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17 January 2020
In its General Election manifesto, the Conservative Party promised to “review and reform” Entrepreneurs Relief, noting that it has not “fully delivered on [its] objectives”.
Now that the Conservatives have formed the new government – with a significant majority – one would expect them to implement their manifesto commitments.
It follows that those who currently qualify for Entrepreneurs Relief in its current form should review their options.
When it was introduced in 2008, Entrepreneurs Relief was intended to replace business asset taper relief (BATR).
BATR and retirement relief were available to qualifying taxpayers without financial limit – and so could be more generous than the Entrepreneurs Relief regime which replaced them.
Nevertheless, there has been sustained criticism of the failure of Entrepreneurs Relief to meet its policy objectives and of its unexpectedly high cost to the Exchequer.
Simplifying greatly, Entrepreneurs Relief will typically be available to those who both: (1) work or hold an office in; and (2) own their business – either as a sole trader, a partner in a partnership or a (usually 5 per cent+) shareholder in a company.
Those criteria must be met for the whole of the two years immediately leading up to the disposal.
The relief applies to a transfer of the whole or part of an interest in the business itself, or of an asset used in the business.
In some circumstances, it is also available to the trustees of a trust, provided that one or more of the beneficiaries of the trust qualifies for the relief in his or her own right.
In each case, the relief must be claimed by the taxpayer.
As it stands, Entrepreneurs Relief applies a reduced CGT rate of 10 per cent to the first £10m of qualifying gains.
It can be applied over any number of disposals and the £10m cap is a lifetime limit.
As the headline CGT rate is currently 20 per cent, Entrepreneurs Relief provides a tax saving of up to £1m for qualifying taxpayers.
Consultation and Reform
Business owners will hope that the government will consult before making any changes to the Entrepreneurs Relief regime, giving affected individuals and representative bodies an opportunity to comment on the proposals.
After all, the government committed to prior consultation in tax matters in its “Protocol on Unscheduled Announcements of Changes in Tax Law” in the “Tackling Tax Avoidance” policy paper of March 2011 and re-confirmed its adherence to the principle in December 2017.
Options and Planning Opportunities
The more pressing issue is to decide how best to capitalise on the relief in its current form. One difficulty is uncertainty about when the rules will change.
A Budget is planned for 11 March 2020.
That should set out the tax rates and policies for the tax year beginning on 6 April 2020. Mid-year changes to tax rates and provisions are rare and it seems likely that any new regime should apply from 6 April 2020 at the earliest.
However, the government might wish to ensure that any new tax policies incorporate “anti-forestalling” provisions designed to prevent action taking advantage of the current regime before a change in the law.
Interim tweaks pending the government’s promised review are also possible.
What are the Options?
There will be no single solution: how best to proceed will be a commercial decision for each taxpayer.
Some, with no intention of disposing of their business in the foreseeable future, will find the proposed changes of little interest.
Others of a sanguine disposition might hope that they will do just as well under whatever regime eventually replaces Entrepreneurs Relief.
There will also be those who adopt a conservative approach to tax planning of any kind for whom taking positive action now would be anathema. They will all await the new rules.
Many, however, will probably conclude that tax rates will not reduce further in the foreseeable future and would welcome the opportunity to capitalise now on the certainty and low tax rates available under the existing Entrepreneurs Relief rules.
For those who wish to ‘lock-in’ to current rates, the date on which they make their disposal for CGT purposes will be crucial.
Time of disposal for CGT
The CGT legislation deems that when an asset (such as an interest in a business) is sold under an unconditional legal contract, the date of disposal for CGT purposes is exchange of contracts (that is, when the contract is signed by all parties to it) and not at completion (that is, when the business is transferred to the buyer and consideration is paid to the seller).
Conversely, if a contract is conditional (so does not bind its parties unless and until one or more prior conditions have been met) then the CGT disposal by the seller will take place when all the prior conditions have been fulfilled.
Essentially, once the contract is completed, the seller looks back to ascertain the date on which the contract was made (or, if later, when it became unconditional).
The effect of these rules is that business owners wanting qualifying disposals to be taxed under the current Entrepreneurs Relief regime must exchange unconditional contracts before a change in the law.
Sale Already in Progress
Those who are already engaged in selling their business, or who are on the point of doing so, would be well-advised to ensure that they exchange contracts with the buyer as soon as possible.
