First of all, what is Entrepreneur’s Relief (ER) (this is now called Business Asset Disposal Relief), and how does this work? Well, Entrepreneur’s Relief is a relief that is available to you as an individual. The relief is available when you dispose of or sell shares in all or part of your business. In turn, this relief reduces the amount of Capital Gains Tax (CGT) that you will pay.
As a contractor, once you have decided to close your 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 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 32.5% or 38.1%.
So, most contractors will opt for the Capital Distribution route.
If you qualify for ER, the CGT rate is 10% on any capital distributions. But, under CGT rules, you currently have an annual CGT allowance of £12,300. So, if in the year of your closure you have no other capital gains, the first £12,300 will be tax-free for you. Any further amount above £12,300 will be taxable on you at 10%.
Claiming for ER
You will meet a claim for ER 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 company must also have been a trading company for at least 24 months leading up to the date of the share disposal.
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. You can also claim up to £1 million of ER relief during your lifetime. This was reduced from £10 million in the March 2020 Budget. The rates of income tax that you pay do not affect this.
The time frame for claiming Entrepreneur’s Relief
Please note, to be able to claim for ER, you will need to do this within a certain time frame:
- 2018/19 tax year (year to 5 April 2019) 31 January 2021
- 2019/20 tax year (year to 5 April 2020) 31 January 2022
- 2020/21 tax year (year to 5 April 2021) 31 January 2023
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 the retained profits are b) 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.’
When you decide to close your company, you 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/