First of all, what is Entrepreneur’s Relief (ER), and how does this work?
Entrepreneur’s Relief is available to you as an individual when:
- You sell all or part of your business as a sole trader or business partner.
- You dispose of or sell shares in all or part of your business (limited company).
As a contractor, the relief is available when your company has ceased trading and you dispose of your shares as part of your company’s closure. In turn, tax relief can be claimed and the ER will reduce the amount of Capital Gains Tax (CGT) that you will pay as part of the final pay-out from your company.
Please note, after a recent change, Entrepreneur’s Relief is now called Business Asset Disposal Relief (BADR).
Contractor / business owner timeline
As a contractor, once you have decided to close your personal company, the next steps to take are:
- Ask your accountant to prepare and finalise the company’s final set of accounts, up to the date that it stopped trading
- File the final set of accounts and a company tax return with HM Revenue & Customs (HMRC)
- Pay over the final Corporation Tax liability to HMRC
We now turn to the balance that remains in the business. On some or even many occasions, this might be a large amount of cash. The remaining balance is payable to the shareholders in their respective share ratios
How the final balance can be paid
The final balance is payable as either dividend or as Capital Distribution. It is also payable as a mixture of these methods.
The dividend route, in most cases, will be far more costly. The highest tax rates on dividends are currently 33.75% or 39.35%.
So, most contractors and small business owners will opt for the Capital Distribution route.
When your company distributes the Capital Distributions, the shareholders will dispose of their share capital.
If you qualify for ER (please see the three conditions in the next section), the CGT rate is 10% on any Capital Distributions. Under CGT rules, individuals currently have an annual CGT allowance of £12,300. So, if in the year of your company’s closure the shareholders each have no other capital gains, the first £12,300 of yours and any other shareholder’s Capital Distributions will be tax-free. Any additional Capital Distribution amounts above £12,300 will be taxable at 10%.
The rates of income tax that you pay do not affect ER or BADR. Therefore, both basic and higher rate taxpayers will pay tax on their Capital Distributions at 10%, if they meet the qualifying conditions.
Claiming for ER (BADR)
You will qualify for Entrepreneurs Relief when you sell or close your business, if you meet certain conditions:
- The individual who is disposing of the shares, must own at least 5% of the shares in the company. They must also have 5% of the voting rights.
- An individual who is disposing of the shares must also be an officer (director) of the company. They must also have been so for at least 24 months leading up to the date of the disposal.
- The business must also have been a company of a trading nature for at least 24 months leading up to the date of the share disposal.
When you close your company, you must also dispose of your business assets within 3 years to qualify for relief.
Please note, you could lose a claim for ER if you resign as a director before disposing of your shares.
There is no limit on how many times you can claim ER. The Lifetime Limit of £10 million was reduced to in the March 2020 Budget.
The time frame to claim Business Asset Disposal Relief (BADR / ER)
Please note, to be able to claim for tax relief under BADR / ER, you will need to do this within a certain time frame:
- 2019/20 tax year (year to 5 April 2020) 31 January 2022
- 2020/21 tax year (year to 5 April 2021) 31 January 2023
- 2021/22 tax year (year to 5 April 2022) 31 January 2024
Please note, you can claim for ER in the `Capital Gains Summary’ section of your Self-Assessment Tax Return.
Indeed, you should speak to your accountant about this, to make sure that you report it correctly.
HMRC anti-avoidance measures
Anti-avoidance measure `phoenixism.’
HMRC brought in A TAAR (Targeted Anti Avoidance Rule) from April 2016.
This scenario applies to `close companies’ where there are five or fewer shareholders. It also applies to any number of shareholders who are also directors of the company. The shareholders also need to have received a distribution from their company. Therefore, this is capital in nature rather than income in order to obtain a tax advantage.
The measure applies to a distribution made, when a company closes down.
The distribution will be income (not capital) where you meet the following conditions:
- an individual who is a shareholder in a close company, receives from this a distribution in respect of shares in a winding-up
- within two years after the distribution, the individual continues to be part of a similar trade or activity
HMRC brought in this measure to target individuals who are closing their company and then setting up another company again soon after. `Phoenixing’ is the term given, when taking advantage of the tax efficiency of the Capital Distribution route.
Further HMRC measure with regards to ER
There is a second less well known HMRC measure. This measure is called `money boxing.’ The term relates to the deliberate building up of cash in a company, until it finally closes down. There is no actual legislation as such to counteract this.
If the amounts involved are a) large and b) the retained profits are being invested, rather being held in a short-term deposit, HMRC may try to deny Entrepreneur’s Relief because the business is no longer a `trading company.’
Whether you are an employee of the company or not, you will need to ensure that you are a) a director and b) own at least 5% of the shares and voting rights and c) your business has been trading for at least 24 months to qualify for ER and d) when you close the company, you must dispose of your shares within three years of the company finishing trading.
When you decide to close your company, you will also need to consider which is the best route for you. It may be better for you to take all of the final balance as a Capital Distribution. On the other hand, it may be better for you to take a mix of dividends and Capital Distribution. If you are not sure which of these is best for you, please check this out with your accountant. They will be able to look at the overall picture and work out, which is the best way for you to go.
Link to Contractor Advice UK group on LinkedIn https://www.linkedin.com/groups/4660081/