We have written in previous Tax Tuesday pieces about the value of the various tax reliefs which are available to entrepreneurs here in the UK.
However, the complexity of the tax legislation means it is all too easy to inadvertently miss out on these reliefs if appropriate care is not taken.
In this Tax Tuesday we look at a particular aspect of Business Asset Disposal Relief (BADR) formerly known as (and still often referred to as) entrepreneurs’ relief and advise on how to miss the potential traps which exist for the unwary!
In broad terms, and assuming various conditions are met, the first £1m of gain on qualifying business assets (including shares in certain trading companies) made in a lifetime by an individual will be subject to the low 10% rate of capital gains tax (CGT) and so can be worth up to £100,000 per individual.
Prior to 11 March 2020, the lifetime limit was £10m rather than £1m so the relief was potentially considerably more valuable.
However, in a typical owner-managed, or family-run trading company/group where there may be five or more key shareholders, a disposal of the business and appropriate BADR claims could conceivably be worth £500,000 or more in total.
Conditions for BADR to apply
Amongst other conditions, outside of shares issued under the Enterprise Management Incentive Scheme (covered previously in Tax Tuesday), the disposing shareholder must hold at least 5% of the ordinary share capital and voting rights and either or both of the following:
– Rights to at least 5% of the profits available and 5% of assets on a winding up (as far as these profits/assets are available to equity holders)
– Rights to at least 5% of the proceeds on a sale of all the company’s share capital.
With several exceptions, generally these conditions need to be met for two years leading up to disposal.
External investment – A potential tax problem?
Many ambitious owner-managed businesses look for external equity finance to give them the backing needed to continue to grow and meet their financial targets.
An inevitable side effect of attracting external equity finance is that existing shareholdings are diluted.
Commercially, the idea is that while existing shareholders will ultimately get a smaller slice of the proverbial cake when the business is sold, funds that external equity finance bring can be used to grow the business and so the cake being shared will ultimately be much bigger.
The solution – Tax elections
However, what happens from a BADR perspective if an existing shareholder’s stake falls below 5%?
Fortunately, it is possible for the taxpayer to elect to make a ‘notional disposal’ of their shares at market value at the time they are diluted and so ‘bank’ the BADR they are due on their shares up to that point.
In addition, a separate election can be made to defer paying tax on this notional gain until the actual disposal of the shares themselves.
There are strict time limits for these elections to be made, being 31 January following the tax year of dilution below 5% for the notional disposal and four years after the end of that tax year for the deferral.
These elections are helpful and can significantly reduce the overall tax liability on an ultimate disposal of a business where growth has been partly funded by external equity.
How can we help?
For advice relating to BADR, or any other tax queries raised, please contact your relationship principal or email firstname.lastname@example.org for more information.
The author takes every care in preparing material to ensure that the content is accurate and up to date. However no responsibility for loss occasioned to any person acting or refraining from acting as a result of this material or from making use of this material can be accepted by the author.