes in recent years as government policy has attempted to correct the perceived injustices in the system. One of the important issues that government has grappled with is the question of whether, and if so how, a person’s business assets should be subject to less tax than personal and investment assets.
After deciding to abolish the taper relief that reduced the amount of tax payable according to how long an asset was held, the previous government settled on another policy that was based on a relatively low capital gains tax rate of 18% on all gains. The present coalition government has introduced a higher rate of 28% for those whose income and capital gains are above the higher rate threshold, while keeping the 18% capital gains tax rate for those whose income and capital gains are within the standard rate band.
There is a general view that the creation and growth of a business by an entrepreneur should not be penalised too much by the imposition of capital gains tax on the eventual sale of the business. This is partly because there is a need to strengthen the entrepreneurial culture of the country so as to boost economic growth and employment. In response to criticism that capital gains tax was burdensome for entrepreneurs, the previous government introduced the entrepreneurs’ relief. This relief has been extended by the current coalition government.
Under the entrepreneurs’ relief, the rate of capital gains tax is reduced to an effective rate of only 10% on the sale of a business, up to the limit of £5 million lifetime capital gains. This helps entrepreneurs who have worked to grow a business and now wish to exit from that business and move on to another activity or into retirement. The entrepreneurs’ relief is not just a retirement relief, however, but applies throughout the life of an entrepreneur whenever a business is sold.
The entrepreneurs’ relief can apply to any trade, profession or vocation that is carried on with a view to making profits. The relief is available in respect of capital gains (during the lifetime of the entrepreneur) up to £5 million. The gains may be on the disposal of a whole business or part of a business by the individual as a sole trader or as a partner in a partnership. For the entrepreneurs’ relief to apply, the individual must have owned the business for at least one year before the disposal. The sale must be of the whole or a substantial part of the business, not just of some of the assets, if the entrepreneurs’ relief is to apply in this situation.
The entrepreneurs’ relief is given in respect of “relevant business assets” which would include intangible assets including goodwill but would not include investments held by the business.
The relief also applies to the assets of the individual’s trade or the trade of a partnership in which the individual is a partner, provided that the assets are sold after the business ceases trading. The individual (or partnership of which the individual was a partner) must have owned the business during the year up to the date of cessation of trading and if the relief is to apply the assets must be sold within three years of the cessation date.
The other situation in which entrepreneurs’ relief is available is the sale of shares or securities in the individual’s personal trading company. The individual must have been an officer or employee of the company and the company must have been the individual’s personal trading company during the whole year up to the date of disposal. A company is an individual’s personal trading company for this purpose if the entrepreneur has at least a 5% shareholding in the company including at least 5% of the voting rights.
The entrepreneurs’ relief may be claimed on more than one occasion during the entrepreneur’s lifetime, but always subject to the overall lifetime limit of £5 million. Business disposals made before the introduction of the entrepreneurs’ relief (on 6 April 2008) are not counted in computing the total lifetime capital gains.
Where an entrepreneur’s gains are above the £5 million limit, capital gains tax is payable on further gains at the normal rates, however the entrepreneur could look at means of deferring the gains such as rolling them over against the purchase of Enterprise Investment Scheme (EIS) shares. In this case, the payment of tax on the capital gains would be deferred until the EIS shares were sold, and could then be rolled over again against further purchases of EIS shares.
Sources:
HM Revenue and Customs www.hmrc.gov.uk
“Taxation” by Alan Melville, fifteenth edition 2010 FT Prentice Hall