Tax planning for exit – Do you qualify for Entrepreneurs’ Relief?

If you’ve spent a long time working hard on a business and building it up, you may well wish to sell it and realise a capital sum in return for what could be a lifetime’s work. I’m pretty confident that you will want to ensure that you receive the capital amount as tax-efficiently as possible. You don’t need to be doing my job for as long as me to work out that if you’re selling your business for £1,000,000, there’s a £370,000 difference between paying 47% tax on the money and paying 10%. The system is currently designed to allow you to receive that money with a 10% tax charge, providing you meet the requirements. Isn’t it time you started tax planning for exit?

What is Entrepreneurs’ Relief?

Entrepreneurs’ Relief was introduced in 2008 to help incentivise entrepreneurs to create and grow valuable businesses without having to pay a big bundle of tax on the capital sum they make when they sell the business.

With Entrepreneurs’ Relief, you pay a 10% tax charge on up to £10m of proceeds. If two of you are 50/50 in the business, you could pay the 10% tax rate on £20m of proceeds (£10m each). I’ve even seen a case where four people in a family, all of whom worked in the business and met the conditions, paid a 10% tax rate on a sum of £40m, a huge saving compared to the 28% Capital Gains Tax (CGT) at the time, which they would have had to pay if they didn’t qualify (a £7.2m tax saving!).

If you’re selling your shares, Entrepreneurs’ Relief works on some clearly set out conditions and unsurprisingly, HMRC are strict in applying the conditions – you either meet the conditions and get the relief, or you don’t meet the conditions and you don’t.

If you’re selling shares, the conditions are as follows:

  • The company is a trading company
  • The individual shareholder is an officer or employee of the company (or the Group)
  • That individual owns 5% or more of the ordinary share capital
  • That ordinary share capital carries 5% or more of the voting rights.

Crucially, the conditions for Entrepreneurs’ Relief apply over a 12-month period leading up to the sale, so to qualify you must meet those conditions every day within that 12-month period.

For this reason, if you’re thinking about or expecting to sell your business in the future, I would strongly recommend that you speak to a tax specialist and review your eligibility for Entrepreneurs’ Relief and other forms of tax planning for exit.

Do you qualify?

Nine times out of ten, the shareholders I speak to qualify, but it’s the one in ten, the case with a little wrinkle in it, that I watch out for. I’ve never sat down with somebody who didn’t think they would get the relief based on a high-level review, but I’ve come across enough people who didn’t meet the criteria after a detailed review, because of some little quirk or misunderstanding of the facts.

Here are a few examples of people who thought they qualified but didn’t:

  • This individual was convinced they had 5% of shares. Actually they had 4.9999% so didn’t qualify! (The ‘spreadsheet‘ was rounding up and showing their shareholding as 5%!)
  • Another individual resigned their directorship just days before the sale to “save time on the day”, and therefore missed out.
  • Occasionally I speak to someone who is convinced that they are a director of their business, as are their colleagues, but upon inspection they weren’t registered as a director at Companies House, and therefore didn’t qualify for the Relief. 

When should you start tax planning for exit?

It’s always going to be helpful to start your planning in good time – definitely more than 12 months before the expected sale date. If you don’t check your eligibility until you’re about to sell, and subsequently discover that you don’t meet one or more of the conditions, you could find yourself in a difficult position where you either have to try to push back the sale or pay a higher rate of tax. Paying 20% instead of 10% tax on £5m of proceeds is an additional £500,000 tax bill, and I’ve never met anyone who likes to receive an extra £500,000 tax bill out of the blue! If the buyer’s not in a position where they can wait another 12 months, you will have to pay the higher rate of tax or risk losing the sale. Planning in good time ensures you are clear about your eligibility so that you don’t find yourself in this position.

As a first step, we would do a formal review of your eligibility, to ensure you meet the criteria and are not the “one in ten” for which this presents a problem. You never know when someone is going to come in and make you an offer you can’t refuse, so it’s best to have ‘your ducks in a row’, be ready to accept their offer and know you’ve had your tax position analysed and qualify for the 10% rate.

Other things to think about when tax planning for exit

It’s important to emphasise that your eligibility will very much depend on your individual circumstances and tax affairs. This article is about the sale of shares, but in other cases the conditions for meeting Entrepreneurs’ Relief can get more complex. For example, if you run a business from a commercial property that you own outside of the limited company (a common situation), but the buyer only wants to purchase the business and not the property, the scale of complexity increases.

You should also give serious thought to the form of consideration and deal structure (and the resulting tax implications), particularly with deferred or performance-related consideration, where you work for the purchaser after the initial sale. Finally, promises made ‘on a handshake’ without the appropriate paperwork, such as, “My Dad gave me £5,000 when I started the business ten years ago, and I promised him 10% of the proceeds if I ever sold it” also add to the complexity.

In conclusion, if you think that you will sell your business at some point in the future, it’s best to speak to a tax specialist to ensure you meet the Entrepreneurs’ Relief criteria and can benefit from the lower rate of tax when the sale occurs.

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