Ideally, this would be before the Budget Statement on 11 March (to minimise the risk of anti-forestalling provisions in the new rules).
Failing that (and subject to any changes announced in the Budget), they should aim to exchange contracts no later than on 5 April 2020.
Those who have not yet begun the sale process – and those who have no wish to dispose of their business but who are attracted to Entrepreneurs Relief – will need another solution.
Depending on their circumstances (and subject to the caveat below), there are at least two options:
1 – Interim Disposal Followed By Sale
This technique was widely used in 2008 and 2010 prior to previous changes in CGT rates.
Where a business owner wants to sell a business (“Tradeco”) in the foreseeable future but will not be able to do so before 6 April 2020, it is possible to exchange unconditional contracts on an interim disposal to a structure (“Newco”) set up for the purpose.
Doing so will ‘lock-in’ to the current Entrepreneurs Relief regime because of the CGT time of disposal rules mentioned above, provided that the interim sale completes at some later date.
Ideally, a second sale to a third-party purchaser would then take place before 31 January 2021 (which is the date by which CGT on the interim disposal would be payable, assuming that sale completes).
This approach gives the business owner breathing space to arrange a commercial sale in the next twelve months or so, while having taken full benefit of Entrepreneurs Relief irrespective of any intervening change in the rules.
One refinement makes this option particularly attractive: as noted above, a CGT disposal is deemed to take place on exchange of contracts.
But if the contract does not subsequently complete for any reason then no disposal ever takes place.
It follows that if a business owner has the ability to un-wind (‘rescind’) the contract then it can be used to maximise Entrepreneurs Relief if a commercial sale is later achieved whilst avoiding any material downside risk if it is not.
If it is not possible to find a commercial buyer for Newco by a specified long-stop date then the owner can rescind the Newco contract.
Importantly, the power to rescind a contract for breach of a term (in this case, failure to complete by a specified date) is not classed as a condition, meaning that the sale remains unconditional.
The owner is returned to his or her original position (less only the costs of implementing the arrangements).
This approach requires close co-operation between corporate and tax lawyers and there are a number of bear traps for the unwary. Specialist and precise drafting are absolute pre-requisites.
2 – ‘Re-basing’
Some business owners may not wish to dispose of Tradeco but still want to take advantage of Entrepreneurs Relief while it still exists.
For them, the interim disposal option will not work because it is predicated on a subsequent commercial sale.
If such people are to capitalise on Entrepreneurs Relief then they must be content to trigger a CGT charge now without any sale proceeds to pay the tax.
If they are prepared to do so, and can meet the CGT from their own resources, this option would ‘re-base’ their interest in the business for tax purposes, meaning that only future gains would be charged to tax under the forthcoming regime.
This result can be achieved by a number of means, each with its own sophistications.
‘Re-basing’ exercises of this kind typically make use of the flexibility offered by English trusts.
Doing so also gives business owners the possibility of combining their CGT planning with Inheritance Tax planning should they wish.
Caveat: Anti-Avoidance Provisions
The options discussed above were all widely used in the past.
One new consideration is the recent development of the law and the practice of HMRC and the Tribunals and Courts in respect of tax avoidance.
Importantly, the General Anti-Abuse Rule (“GAAR”) was introduced in 2013.
This is intended to counteract “tax advantages arising from tax arrangements that are abusive.”
None of the options summarised are considered to be “abusive” on any basis, let alone within the scope of the GAAR (they simply apply current tax rules to straightforward arrangements), but business owners wishing to implement them would need advice on this point in the context of their specific circumstances and objectives.
This is, after all, a contested area with multiple perspectives.
Nevertheless, past governments have been more than happy for taxpayers to trigger taxable disposals of this sort in advance of changes in tax rates: after all, doing so brings forward the CGT receipts for the Exchequer.
Time is short for affected business owners to take advice on these points and to implement any planning needed to make best use of Entrepreneurs Relief whilst it still exists.
Advisers are already receiving enquiries and are expecting a busy first quarter to 2020. Those affected should not wait.
This article was originally published by FTAdviser: https://www.ftadviser.com/companies/2020/01/14/how-to-make-use-of-entrepreneurs-relief/?page=1
17 January 2020
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