Capital Gains Tax (CGT) has a main rate of 20% (reduced from 28% in April 2016) other than for basic rate taxpayers who now have a rate of 10%. However, a higher rate of 28% continues for the disposal of residential properties. Importantly, Entrepreneurs’ Relief (ER) can allow a tax rate of 10% to apply for ‘qualifying business disposals’ on the first £10 million of capital gains in an individual’s lifetime. ER is an important relief; so how does it work for shares?
What is a ‘qualifying business disposal’?
In order to qualify for ER there must be a qualifying business disposal. The following are qualifying business disposals:
- A material disposal of business assets
- A disposal of trust business assets
- A disposal associated with a relevant material disposal
What is a material disposal of business assets?
- A disposal of the whole or part of a business – where the individual has owned the business for the year leading up to the date of disposal
- A disposal of assets in use for the purposes of the business where the business ceases to be carried on – if the disposal is made within three years and the individual owned the business for the year preceding the cessation
- A disposal of shares or securities of a company – if one of the following conditions is met:
Condition A – throughout the year preceding the disposal (i.e. 12 months):
- The company is the individual’s ‘personal company’
- The company is a trading company or holding company of a trading group, and
- The individual is an officer or employee of the company or trading group.
Condition B – where the company has, within the three years preceding the disposal, ceased to be either a trading company or a member of a trading group, the terms of Condition A above must be satisfied throughout the year preceding the cessation.
For the purposes of ER, an individual’s personal company is one in which they hold at least 5% of the ordinary share capital of the company and have at least 5% of the voting rights in the company. These conditions are relaxed for members of qualifying share option schemes.
A trading company or trading group is defined as one which carries on trading activities and does not carry on other activities to a substantial extent. This is the same as the definition that applied for holdover relief and substantial shareholding exemption purposes.
What is a trading company?
HM Revenue & Customs’ (HMRC) must be satisfied that the strict “trading company” definitions are met. In the case of a single company, it must be “a company carrying on trading activities, whose activities do not include, to a substantial extent, activities other than trading activities”. In practice, HMRC applies a 20% benchmark to determine a substantial level of non-trading activities. HMRC will look at the factors affecting each case but, as an example, it may review contribution to profits, assets employed, expenses and management time (see HMRC manuals at CG64090). As this is a subjective area, it is necessary to consider each case on its own merits.
In terms of a trading group, the definition is much the same as a sole trading company. A trading group is a 51% group of companies where the activities of the group do not include any non-substantial, non-trading activities. Any intra-group transactions are ignored.
Can I get guidance as to the company’s trading status?
A non-statutory clearance can be requested from HMRC and guidance can be found in the HMRC manuals at CG64100 which states:
“The company itself may have genuine doubt or difficulty as to its trading status. There is no statutory clearance procedure under which companies can have their status confirmed. However, in such circumstances a company can seek from HMRC an opinion under the terms of the Other Non-Statutory Clearance service as to its trading status for the purpose of a shareholders Entrepreneurs’ Relief claim.”
Advisers may wish to consider obtaining a tax clearance if there is doubt about the trading status of the company to underpin a subsequent for ER on the disposal of shares.
As with all such tax situations, advice should also be sought before proceeding. For further details please get in touch.
