Entrepreneur's Relief (Business Asset Disposal Relief) for UK contractors

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Introduction 

First, what is Entrepreneurs’ Relief 2024, and how do the rules work for UK contractors? Further, how does UK Entrepreneur Relief for contractors work when a UK contractor chooses to close their limited company due to having finished UK contracting? In this guide, we’ll look at the tax relief for entrepreneurs and how the rules work for this. Also known as Entrepreneur Tax (UK), how do you qualify for Entrepreneurs’ Relief (ER) when closing your limited company? Our guide will consider the contractor ER tax rate and the various Entrepreneurs’ Relief conditions. It’s worth pointing out that contractor Entrepreneur Relief (UK) is now called Business Asset Disposal Relief (BADR). However, we’ll refer to ER for ease of reference. When you close a limited company, taking the Entrepreneur Tax relief route is tax efficient. However, to qualify, you must meet the ER conditions.

Key to note, Entrepreneur Tax Relief (UK) is available to individuals when:

  • You sell all or part of your business as a sole trader or partner in a partnership.
  • You dispose of or sell shares in all or part of your business (limited company).

Capital Gains Tax (CGT) applies when an individual disposes of assets by an individual. ER (BADR) is a business disposal relief that helps reduce the CGT if you meet ER (BADR) conditions. As a limited company contractor, ER may be claimable when your company has ceased trading and you dispose of your ordinary share capital as part of your company’s closure. Indeed, this is because you’ve made a contractor business disposal of your former company. In turn, you can claim tax relief on your contractor’s disposal of the business, and the ER tax relief reduces the amount of Capital Gains Tax (CGT) you’ll pay as part of the final payout from your company.

Initial thoughts

Entrepreneur Tax Relief 2024 & what to consider for UK contractor limited company closure? 

As a limited company contractor, once you decide to close your UK limited company, the following steps for the contractor/business owner timeline to take are:

  • Ask your contractor accountant to prepare and finalise the company’s last set of contracting accounts until it stops trading.
  • File the final set of contractor accounts and a company tax return with HM Revenue & Customs (HMRC).

We now turn to the balance which remains in the business. This might be a large amount of cash on some or even many occasions. The remaining balance is payable to the shareholders in their respective share ratios.

How do you pay the company’s final balance? 

The final balance from your UK contracting company is payable as either a dividend or a Capital Distribution. Indeed, it can be paid using a combination of these methods.

The dividend route is usually far more costly. The highest tax rates on dividends are currently 33.75% or 39.35%.

So, most limited company contractors and small business owners will opt for the Capital Distribution route.

When your company distributes the Capital Distributions, the shareholders dispose of their share capital.

Entrepreneur Tax Relief when closing the company

If you qualify for Entrepreneur Tax Relief (please see the three conditions in the next section for what qualifies for BADR), the CGT rate is 10% on any Capital Distributions. Under CGT rules, individuals have an annual CGT allowance of £3,000 in 2024/25 (£6,000 in 2023/24). Suppose the shareholders each have no other qualifying gains in the year of your company’s closure. In this case, the first £3,000 of your and any other shareholder’s Capital Distributions are tax-free. If you’re eligible for HMRC Entrepreneurs’ Tax Relief (BADR tax relief), any additional Capital Distribution amounts above £3,000 are taxable at 10%.

The income tax rates you pay don’t affect ER or BADR. Therefore, basic and higher-rate taxpayers pay tax on their Capital Distributions at 10% if they meet the ER (BADR) qualifying conditions.

How does UK Entrepreneurs Relief 2024 work & how can you claim ER (BADR)? 

HMRC Entrepreneurs’ Relief conditions/Business Asset Disposal Relief conditions 

There are three main Entrepreneurs’ Relief qualifying conditions that you must meet when you close your UK contractor limited company and claim ER. As mentioned, the new name for Entrepreneurs Relief is Business Asset Disposal Relief. Therefore, when you close your company, it will claim BADR relief (HS275). You can view the HMRC customer forum in this area to view any public questions.

Therefore, you’ll qualify for contractor Entrepreneur Relief (limited company) when you sell or close your business if you meet the following Entrepreneur Relief qualifying conditions:

  • The individual disposing of the shares must own at least 5% of the shares in the company. They must also have 5% of the voting rights.
  • When disposing of the shares, you must be either an employee or officeholder of the company. An officeholder means being a company officer, e.g., a director. Alternatively, you could have been a sole trader. You must have been so for at least 24 months leading up to the date of the disposal.
  • The business must have been a company of a trading nature for at least 24 months leading up to the date of the share disposal (entrepreneurs’ relief – trading company).

