Entrepreneurs’ relief rules made tougher
Generally, a period of roughly 3 months elapses between the publication of a Finance Bill and that Bill becoming law. This allows for the Bill to be scrutinised and gives HMRC time to correct errors and to publish guidance on how the law will be applied. This time around, and because of the Election, it took only two days for Finance Bill 2015 to become Finance Act 2015, meaning that no meaningful scrutiny was possible.
The ramifications of this will become clear over time but already we are concerned that some of the changes targeting avoidance could go further than HMRC intended, catching some genuine commercial arrangements. And nowhere is this more true than with regard to entrepreneur’s relief (ER).
ER is an important relief as where it is due the tax rate on a disposal is 10% rather than 28%. However, it is notoriously complicated and many people miss out on it because they fail to take account of the rules in the years running up to a disposal. FA 2015 makes a number of changes to the rules for ER, mainly to tighten them with the purpose of preventing avoidance. However, in our view the rules go further than this in some cases and could be capable of wider application, particularly with regard to family businesses.
The position will become clearer when HMRC publish guidance on the changes but in the meantime if you are considering making a disposal where ER could be due, we would suggest you take appropriate advice. Missing out on ER could be an expensive mistake to make!
An individual who qualifies for ER on the disposal of an interest in a partnership or shares in a trading company may also qualify for ER on an associated disposal; that is, a disposal of an asset owned by the individual but used in the business of the partnership or the company. A good example would be a medical partnership where the property from which the practice is carried on is owned by one or more of the partners personally.
At Budget 2015 it was announced that the associated disposals rules would be tightened. Briefly, HMRC were concerned that an individual could benefit from ER on an associated disposal without making a ‘meaningful’ withdrawal from the partnership or company. To address this, FA 2015 makes a number of changes to the rules with effect from 18 March (Budget Day). These include the introduction of two new conditions which must be met for relief on an associated disposal to be available:
1. the individual must dispose of at least at 5% interest in the partnership’s assets or at least a 5% interest in the company’s share capital;
2. and at the time of the disposal, there must be no arrangements in place for the person making the disposal (P), or a person connected with P, to acquire an interest in the partnership or shares in the company.
The application of both of these new conditions is unclear. For example, what is meant by an “interest in the partnership’s assets”? Also, is one business partner connected with another for these purposes? If so, ER could be denied on an associated disposal where the disposal of the interest in the partnership is to one or more of the other partners.
Note that family members are connected and so it is likely that ER will be denied on an associated disposal where the disposal of the interest in the partnership or shares in the company is to a relative. If correct (and HMRC need to confirm this), this is an important change in the rules which could have significant tax implications in the context of a family business.
The disposal of goodwill by a sole trader/partnership to a company
Before Autumn Statement 2014 (3 December 2014), it was common for a sole trader/partner who transferred the goodwill attaching to his/her business on the incorporation of that business to benefit from ER.
Going forward, this will only be the case where the person making the disposal (P) is not connected with the company at the time of the disposal.
Thankfully, there is an exception for retiring partners. This is to cover the situation where a partner decides to retire from the partnership and at the same time the business is transferred to a company. Without this exception, P would not be able to claim ER on the disposal of the goodwill because he/she would be connected with the company by virtue of being connected with the partners who become shareholders in the company. This exception means that the retiring partner can claim ER provided that they are not connected with the company in any other way.
Unfortunately, there will be many other commercial situations where ER may be denied. For example, where the disposal is to a company in which a family member owns shares, and where the disposal is to a third-party company but the consideration is part cash and part shares.
Changes to the meaning of “trading company” and “trading group”
It is a condition of ER on a disposal of shares in a company that the company is a trading company or the holding company of a trading group. In response to concerns that the rules in this area where being abused, HMRC have changed the rules to tighten the definition of “trading company” and “trading group” where the company/group has an interest in a joint venture company or a partnership.
Again, the revised rules aren’t particularly clear and we are waiting on guidance from HMRC to clarify the situation. However, it would appear that the changes go further than putting a stop to avoidance and will impact on some structures put in place for genuine commercial reasons.
However, it’s not all bad news. In the one positive change made to the rules by FA 2015, ER is extended to gains deferred into investments made under the Enterprise Investment Scheme (EIS). Who says HMRC doesn’t have a heart?