Good-Bye to Entrepreneur’s Relief on the "Goodwill" of the business
The knock-on effect of one of the latest anti-avoidance measures by government has kicked Entrepreneur’s Relief (ER) into the long grass. This means that businesses – on any transactions made on or after 3 December 2014 – are no long able to benefit from the 10% tax on any gains.
Why hit small businesses again?
The Chancellor announced in his Autumn Statement 2014 that Entrepreneur’s Relief (introduced in 2008) will no longer be available to reduce tax. This is because government suspects that ER has sometimes been used to extract funds from a business at the reduced 10% CGT rate rather than the normal rates of Income Tax and NI Contributions (18% or 28%). As the explanatory note to the draft legislation reads: "... together these measures remove two incentives which encourage incorporations of businesses for tax reasons rather than for the genuine commercial benefits which may follow from a business being carried on by a company rather than by an individual. HMRC has observed an increasing trend amongst professionals and specialist traders to incorporate their businesses in order to gain these tax advantages."
So what was Entrepreneur’s Relief?
In the past, for example, had a sole trader incorporated their business, tax relief was available on incorporation of an existing business or sale of one business to another, and relates to the "goodwill" associated with the business – its reputation and customer relationships. These "intangible assets" could be sold on to a close company related to the seller.
How did it work?
Some businesses hold great value in "goodwill" – be that reputation, customer relationships or the value of continuing contracts – when they incorporate or sell on to another company, and these were transferrable to the company alongside other assets. In 2008, it was perceived that as the company that takes over the trade is unlikely to have the funds to pay the seller for the assets transferred, the goodwill of the business could be held on account within the company that bought it.
After deducting generous CGT annual exemption from the value of the goodwill, the seller pays 10% CGT (claiming ER) on the balance. The seller then gradually extracts funds equal to that balance, as tax-free and NI-free payments from the company, as the CGT has already been paid.
The government has decided that the combination of 10% tax for the business founder, plus corporation tax relief for the successor company, on a value which is difficult to prove with any accuracy anyway, is an abuse of the tax rules.
What do the new rules mean when selling on a business?
The change has been made alongside another measure to restrict Corporation Tax deductions when goodwill is acquired from a related party on incorporation. The change has been made to remove unfair advantage to owners of businesses who sell on the business to a close company and benefit from a lower Capital Gains Tax rate. The measure will apply to disposals of goodwill to a related close company on or after 3 December 2014.
ER on incorporation, what are the new rules?
Where a business wants to incorporate, other CGT reliefs to reduce or defer any capital gains arising are available. For example, incorporation relief (TCGA 1992, s 162) will automatically apply where all assets (not cash) of the business are transferred to the company. Alternatively (providing that section 162 is not applied), holdover relief can be claimed on the gains that arise, on an asset-by-asset basis (TCGA 1992 s 165).
However, incorporation relief or holdover relief will neither roll the gain into the value of the new shares of the company nor into the base-cost of the assets held by the company. In either situation the seller is still unable to drawdown anything tax free from the company.
Please contact your account manager for further clarification, and certainly contact us should you be planning on incorporating or selling on your business.