TT126: Entrepreneur Relief – Asset Sale Pitfalls
Historically, under Taper Relief, you could sell a business asset after two years of ownership and any capital gain would be taxed at 10%.
Not only did the shares in an unquoted trading company or an interest in a partnership count as business assets, but any property used in the trade of an unquoted limited company or partnership also qualified, even if it were held outside the business in personal names. The property owner could charge rent to the business and this would not have an impact on the rate of tax on a future capital gain.
With the demise of Taper Relief, from April 2008 a new regime has existed for taxation of capital gains on business assets. See TT104 for the major details of the change. Although a flat rate of tax of 18% now applies to most capital gains, the first £1M of gains made by any individual during their lifetime on business assets is taxed at 10%. This relief is called Entrepreneur Relief (ER) and applies, for example, when the shareholder sells shares in a Personal Company (as defined), see TT111 for details.
However, business owners should be aware that the rules for assets (e.g. properties) held outside of businesses and rented to them have been changed since the days of Taper Relief.
Here we deal with our clients’ most common scenario where: they own property personally: they rent it to a limited company for use in that company’s trade; and they are working shareholders in the company. Other, similar, rules exist for businesses run through partnerships.
Remember that generally a disposal can include a sale, a gift, a transfer or a sum derived from a capital asset (e.g. compensation). It is a common misconception that a gift that realises no money is not a taxable disposal, but it is – and tax will normally be payable.
In some circumstances for business assets or gifts into trusts a holdover election can be made to avoid paying the tax and transfer the taxable gain back into the base cost of the asset for the new owner, but advice should be taken before making any gift of an asset that stands at a gain!
The new rules
To qualify to pay tax at 10% on a gain made on a sale of shares in a company you must satisfy certain employment, percentage ownership and length of ownership tests (see TT111).
This makes the company a Personal Company (as defined).
To make a gain that qualifies for ER when selling a property held personally you must satisfy additional, stringent tests compared to Taper Relief. These are:
- The individual who personally owns the property must, at the same time, make a disposal of the whole or part of their interest in the shares of the Personal Company which uses the property.
- The associated disposal of the property is made as part of the withdrawal of the individual from participation in the business of the company
- The property must be used in the business for a period of one year ending with the earlier of the date of disposal of the shares in the company or the cessation of the business of the company.
Assuming you meet the above conditions, the ER available to claim on the property will then be reduced proportionately depending upon:
- The time the asset was occupied by third parties compared to the Personal Company.
- The proportion of the asset that was used for business (e.g. one floor might be rented out as accommodation).
- The time during the period of ownership of the assets that the owner was involved in the business of the company (i.e. the company qualified as a Personal Company, see Topical TipsTT111).
- The extent to which a market rent was charged.
For example, if the property was rented out to a third party tenant for a period of time, then that proportion of the gain would not qualify for ER. Similarly, if the owner of the property charged 75% of market rent to their business then only 25% of the gain would qualify for ER.
If an individual sells the property without selling any shares in the company then no ER can be claimed on the property gain! Timing is key!
If an asset such as a building is held outside the business then any payment for its use by the business (e.g. rent) will reduce the amount of ER than could be claimed if the asset was sold in the correct way.
Barnes Roffe Topical Tips:
- Remember, ER only is claimable by individuals (or trustees under certain circumstances). Companies continue to pay corporation tax on chargeable gains.
- Beware that gifts of assets which stand at a gain are still taxable disposals and you should seek advice before making such a gift (or making a sale at below market value).
- Be very careful when selling an asset used in the business but personally owned, as planning will be needed to get ER on the sale.
- Make a decision as to whether you need the rent on the asset owned personally to ensure that maximum ER can be claimed (assuming the asset is disposed of in the correct way).