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You Can Choose Your Friends But Not Your Family... Is That Really The Case When It Comes To Entrepreneurs' Relief?

You Can Choose Your Friends But Not Your Family... Is That Really The Case When It Comes To Entrepreneurs' Relief?

As the saying goes – you can choose your friends, but not your family – the same could previously have been said when it came to your succession planning.  Changes introduced by the Finance Act 2015 had the effect of potentially depriving individuals from claiming 10% entrepreneurs’ relief (“ER”) on goodwill in circumstances where it is being transferred from an unincorporated business to a newly incorporated company set up in favour of family members as part of genuine succession planning.

Such measures were caused inadvertently by the desire to combat abuse of the ER rules.  Specifically, it wanted to prevent a scenario whereby an individual incorporates a company to purchase the assets and goodwill of his business (the latter of which may have been attributed a high value) with the consideration standing to the credit of a director’s loan account.  As a result, the individual could be charged 10% capital gains tax on the disposal of the business assets and goodwill and thereafter withdraw amounts tax-free under his director’s loan account (instead of paying income tax at a higher rate).  The previous rules therefore sought to exclude the benefit of ER in such scenarios involving “connected persons”.

Although not deliberate, the definition of “connected persons” was wide enough to have a material adverse impact on family owned businesses – particularly in circumstances where an owner wished to legitimately retire and dispose of the business to one or more family members.  Professional bodies (such as the Institute of Chartered Accountants in England and Wales Tax Faculty) provided feedback to the UK Government, noting that they were having a negative impact on normal business transfer arrangements such as during succession planning among family businesses.  The good news is that the 2016 Budget introduced changes that narrowed the definition of “connected persons” and therefore permitted ER relief to be claimed on transfers of goodwill, provided that immediately after the disposal, the individual (together with his “connected persons”) owned less than 5% of the ordinary share capital and 5% of the voting rights of the newly incorporated company.

This was one of a series of amendments to the ER rules introduced by the 2016 Budget.  Another noteworthy change was the extension of the ER regime to long-term investors, provided they subscribe for new shares on or after 17 March 2016 and retain these shares for a period of at least three years from 6 April 2016.  There is no requirement for such individuals to hold a minimum 5% of the business and be engaged as an employee and/or officer, therefore enabling owner-managed businesses to dangle a larger carrot when looking for external investment and the introduction of new skills and external influence.  

The benefit of the ER scheme enables individuals to be charged a reduced rate of 10% capital gains tax on qualifying disposals (up to a maximum lifetime allowance of £10m).  Regardless of whether a family or owner-managed business is at the early stages and looking to expand, or whether it has successfully matured and the time has come for the owner to retire, the rules regarding ER will play an important role and should therefore be carefully considered. The recent changes improve flexibility for those in control of owner-managed businesses, proving that you can now choose your family in some circumstances (even if you are still stuck with them for Christmas dinner...).

Ross Byford