When you meet the above conditions, your disposal will qualify, and you can claim Business Asset Disposal Relief (limited company). Under HMRC ER (BADR) conditions, when you close your company, you must dispose of your business assets within three years to qualify for relief. Furthermore, you could lose a claim for contractor ER if you resign as a director before disposing of your shares.

Further notes on claiming ER/BADR

Entrepreneurial Tax Relief may be available when someone sells their business or part of it. This includes both certain assets within a partnership or, indeed, shares or securities in your company. There’s no limit on how many times you can claim contractor ER. There are changes to Entrepreneurs Relief from time to time, and the HMRC Entrepreneurs Relief Lifetime Limit (now Business Asset Disposal Relief Lifetime Allowance) of £10 million was reduced to £1 million in the March 2020 Budget.

How to claim Entrepreneurs’ Relief on Self-Assessment?

This is usually a task for your accountant, and when they complete your tax return, the disposal must go in the Capital Disposal section. This is part of the Capital Gains Tax Area on the Self-Assessment tax return. The actual gain is the final payout from the company, less the cost of the original shares you disposed of when your company closed. Next, you should indicate the gain is subject to ER (BADR) within the Capital section.

What is the time frame for claiming ER/BADR tax relief? 

When you claim for tax relief under contractor BADR / ER, there’s a timeline to meet. Therefore, it’s important to remember to qualify for ER, the following specific time frames apply:

Tax year Covers The time frame you must claim ER (BADR) by
2021/22 Year to 5 April 2022 31 January 2024
2022/23 Year to 5 April 2023 31 January 2025
2023/24 Year to 5 April 2024 31 January 2026
2024/25 Year to 5 April 2025 31 January 2027

When you claim for contractor ER (BADR), you can do this via the `Capital Gains Summary’ section of your Self-Assessment Tax Return.

Indeed, it would help if you spoke to your accountant about this to ensure you report ER/BADR correctly. 

HMRC Entrepreneurs’ Relief anti-avoidance measures 

Anti-avoidance measure `Phoenixism’ 

HMRC introduced a TAAR (Targeted Anti Avoidance Rule -CTM36305) in April 2016. With the update from ER to BADR, this is now known as Business Asset Disposal Relief anti-avoidance.

The Phoenixing rules (HMRC) scenario applies to `close companies’ with five or fewer shareholders. Indeed, it applies to any number of shareholders who are company directors. The shareholders should have also received a distribution from their company. Therefore, this is capital rather than income to obtain a tax advantage.

The BADR/Entrepreneurs’ Relief 2-year rule is a measure which applies to a distribution made when a company closes. As a result, the distribution is income (not capital) where you meet the following conditions:

  • An individual who’s a shareholder in a close company receives from this a distribution in respect of shares in a winding-up.
  • Within two years up to the date of the distribution, the individual continues participating in a similar trade or activity.

HMRC introduced the ER/BADR 2-year rule measure to target UK contractors and other individuals who were closing their companies and setting up another soon after. `Phoenixing’ is the term used when taking advantage of the tax efficiency of the Capital Distribution route.

A further HMRC measure on Entrepreneurial Relief 

There is a second, less well-known HMRC measure called `moneyboxing‘. The term relates to the deliberate accumulation of cash in a company until it finally closes. There is no actual legislation to counteract this.

If the amounts involved are a) significant and b) the retained profits are being invested rather than being held in a short-term deposit, HMRC may try to deny ER/ BADR tax relief because the business is no longer a `trading company.’

Final thoughts 

Whether you’re an employee of the company or not, you must satisfy the Entrepreneurs’ Relief/Business Asset Disposal Relief conditions to qualify for contractor ER. Therefore, to recap, you must ensure you meet the following three main conditions:

  • You own at least 5% of the shares and voting rights.
  • You’re an employee or officeholder (director).
  • Your business has been trading for at least 24 months to qualify for ER / BADR relief.

In addition, when you close the company, you must dispose of your shares within three years of the company finishing trading.

Finally, when you close your company, you must consider the best route before claiming BADR (ER). It may be better for you to take all 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 and claim Entrepreneurs’ Tax relief (UK). If you’re unsure which is best, please check this out with your accountant. They’ll be able to look at the overall picture and find the best tax-efficient route for you.

Link to Contractor Advice UK group on

LinkedIn    https://www.linkedin.com/groups/4660081/

Published On: April 6th, 2024 / Categories: Closing Your Company /

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