Helpful changes to Entrepreneurs’ Relief

Billy Cleland

Billy Cleland

Tax Director

Many changes have been made to the operation of the invaluable Entrepreneurs’ Relief.

Since its humble beginnings, this relief has been attractive to business owners and has caused entrepreneurs to structure their businesses in a way which will ultimately qualify for ER when the business is sold or otherwise disposed.

The amount of tax relief was initially capped at £80,000 (being £1 million of gains taxed at 10% instead of 18%). However with subsequent changes, the maximum tax relief now available is £1.8 million.  

The increased cost for ER caught the eye of the National Audit Office which noted the projected cost to the Exchequer was estimated at £1 billion but in reality was costing close to £3 billion. This unsurprisingly caused HMRC to review the operation of the ER and in the 2015 Budget stopped some practices which were viewed as abusive.

However, these changes made it more difficult for entrepreneurs to claim 10% tax on the following: 

  • Associated disposals (being those disposals linked with the disposal of a partnership interest or shares in the company)

  • Goodwill on incorporation

  • Joint venture structures

The changes in the 2015 Budget were rushed through without proper consultation or scrutiny prior to the May 2015 General Election. The unintended consequence was that many benign, commercial transactions were caught out by the new rules.  In effect, entrepreneurs were facing a 28% tax liability rather than 10%. 

Following representations made to HMRC, the Government has now relaxed the rules so that many commercial transactions will now qualify for ER. It is important to note that the changes are not simply a reinstatement of the rules before the 2015 Budget.

A broad summary of the rules is noted below although a detailed review is required for your own specific circumstances.

Associated disposals

There are two disposals: the material disposal (e.g. partnership share or shares in a company), and the associated disposal (e.g. property used by the partnership/company).  For the associated disposal to qualify for ER, the material disposal must comprise of a reduction of no less than 5% of the entrepreneurs’ interest in the partnership/company. 

Where the entrepreneur does not hold 5% of the partnership/company, they may still qualify if they have previously held 5%.  This requires the 5% to have been held for three continuous years in an eight year period.  Other conditions apply but the rules have also been amended so that commercial disposals to family members may qualify for ER.

Goodwill on incorporation

It was increasingly common for entrepreneurs to incorporate their business and pay 10% tax on the increase in asset values, including goodwill.  This offered substantial savings over paying income tax and national insurance contributions.  In December 2014, the rules were amended to prevent abuse of the ER rules when disposing of goodwill to a close company which was a “related party”.

The changes made in the 2016 Budget relax the rules but it is still not permitted to incorporate your own business and claim ER on the goodwill.  However, the new rules do permit ER to be claimed on disposals to family members.

There is relief available if, as part of the sale of a business, you incorporate the business and that company is then sold.  Under the old rules, ER would not be available on the goodwill.  Following the changes made in the 2016 Budget, you may qualify for ER if certain conditions are satisfied.

Joint venture companies and partnerships

Many of the more abusive schemes allowed employees/partners who held a negligible commercial interest in the business to qualify for ER. The new rules contain separate provisions for joint venture companies and partnerships. 

For companies, there is a shareholding test and a voting rights test.  For partnerships, there is a profit and assets test and a voting rights test.  The objective of the new rules is to allow those entrepreneurs with a 5% commercial interest in the trade to continue to benefit from ER, whilst blocking those with smaller interests from benefitting from 10% tax. 

The rules are complex as it requires close examination of various partnership and company structures. 

If you are in any doubt as to whether you qualify for ER, then please speak to your usual Johnston Carmichael adviser.