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

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Introduction 

First, what is Entrepreneur’s Relief (ER), and how do the Entrepreneurs’ Relief rules work for UK contractors? Further to this, how does UK Entrepreneur Relief for contractors work when a UK contractor chooses to close their limited company due to having finished UK contracting? Also known as Entrepreneur Tax (UK), how do you qualify for Entrepreneur’s Relief when the time comes round to closing your limited company? In this guide, we’ll consider the contractor Entrepreneurs’ Relief 2023 tax rate and the various Entrepreneur’s 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 very tax efficient, however you need to 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 business partner.
  • You dispose of or sell shares in all or part of your business (limited company).

Capital Gains Tax (CGT) applies when there’s a disposal of assets by an individual. ER (BADR) is a business disposal relief which is available and helps reduce the CGT, if you meet ER (BADR) conditions. As a limited company contractor, you may be able to claim Entrepreneurs’ Relief (limited company) when your personal 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) that you’ll pay as part of the final pay-out from your company.

Initial thoughts

Entrepreneur Tax Relief 2023 -UK contractor close down limited company 

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

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

We now turn to the balance that 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 the final balance can be paid 

The final balance from your UK contracting company is payable as either dividend or as Capital Distribution. It can also be paid 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 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.

Common questions

As a UK contractor or limited company owner, closing your business, you may have several questions regarding ER / BADR. Therefore, these may include:

  • What is Entrepreneur Relief?
  • How does Entrepreneurs Relief work?
  • What is Entrepreneur Tax Relief?
  • What is Business Asset Disposal Relief?
  • How does Entrepreneurs Tax Relief work?
  • How to claim Entrepreneurs Relief?
  • What is Entrepreneurs Relief called now?
  • How to claim Entrepreneurs Relief on tax return?

In this guide, we’ll consider all the above and see how ER / BADR works in practice.

Entrepreneur Tax Relief when closing 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 currently have an annual CGT allowance of £12,300 in 2022/23 (this is decreasing to £6,000 in 2023/24). Let’s suppose in the year of your company’s closure, the shareholders each have no other qualifying gains. In that case, the first £12,300 of your and any other shareholder’s Capital Distributions will be tax-free. If you’re eligible for HMRC Entrepreneur’s Tax Relief (BADR tax relief), any additional Capital Distribution amounts above £12,300 is 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 UK Entrepreneurs Relief 2023 works and how to claim for ER (BADR) 

HMRC Entrepreneur’s Relief conditions / Business Asset Disposal Relief conditions 

There are three main Entrepreneur’s Relief qualifying conditions which you need to 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 be claiming BADR relief (HS275). You can view the HMRC customer forum on 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. Basically, an officeholder means being a company officer, e.g., a director. Alternatively, you could have been a sole trader. You 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 (entrepreneur’s relief – trading company).

When you meet the above conditions, your disposal can then be shown to be qualifying for Business Asset Disposal Relief (limited company). Under HMRC Entrepreneur’s Relief conditions, when you close your company, you must also 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 also be available when someone is selling their business or part of their business. 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. Key to note, 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 Entrepreneur’s Relief on Self-Assessment

This is usually a task for your accountant and when they complete your tax return, and the disposal needs to 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 pay-out from the company less the cost of the original shares that you disposed of when your company closed. Next, you will need to indicate that the gain is subject to ER (BADR) within the Capital section.

The time frame to claim ER / BADR tax relief 

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

Tax year Covers Time frame to claim ER (BADR) by
2020/21 Year to 5 April 2021 31 January 2023
2021/22 Year to 5 April 2022 31 January 2024
2022/23 Year to 5 April 2023 31 January 2025
2022/24 Year to 5 April 2024 31 January 2026

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 that you report Entrepreneurs’ Relief correctly. 

HMRC Entrepreneur’s Relief anti-avoidance measures 

Anti-avoidance measure `Phoenixism’ -Entrepreneur’s Relief 2-year rule 

HMRC brought in 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. It also applies to any number of shareholders who are company directors. The shareholders also need to have received a distribution from their company. Therefore, this is capital rather than income to obtain a tax advantage.

The ER / BADR 2-year rule is a measure which applies to a distribution made when a company closes. As a result, the distribution will be 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 brought in the Entrepreneur’s Relief 2-year rule measure to target UK contractors and other individuals who were closing their company and 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 regarding Entrepreneurial Relief -`Moneyboxing’ 

There is a second less well-known HMRC measure called `moneyboxing‘. The term relates to the deliberate building up of cash in a company until it finally closes. There is no actual legislation as such 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’ll need to satisfy the ER / BADR conditions to qualify for contractor ER. Therefore, to recap, you’ll need to ensure that you meet the following three main conditions:

  • You own at least 5% of the shares and voting rights.
  • You are 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 thinking about 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 of these is best for you, 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: January 4th, 2024 / Categories: Closing Your Company /

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