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WOMAN SCOTLAND | Magazine

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Following on from my article in the last issue on exiting from a business, I wanted to follow up by highlighting the pitfalls some business owners encounter with regard to obtaining Entrepreneurs’ Relief (“ER”). Where a disposal of shares qualifies for ER a lower 10% rate of Capital Gains Tax applies rather than the higher or additional rate of 20%, so if ER is denied this can potentially double the tax cost of exit.

What can stop a company qualifying?
ER is only available on a sale of shares if the company is engaged in trade. This means that companies whose activity is the passive holding of investments, such as most property rental businesses, cannot qualify.

However, even if a company’s main activity is trading, this does not mean a claim for ER is safe from a challenge by HM Revenue & Customs (HMRC) if the company has “substantial” nontrading activities such as:
• Income from investments
• Holding non-trade assets
• Time spent by employee/directors on
investment activity

HMRC interpret “substantial” to mean more than 20% of a company’s overall activity. One of the most common issues arises where a company retains more cash than is needed to cover short term liabilities. The passive holding of cash is not a trading activity and where such cash reserves equal 20% or more of a company’s net assets HMRC may seek to deny ER on the sale of the company’s shares.

Be careful about groups
If a company is the holding company of a group, then it is the group’s activity as a whole that determines whether shares in the holding company qualify for ER. If non-trading subsidiaries form part of a corporate group this can potentially render the whole group ineligible for ER. Therefore holding an investment company, such as a property rental business, in an active trading group can create tax issues on exit.

Consider other shareholders
Even if a company is a qualifying company for ER this doesn’t mean every shareholder will obtain relief. To qualify for ER on the disposal of their shares an individual must hold at least 5% of the ordinary share capital, have voting rights and be an employee or director of the company. These conditions need to be met for a year before sale.
Issues arise where for example:
• Shares have been given to family members who have no involvement in the trade
• Some share classes are non-voting
• Shareholdings have been eroded below 5% by subsequent share issues

Don’t wait until it’s too late!
Some conditions need to be met 12 months prior to sale therefore it is important to regularly review a company’s position to obtain assurance with regard to ER on exit. A company’s non-trading activity can also negatively impact on eligibility for Business Property Relief resulting in all or part of the value of its shares being chargeable to Inheritance Tax in a shareholder’s estate. Should an issue be identified, there are various restructuring options available to separate non-qualifying activities from a trade or remove excess cash. Which route is most appropriate will depend on a business’s particular circumstances and should be discussed with a professional tax adviser.

If you would like to explore this issue further or have any general tax questions, please do not hesitate to contact Aileen Gates, Head of Tax, at aileen.gates@campbelldallas.co.uk or telephone 0141 886 6644.