A big part of my job is advising small business owners how to extract profits from their companies in the most tax efficient way. We’ve looked at Dividends, Salary and Pensions all of which work well but you may or may not have heard of “entrepreneurs relief”.
Entrepreneurs Relief can be hugely beneficial in reducing your tax liability should you sell part or all of your business or even just close it. Let’s take a look at what it is and how it works.
Entrepreneurs Relief has been around a while but since 2011 if you sell part or all of your business you can claim a reduced Capital Gains tax rate of just 10% on any proceeds. (we’ll deal with closing your business later).
When you sell an asset, which your business is, you are taxed on the profits under Capital Gains Tax (CGT) which is paid via Self-Assessment.
Currently you are permitted to receive the first £11,300 tax free and then excess profits are taxed at the a rate of 20%. This rate already represents a pretty good deal if you consider that you may well sell a business for several hundred thousand pounds (maybe millions).
The standard rate of CGT of 20% represents a much better rate than if the gain was treated as income and taxed at 20%, 40% and 45%.
If your sale qualifies for Entrepreneurs relief however then the standard rate of CGT (20%) is halved to just 10%. Currently Entrepreneurs relief has a lifetime allowance of £10m which means you’re unlikely, unless extremely fortunate, to exceed the available allowance.
Of course there are some qualifying rules!
- Your company needs to be a trading company (more than 20% of turnover from “Trade”)
- Your company should be active for at least 1year prior to sale or cessation of trade.
- You need to hold 5% or more of the shares
- If selling part of the company that part needs to be able to trade as standalone business
Non-trading activities include investment activities, property development, and licencing arrangements.
What if you close your company rather than sell it?
If your company has large retained cash profits and a sale isn’t practical, then its possible Entrepreneurs relief can offer an attractive route to removing the cash.
HMRC would normally want you to remove the additional funds by taking dividends but depending on how quickly you want to draw the money and how much is left in the business this can be expensive.
It is possible that you could close your company and withdraw the funds as a capital gain and claim entrepreneur’s relief and therefore reduce your tax liability to just 10% on the retained profits.
Again, there’s a catch!
- It must be a genuine cessation of trade.
That means you can’t close a business this year, claim Entrepreneurs relief and then start a similar trade within 2 years. If you do HMRC will argue that no cessation of trade occurred and you’ll be forced to treat the withdrawal as Dividend and pay any difference in tax and interest.
Entrepreneurs relief offers a fantastic benefit if you genuinely build and sell a business.
Theoretically If you could regularly build a business without withdrawing any payment and sell that business for a profit you could keep your personal tax rate to just 10% on your first £10m of earnings… (we should all be in the business of buying and selling businesses)
Entrepreneurs relief also offers a somewhat risky opportunity to reduce your tax on retained profits when closing a company. Just ensure that you don’t return to that trade within 2 years.