Claiming Entrepreneurs’ Relief is not as simple as it seems.

Entrepreneurs and key employees within companies need to read the small print before assuming that they are entitled to ‘Entrepreneurs’ Relief’ (ER).

Failure to qualify for potentially valuable ER could result in them paying 28% Capital Gains Tax rather than 10% on the sale of their business or shares. It is important to note that the ability to claim the relief (and a claim must be made) is subject to a number of strict conditions which can easily catch people out.

The rationale behind the relief is to encourage more entrepreneurial activity by increasing the post-tax rewards for creating and realising value from a successful business. However, the rules governing eligibility are such that many individuals who are working to meet that policy objective are likely to fail to reap the rewards. The relief is only available to individuals (not companies) and to the trustees of certain settlements.

Although Entrepreneurs’ Relief was doubled to a lifetime limit of £10m in April 2011, the qualifying criteria can be onerous unless you take time to understand them. In order to qualify, you must have held the assets being sold for at least 12 months and, if shares are being sold, you need to have been a director (or employee of a relevant company) and have held 5% of the ordinary shares and 5% of the votes for at least 12 months preceding the sale. These conditions can restrict the ability of external investors, employees with minority shareholdings and employee share option holders to take advantage of ER.

However, it is not just the personal conditions that could exclude a claim for the relief. ER is only available on qualifying business disposals. As a consequence, significant non-trading activity (more than 20% of some or all of turnover, net assets, profit or time spent by directors – all of which need to be weighed against each other) can also result in the relevant interest falling outside the ER conditions. A particular problem can also arise where the business/company has significant cash on its balance sheet which HMRC deem is not being used for trading purposes.

So, what is ER’s worth? The doubling of the lifetime ER limit means that in theory an individual can claim ER which could lead to a maximum CGT saving of £1.8m – or £3.6m for a husband and wife (both spouses are eligible to claim). However, the hoops through which claimants need to leap in order to claim ER can be difficult and we would strongly recommend that potential claimants hoping to take advantage of ER review their business structure carefully to avoid falling foul of the qualifying criteria.

December 2011