Entrepreneurs’ relief needs perfect timing. A recent tribunal considered a disputed claim for entrepreneurs’ relief (ER) by a former director in respect of shares sold in a company which he helped establish. The case centered on the timing of the sale. What’s the timing got to do with it?
ENTREPRENEURS’ RELIEF (ER)
The government continue to find ways to restrict where capital gains tax relief in the form of entrepreneurs’ relief (ER) can be claimed, but it can still be a very valuable tax break. It offers business owners a 10% tax rate on gains they make from selling part or all of their business. There are many conditions to meet but with the right planning, they are relatively straight forward.
ER BASIC CONDITIONS
The conditions for ER differ slightly depending on whether your business is incorporated or not. For company shares the following must apply for at least one year before you sell them:
- the company’s, or group of companies, main activities involve ‘trading’
- you own at least 5% of ordinary shares and voting rights in the company
- you’re an employee, director or company secretary of the company (or one in the same group of companies)
THE CASE IN QUESTION
Mr Moore (M) founded Alpha Micro Components in 1995 with two colleagues. He owned 30% of its shares. A disagreement between M and his fellow directors culminated in M’s resignation and an agreement that the company would buy back his shares. The share purchase agreement and the resignation were noted in the company records in May 2008, but these stated that the date M resigned was in February 2008.
The share sale went ahead and in due course M declared the resulting capital gain on his tax return and claimed ER of £37,500. As frequently happens when ER is claimed HMRC reviewed M’s tax return and following an enquiry refused the claim. M appealed to the First-tier Tribunal (FTT).
HMRC argued that while M met the first two conditions he failed to meet the final one because he had not been a director or employee at the time of the share sale; he had resigned three months earlier. Trap: A break between being a director or an employee and selling shares in a company, even for a day, will mean that ER can’t be claimed.
At the FTT M conceded HMRC’s point over timing, but then argued that ER was still due because a binding agreement to sell his shares had been reached at the time he resigned. That would have preserved M’s right to ER. The FTT quickly unearthed facts that didn’t support this either. The company had not been in a financial position to make an agreement. It seemed to be more a situation that M had resigned and left the company suddenly.
If you are in a similar position to M, or you intend to sell shares in your company for any other reason, you should remain a director until the sale or until a definite agreement for sale is reached.
Where it’s not possible to remain a director, negotiate an agreement (in writing) that they retain some role in the company as an employee. It can be a loose arrangement, and unpaid; as long as it’s genuine it’s sufficient for ER purposes.
The director’s claim for ER failed because he resigned shortly before he sold his shares. You must be a director or employee at the time shares are sold or at least have a binding sale agreement. Agreeing to work as an employee under a loose arrangement, even unpaid, will be enough to avoid ER being lost.