Entrepreneurs’ Relief was introduced in 2008 to encourage entrepreneurship by reducing the amount of tax paid by business owners selling their businesses to just 10%.
Entrepreneurs give a lot back to society. Their ventures create jobs, inject money into the economy, and offer their community unique services and products.
However, entrepreneurship can be a long and difficult road; it’s important to support entrepreneurs wherever possible, to encourage individuals to take on the challenge of going it alone.
Entrepreneur’s Relief offers budding entrepreneurs an incentive to take on the risk of starting their own business. This scheme allows them to do so safe in the knowledge that they’ll pay a lower tax rate if things don’t go as planned and they decide to dispose of their business in the future.
What is Entrepreneurs’ Relief?
The key points:
- Legal scheme run by the UK Government
- Reduces the amount of Capital Gains Tax that entrepreneurs pay when selling all or part of their business
- Capital Gains Tax is paid at a reduced rate of 10% on all qualifying assets
- A set of qualifying conditions must be fulfilled to be eligible for the relief
- Gains of up to £10m can be made per person in their lifetime
Entrepreneurs’ tax relief is one of the best cushions offered to new business ventures. But, before claiming the relief, the entrepreneur must ensure that they have met all the required conditions for at least 12 months. Otherwise, their claim will not be successful.
What is Capital Gains Tax?
When selling an asset that has increased in value, you are required to pay Capital Gains Tax on the profit you receive from its sale. The amount that you’re required to pay depends on your income tax rate.
How Entrepreneurs’ Relief has changed over the years
When Entrepreneurs’ Relief was first introduced by the government in 2008, it allowed business owners to pay tax at the lower rate of 10%, up to a lifetime allowance of £1m.
This was increased to a lifetime allowance of £2m in 2010, £5m just 3 months later, and then £10m in 2011, where it still stands today.
Prior to the 2016 Budget, Entrepreneurs’ Relief could only be claimed by business owners. The 2016 Budget extended this to include external investors selling ordinary shares in unlisted trading companies.
Entrepreneur relief conditions: who can claim?
- Sole traders and partners
Sole traders and partners who are selling their business can claim Entrepreneurs’ Relief providing they have owned the business for at least one year prior to the date they sell it.
- Individuals with shares or securities in the company
Individuals with shares of at least 5% and voting rights in a company can file a claim, providing that they have had their shares for at least one year before selling them.
This includes those who got their shares through an Enterprise Management Scheme (EMI) after 5th April 2013. In the case of EMI shares, you must have been given the option to buy the shares at least one year prior to selling them.
- Spouses of claimants
Spouses of claimants can make an additional claim providing they own at least 5% in shares and work as an employee in some capacity.
What is meant by ‘trading company’?
Entrepreneurs’ Relief can only be claimed on the sale of a trading company. It is perhaps easier to define what this doesn’t include rather than what it does. Non-trading activities include investment activities and property development.
If the company being sold has ceased trading, to qualify for the relief it should have satisfied the trading conditions for one year ending on the day the company ceased trading and have ceased trading within three years ending on the date of disposal of its assets.
Calculating your tax
The sum to calculate how much tax you are due to pay after Entrepreneurs’ Relief has been applied is different depending on what gains you have made.
Before trying to make any calculations you should work out whether or not all of your gains qualify for the relief by checking the details for eligibility carefully.
How to work out your gain
Your gain can usually be worked out by simply finding the difference between what you paid for your asset and the amount you sold it for. If you inherited the asset or it was given to you then different rules may apply, find out more about working out your gain here.
Everyone receives an annual tax-free allowance of £11,700 (£5,850 for trusts). You are only required to pay tax on gains over this amount.
If all your gains are eligible to Entrepreneurs’ Relief
- Identify your gains.
- Add your gains together and deduct your qualifying losses. This is your taxable gain that is eligible to Entrepreneurs’ Relief.
- Now deduct your tax-free allowance. The figure you get is the amount that you’ll pay 10% capital gains tax on.
If you have gains that aren’t eligible
If some of your gains aren’t eligible to Entrepreneurs’ Relief, things become a little more complicated as you will need to work out separately how much tax is due on the gains that don’t qualify. This will depend on when the gain was made and your income tax rate.
Higher rate income tax
If you are a higher rate income tax payer, you will pay tax at a rate of 28% on any gains that do not qualify for the relief.
The exception to this is gains made on residential properties after the 6th April 2016, these are taxed at a rate of 20%.
Basic rate income tax
- Begin by calculating how much of your basic rate band can be used against your gains. To do this you should work out your taxable income and deduct from it your personal allowance and any other income tax reliefs you are eligible for. Now deduct this amount from the basic rate tax band for the year in which the gains were made. The result is the amount of basic rate band you can use against your gains.
- Identify your gains.
- Use your basic band rate against eligible gains, tax on these will be charged at 10%.
- Use any remaining basic band rate against other non-qualifying gains. You will pay tax at a rate of 18% on these if they were made before 6th April 2016, and 10% if they were made after this date, unless gains were made on residential properties, which are still charged at 18%.
- Tax on gains above the basic rate band will be paid at a rate of 28%, unless they were made on residential property after 6th April 2016, in which case tax should be paid at a rate of 20%.
How to claim Entrepreneurs’ Relief
There are two ways in which to put in your claim for Entrepreneurs’ Relief. You can either include the details in your Self-Assessment tax return, or fill in Section A of the Entrepreneurs’ Relief help sheet.
It is important to put forward your claim before the first anniversary of 31 January after the tax year in which business or shares were sold.
For further help making a claim for Entrepreneurs’ Relief you can view the guide from HM Revenue & Customs here or speak to a tax adviser.