Entrepreneurs’ Relief: the importance of timing

Posted: 25/10/2019

Entrepreneurs’ Relief (ER) is a valuable capital gains tax (CGT) relief. If it applies, it reduces the normal top rates of CGT from 20%, or 28% in the case of residential property, to 10%. This rate applies to the first £10 million of gains (the ‘lifetime limit’) realised by the taxpayer.

Given how valuable the relief can be, it is important to plan ahead and ensure the numerous conditions will be met.

ER applies to ‘qualifying business disposals’ but this term encompasses a range of disposals including sales and gifts of:

• qualifying shares,
• all or part of a business, and
• assets used in a business.

What is a business for ER?

A business qualifies for ER if it is a trade, profession or vocation conducted on a commercial basis with a view to making profits. An important aspect here is proving the carrying on of a ‘trade’. A taxpayer may very clearly be conducting a purely trading business over a consistent period. However, that is not always the case. Particular issues arise where a business conducts secondary, non-trading activities, where disposals of land are involved or (as in the case of Potter v HMRC referred to below) where the trade declines and then ceases.

The importance of timing

In most cases, the conditions for ER must apply throughout a period of two years ending on the date of the disposal. This two-year period was increased from one year for most disposals on or after 6 April 2019.

This is not the only rule about timing, however.

If, for example, there is a disposal of shares in a trading company at a time when the business ceases, there are two timing conditions:

• the company must qualify as the taxpayer’s ‘personal company’ for a period of (now) two years ending on the date on which the company ceases to be a trading company; and
• the date of cessation must be within the period of three years ending with the date of the disposal.

The courts considered this timing issue recently, in the case of Potter v HMRC [2019] UKFTT 0554 (TC).

The case involved a claim for ER on a disposal of shares when a company called Gatebright Limited was liquidated. HMRC refused the shareholders’ claim for ER, saying that the timing conditions were not satisfied because the company had ceased its trading activities more than three years before the disposal.

Gatebright had been a successful business, trading in the London Metal Exchange and brokering credit deals. It was adversely affected by the financial crash in 2008 and by the ill health of Mr Potter who personally dealt with the trading. The company issued its final invoice in 2009 and HMRC argued that because no deals had been struck after 2009, the trade had ceased more than three years before its liquidation in 2015. Mr and Mrs Potter argued that Gatebright had continued to trade up until 2014 because they were actively attempting to continue the company’s usual business until that point.

The First-tier Tax Tribunal held that, whilst there was a pause in trading after 2009, the taxpayers had satisfied the timing conditions; they had not ceased trading more than three years before the disposal.

Mr Potter’s evidence, corroborated by the company accounts, appears to have been crucial in ensuring that the Tribunal understood the particular nature of their business and the way it was conducted (which also explained why there was little documentary evidence of seeking deals etc). This meant the Tribunal was able to apply the ER rules in the right context. Clearly, that approach is also important when planning in advance of a disposal.

Disposals of trust business assets

ER is also available to trustees. The conditions applying to disposals by trustees of settled property include a requirement for a trust beneficiary to have a right to income, either of the whole trust or of the trust business assets that are disposed of.

In the recent case of The Quentin Skinner 2005 Settlements v HMRC [2019] UKFTT 0516 (TC), the First-tier Tax Tribunal considered the trustees’ claim for ER. The dispute centred on one timing aspect of the ER rules.

HMRC argued that it was necessary for a beneficiary to have the right to income for a period lasting 12 months, which ends not more than three years before the disposal. If that interpretation was correct, the ER claim could be wholly rejected because the trust beneficiaries had a right to income for less than 12 months.

The Tribunal agreed with the taxpayers’ interpretation of the rules - that there was no requirement as to the duration of the right to income - and the claim for ER was upheld.

It is important for trustees to be aware of HMRC’s reading of this particular rule, and of this Tribunal decision, when planning disposals of business assets.

It is clear from these cases that timing is crucial for a successful ER claim. Failure to plan in advance can mean this valuable relief is lost.

If you have any questions on ER or wider tax and succession planning issues, particularly for family businesses, please contact us. We would be happy to advise on ER or the other valuable tax reliefs available.

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