In this article, we are sharing the entrepreneurs tax relief procedure and what could stop you claiming in the future.
Entrepreneurs’ relief is a reduction in capital gains tax to 10% when you sell or dispose of all or part of your business. In the context of a limited company, this means selling or disposing of your shareholding. In order to qualify you must:
As stated above, in April 2016, HMRC changed its tax rules in order to narrow the circumstances under which entrepreneurs relief can be claimed in a members voluntary liquidation. In fact, if you fall foul of these rules, the monies received would be taxed at income tax rates rather than as capital gains. This could mean a heavy tax burden. HMRC may reclassify the funds as income if all of the following criteria are met:
As a consequence of these changes, we have had to advise several prospective clients against seeking the beneficial tax treatment through liquidation as HMRC would be likely to change the treatment to that of income.
One of the more common issues we find arising, is where shareholders have multiple companies running similar trades in tandem with each other. They often want to close one company, but keep the others running. Unless it can be shown that there is an alternative main purpose for winding up the company, which is likely to be difficult in these circumstances, this will generally fall foul of the above criteria.
An example of this could be a pair of software companies with the same ownership and management structures. They also boast the same description on companies house. One company focuses on distribution and development of existing bespoke software, while the other company develops new bespoke software. The sales company has been profitable and are selling on their existing software rights and winding up this company. However, they are continuing to develop new software with the other company. In this instance, this is likely to be classed as a similar trade. HMRC would then be likely to reclassify the distributions as income. This would mean a higher tax burden and entrepreneurs relief cannot be claimed.
If a case that can be put forward that the main purpose of the liquidation is other than that to obtain favourable tax treatment, there is the option to seek clearance from HMRC before entering members voluntary liquidation. In such circumstances, we can work with your accountant to assist them in preparing a report to HMRC to obtain this clearance. Thus giving you the peace of mind before starting the process.
Many companies we encounter are husband and wife owned, or owned by one of the parties. Relationship breakdowns are always unfortunate. However, if a decision is made to wind up the company to claim entrepreneurs’ relief, after a readjustment of shares in the separation, this can also cause problems with the claim.
As described above, the shareholding must have been available for a year prior to the winding up of the company. Couples are not classified as a single entity in this regard, so the separation redistribution will trigger the start of another period of a year necessary for the transferred shares. It will then likely be the case that only one partner may be able to claim entrepreneurs’ relief conditions on the capital distribution, whilst the other would have to pay the full rate of capital gains tax.
It is worth bearing in mind the corporate shareholders do not benefit from entrepreneurs’ relief or an alternative rates for capital gains tax. Any capital distributions in a members voluntary liquidation, or income distributions ahead of dissolution, will be taxed at the existing corporation tax rate. Consequently, a members voluntary liquidation will appear to be an unnecessary expense to these shareholders. If they hold a sufficiently large vote within the company, they may choose to block a winding up resolution.
As stated above, one of the criteria to claim entrepreneurs’ tax relief is that the company needs to have been trading in the last three years. Where the company has substantial income from non-trading activities, HMRC will disallow a claim for entrepreneurs relief. Whilst this does not preclude you from benefiting from the lower tax rate from a capital distribution in members voluntary liquidation, you will not benefit from the 10% rate for entrepreneurs’ relief. Non-trading activity includes:
Substantial non-trading income is defined in the capital gains legislation as anything exceeding 20% of the business activity. The activity of the business is measured on the following basis:
Excess cash in a company bank account is not taken into account in measuring the overall asset proportion, but other investments will be.
Whilst the scope for benefiting from capital distributions in members voluntary liquidation and claiming entrepreneurs tax relief has narrowed in recent years, this leaves the majority of instances where this would be sought will still qualify. If you require assistance with the winding up process, or would like to discuss any of the above in more detail, please don’t hesitate to contact our business rescue experts.
Business expenditure can be classed as trading expenditure or capital expenditure. If an item has lasting benefit for the company (such as plant and machinery), then it is typically considered capital expenditure. Capital allowances are forms of tax relief on certain types of capital expenditure. The primary aim of capital allowances is to claim a proportion of the cost of the expenditure back against your company’s taxable income or profits. In turn, this reduces your tax bill and allows you to write off the cost of capital expenditure over time.
Trading or revenue business expenses are items that last for shorter periods. For example, office stationery is a revenue expense; as most day to day accounting items will be. However, capital expenditure, or capital expense, is a more significant item of expenditure, usually benefitting the company over a longer period of time. You would expect the company asset to benefit the company for more than a year for it to be considered capital expenditure.
Capital allowances are available on the fixed contents of your business. As mentioned above, they have to be regarded as a benefit for your company for the tax relief. The UK government states you can claim capital allowances on company assets that are used to keep you in business. The tax relief can refer to allowances for plant and machinery expenditure, equipment and business vehicles, for example. The capital allowances list can also include heating for your company building, as well as lifts, computers, air conditioning; anything that benefits your business over a fixed term.
Annual Investment Allowance enables companies to claim 100% of the cost of plant and machinery for the business, in the year that you buy it. The AIA is an important form of tax relief for all business owners, providing relief at 100% for assets up to £200,000.
However, it is important to note that you can only use your AIA within the first year that you buy the company asset. If you choose not to claim the Annual Investment Allowance in the year that you buy the plant or machinery, you will not be able to claim tax relief the next year. You can not claim AIA for equipment that is leased, that you have previously purchased and moved to your new premises, or items for business entertainment.
The Writing Down Allowance (WDA) refers to tax relief if you have already claimed the full Annual Investment Allowance on items within the first year. WDA is also an alternative to tax relief, should your company assets not qualify for AIA. These assets could include items that you had bought before you claimed the AIA or even items such as cars.
Writing Down Allowances are split into separate groups, depending on the tax relief. They need to be grouped into ‘whole life assets’ - such as heating systems - and ‘short life assets,' including vehicles.
Enhanced capital allowance is another form of capital allowance. The Enhanced Capital Allowance (ECA) was introduced in 2001, to encourage the use of energy-saving plant and machinery, as well as low carbon dioxide emission cars and other similar items.
Qualifying for the ECA provides fantastic tax saving for companies, allowing you to claim 100% on company assets. You can claim the Enhanced Capital Allowance in the first year of the installation.
Research and development tax relief is available to businesses in the science and technology market. You can claim up to 150% on HMRC R&D tax relief.
You can also claim on other capital allowances, such as renovating business premises, extracting minerals, intellectual property, patents and dredging.
A business can make significant savings by understanding what capital allowances are and which purchases qualify for capital allowances.