Overview of business asset disposal relief

For 2019/20 and earlier years, the relief was known as Entrepreneurs’ Relief. The relief applies for capital gains tax (CGT) purposes only. The effect of BADR is to reduce the rate of CGT payable on qualifying gains to 10% (compared to the current standard rate of CGT for higher/additional rate taxpayers of 20%).

Broadly, disposals by individuals qualify for relief if they are the disposal of whole or part of a business, for example by a sole trader or partner, or the disposal of shares in a trading company of which the individual is an employee and meets the minimum shareholding requirement (see later).

A disposal of assets used in a business may also qualify for relief provided the disposal was ‘associated’ with a ‘material disposal’, i.e. of the business itself or interest or shares in the business. The relief is also available for a disposal of assets, or of interests in such assets, which were used for the purposes of a business that has now ceased, provided they were in use for those purposes at the time of cessation.

The relief can also be available to trustees. However, for the purposes of this article I focus purely on individuals.

Qualifying capital gains for each individual are subject to a lifetime limit as follows, for disposals on or after:

• 6 April 2008 to 5 April 2010 - £1 million
• 6 April 2010 to 22 June 2010 - £2 million
• 23 June 2010 to 5 April 2011 - £5 million
• 6 April 2011 to 10 March 2020 - £10 million
• 11 March 2020 - £1 million

An individual must make a claim for BADR either via their self-assessment tax return or in writing to HMRC by the first anniversary of 31 January following the end of the tax year in which the qualifying disposal takes place. So, for a qualifying business disposal which takes place in the 2021/22 tax year, a claim for BADR must be made by 31 January 2024.

A sale of whole or part of a business

An individual carrying on a trade, either as a sole trader or through a partnership may qualify for BADR on disposing of their interest in the business.

To qualify for relief, both of the following must apply for at least two years up to the date that the business is sold:

• the individual must be a sole trader or business partner, and
• they owned the business for at least two years.

Sale of shares or securities

To qualify for relief, the following must apply for at least two years up to the date that the shares are sold:

• the individual must be an employee or director of the company (or one in the same group), and
• the company’s main activities must be trading (so shares in an investment company would not qualify), and
• the company in which the shares (or securities) are held needs to be the taxpayer’s ‘personal company’.

This means the taxpayer must hold at least 5% of both the ordinary share capital and voting rights of the company, and also:

• either be entitled to at least 5% of the company’s distributable profits, and, in a winding up, have an entitlement to at least 5% of the company’s assets, (which must come from the individual’s own holding of ordinary share capital), or
• be entitled to at least 5% of the proceeds in the event of a company sale.

For the final two conditions, it is not necessary that a distribution is made, a winding up takes place, or the company is sold. The conditions are based on what the individual would be entitled to if those events happen.

As mentioned above, the company must be a trading company or holding company of a trading group. The legislation defines a trading company as one which is ‘carrying on trading activities whose activities do not include, to a substantial extent, activities other than trading activities’.

HMRC consider a ‘substantial extent’ to mean ‘more than 20%’. In practice, the 20% test is applied to various criteria such as turnover, asset base, management time, expenditure, etc., and will depend on the facts and circumstances of each case.

A company, group or subgroup whose non-trading activities amount to more than 20% of its total activities does not meet the trading requirement. Activities other than trading activities will include any investment-related activities such as property investments, investment portfolios and holding excess cash on deposit.

Example

Ezra is an additional rate taxpayer. He runs a technology company with his brother. In September 2020 he sells 60% of his 50% shareholding to his brother for £550,000. He acquired the shares for £200,000 in February 2011. He has been a Director since July 2014. Ezra claims BADR in respect of the gains on the shares.

His capital gains tax liability for 2020/21:

Proceeds                                  £550,000

*Less cost                             (£120,000)

                                                £430,000

Less annual exemption          (£12,300)

                                                £417,700

CGT payable £41,770

*£200,000 x 60% of his 50% holding = £120,000

He now has a 20% holding in the company.

In May 2021, Ezra decides to sell his remaining shareholding to his brother for £300,000.

His capital gains tax liability for 2021/22:

Proceeds                                  £300,000

*Less cost                               (£80,000)

                                                £220,000

Less annual exemption          (£12,300)

                                                £207,700

 

CGT payable £20,770

*£200,000 x 40% of his 50% holding (or £200,000 - £120,000) = £80,000

As an additional rate taxpayer if the disposals had not qualified for BADR he would have paid CGT of £125,080 (i.e. £83,540 (£417,700 x 20%) + £41,540 (£207,700 x 20%)) as opposed to £62,540 thereby saving CGT of £62,540.

This example illustrates that it is possible for an individual to make more than one claim for BADR up to the total of the lifetime allowance which is currently set at £1 million.

It also shows that it is not necessary to dispose of an entire shareholding to qualify for relief. A sale of some of the shares will qualify for BADR provided the conditions for the relief are met.

Further, for married couples or those in a civil partnership, each individual is able to benefit from their own lifetime limit on qualifying capital gains in respect of BADR. This means that where both partners have an interest in a company, there may be planning opportunities to maximise the available relief under BADR. It may be possible to employ a partner in the business and transfer sufficient shares to them so they can also benefit from relief upon future sale. And, if they do work in the business, employer pension contributions could be paid on their behalf to build a retirement fund and maximise tax savings. Paying pension contributions for employees will also help reduce any excess cash which is held in the business account which could otherwise impact on the ‘20%’ substantial test mentioned above.