PKF-FPM Tax Corner
QUESTION: I'm planning to sell the shares I own in my trading company in the next year. I want to avail of entrepreneur's tax relief so that my tax rate on the sale is only 10 per cent, but I'm concerned that some investments held by the company may have an adverse impact on whether I will be eligible for this relief. Will I have higher tax to pay if the company's activities are not all trading activities?
ANSWER: Entrepreneurs' relief (ER) provides relief for disposals by business owners by charging a tax rate of 10 per cent on the disposal, rather than the usual 18 per cent of 28 per cent capital gains tax rate. ER is available on material disposals of business assets which includes the sale of businesses operated as a sole trader, partnership or through a limited company. It also occasionally available of the sale of assets associated with a business. The maximum gain to which relief can apply is currently £10 million. This is a lifetime limit so an individual making a number of disposals of businesses during his lifetime may exceed the limit.
To avail of the relief the company must be a trading company or the holding company of a trading group in the 12 months leading up to the date of disposal. The definition of a trading company is based on the activities the company carries on. Essentially if a company carries on only trading activities and has no investments on the balance sheet it will meet the definition. Once there are assets on the balance sheet which constitute investments, the company must consider whether the investment activities are substantial relative to the trading activities of the business.
HMRC guidance indicates that this is a 20 per cent test, and that in considering it HMRC will consider the time spent by the directors of the company on the various activities, the income received from the activities and the value of assets held in relation to those activities. Large cash balances were considered to be a problem historically, but if the cash is not actively managed and is derived from an investment trade it is possible to argue that this does not constitute an investment activity as such. The trading test only has to be met for at least 12 months prior to the disposal so if there is concern about a company, then appropriate action can be taken well before a sale to ensure that at the point of sale the company has met the trading activities test for at least 12 months.
In order to qualify for relief you must also own at least 5 per cent of the ordinary share capital of the company, which must entitle you to at least 5 per cent of the votes. You must also be an officer or employee of the Company and all conditions must be met for at least the 12 months leading up to the disposal. Once the conditions have been met, you are at liberty to dispose of any shares or securities (including loan notes) in the company provided these meet the definition of securities, however long they have been held. Relief would extend to shares owned for a much shorter period, provided that the base level of 5 per cent has been owned for a minimum of 12 months and the officer employee test has also been met for the same period. The rules are complex and therefore specific professional advice should be sought before contemplating the disposal of your shares.
* Paddy Harty (p.harty@pkffpm. com) is director at PKF-FPM Accountants (www.pkffpm.com). The advice in this column is specific to the facts surrounding the question posed. Neither the Irish News nor the contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies.