Budget Notes

BN48 CAPITAL GAINS TAX: RELIEF ON DISPOSAL OF A BUSINESS (ENTREPRENEURS' RELIEF)

Who is likely to be affected?

1. Individuals and trustees who dispose of the whole or part of a trading business, or of shares in a trading company in which they have a qualifying interest.

General description of the measure

2. Legislation will be introduced in Finance Bill 2008 to establish a new entrepreneurs' relief, which will complement the capital gains tax (CGT) reform package announced at the 2007 Pre-Budget Report (PBR). Entrepreneurs' relief may be available in respect of gains made by individuals on the disposal of:

•    all or part of a trading business the individual carries on alone or in partnership;

•    assets of the individual's or partnership's trading business following the cessation of the business;

•    shares in (and securities of) the individual's "personal" trading company (or holding company of a trading group);

•    assets owned by the individual and used by his / her "personal" trading company (or group) or trading partnership.

3. The first £1 million of gains that qualify for relief will be charged to CGT at an effective rate of 10 per cent. Gains in excess of £1 million will be charged to CGT at the rate of 18 per cent.

4. An individual will be able to make claims for relief on qualifying disposals made on or after 6 April 2008. Claims may be made on more than one occasion up to a 'lifetime' limit of £1 million. Disposals on or before 5 April 2008 do not affect the lifetime limit. The £1 million limit will only begin to diminish when the relief is claimed.

5. Trustees will be able to claim relief on certain disposals of business assets and company shares and securities where a "qualifying beneficiary" has a qualifying interest in the business in question. Trustees must make claims jointly with the "qualifying beneficiary". Any relief given on the trustees' gains will reduce a beneficiary's £1 million lifetime limit on relief.

Operative date

6. This measure will have effect for qualifying disposals made on or after 6 April 2008. Transitional provisions will also allow relief to be claimed in certain circumstances where gains that have been deferred from disposals made on or before 5 April 2008 become chargeable after that date.

Current law and proposed revisions

7. Section 4 of the Taxation of Chargeable Gains Act 1992 (TCGA) provides that an individual is chargeable to CGT at the rates for income tax on savings income (10 per cent, 20 per cent or 40 per cent in the tax year 2007-08). His or her net chargeable gains (after deduction of allowable losses, taper relief, any other reliefs, and the annual exempt amount (AEA)) are treated as the top slice of his or her income. Most trustees and personal representatives are currently chargeable at the trust rate (40 per cent for 2007-08).

8. For the tax year 2008-09, there will be a single rate of capital gains tax set at 18 per cent as announced at 2007 PBR. The rate will have effect for individuals, trustees and personal representatives. PBR Note 17 sets out details of the proposals.

9. In addition on and after 6 April 2008, where the new entrepreneurs' relief is available it will reduce by 4/9ths the gains for which relief is due. Where a number of gains and losses arise on the disposal of a business, the reduction is applied to their aggregate. The net amount of gains after relief will then be liable to CGT at the new 18 per cent single rate, resulting in an effective 10 per cent rate (5/9ths x 18 per cent). An individual will be entitled to entrepreneurs' relief on gains of up to £1 million on qualifying disposals. This £1 million limit is a "lifetime" limit. It will be necessary to keep a record of the amount of gains in respect of which the relief is claimed to work out the relief due on any later qualifying disposals.

10. There will be no minimum age limit for entrepreneurs' relief. And entrepreneurs' relief will be available where the relevant conditions are met throughout a qualifying period of one year.

Sole traders and partnerships

11. The relief will have effect for gains arising on the disposal by an individual of the whole or part of a qualifying business. A business qualifies if it is a trade, profession or vocation (including the commercial letting of furnished holiday accommodation in the UK, but not other types of property letting business). The individual must have owned the business, or be a member of a partnership that owns the business, throughout the one-year period ending with the disposal.

12. A disposal by a member of a partnership of the whole or part of his / her interest in the partnership will also qualify if the partnership carries on a qualifying business and the individual meets the ownership test throughout the year ending with the disposal.

13. Where a qualifying business is not disposed of but simply ceases, relief will be available on gains on assets in use in the business at the time it ceased where the assets are disposed of within three years of the date of cessation.

14. Gains on disposals by sole traders and partners of shares or securities or on assets held as investments will not qualify for relief. But there are circumstances in which relief will be available on the disposal of shares and securities in a trading company and on "associated disposals". Details of these are set out below.

Shares and securities

15. The relief will have effect for gains on disposals of shares in (and securities of) a trading company (or the holding company of a trading group) provided that throughout a one-year qualifying period the individual making the disposal:

•    is an officer or employee of the company, or of a company in the same group of companies; and

•    owns at least 5 per cent of the ordinary share capital of the company and that holding enables the individual to exercise at least 5 per cent of the voting rights in that company.

16. Where the company (or group) does not cease to trade, the one-year qualifying period is the year ending on the date the shares or securities are disposed of. Where the company (or group) ceases to trade before the disposal of the shares or securities, the one-year qualifying period ends on the date trading ceased, and the disposal must be made within three years of the date of cessation.

17. The terms "trading company", "holding company" and "trading group" will have the same meaning as they do for the purposes of taper relief on business assets. There will be no requirement to restrict the gains qualifying for relief by reference to any non-trading assets held by the company (or group).

"Associated disposals"

18. Where an individual qualifies for entrepreneurs' relief on a disposal of shares or securities under paragraphs 15-17 above, relief will also be available if the individual makes an "associated disposal" of an asset which was used in the company's (or group's) business. For example, if a company director who owns the premises from which the company carries on its business sells the premises as well as selling his shares in the company, the sale of the premises may count as an "associated disposal" and the gain on the disposal may attract entrepreneurs' relief. The relief due on an associated disposal will be restricted in certain circumstances, for example, where the asset in question is not wholly in business use or where the individual is not involved in carrying on the business (as an officer or employee of the company with a qualifying interest in it) throughout the period during which the asset was owned.

19. A similar rule will allow relief on an "associated disposal" of an asset used in a partnership's business and owned separately by a member of the partnership who is entitled to relief on disposal of his interest in the assets of the partnership. Again, relief will be restricted in circumstances equivalent to those indicated in the previous paragraph.

Deferred gains

20. It will be possible to claim relief where, on or after 6 April 2008:

•    shares or securities are exchanged for other shares or securities (including qualifying corporate bonds (QCBs)); and

•    gains on disposal of the original shares or securities would meet the qualifying conditions for relief; but gains do not arise at the time of the exchange under the normal CGT rules for such exchanges.

21. Where QCBs are received in the exchange, entrepreneurs' relief will be claimable in determining the amount of gain to be deferred until the QCBs are disposed of. In other cases people may elect to disapply the normal CGT rules, so that gains will arise at the time of the exchange and the relief will be claimable on those gains.

22. Similarly, where gains are deferred on or after 6 April 2008 as a result of an investment in qualifying shares under the Enterprise Investment Scheme (EIS), entrepreneurs' relief will be claimable in determining the amount of gains to be deferred.

23. Transitional rules will also allow entrepreneurs' relief to be claimed where gains that have been deferred on or before 5 April 2008 under the rules for exchanges of shares, etc., for QCBs, or on investment under the EIS or in a Venture Capital Trust (VCT) become chargeable on or after 6 April 2008. The relief will be claimable if the disposal giving rise to the gain that has been deferred would have qualified for the relief if the relief had been in force at the time of that disposal.

24. A further document has been published today on the HMRC website containing examples of how the relief will work. Detail about the relief can be found in the draft legislation and explanatory note available on the HMRC website. Draft legislation relating to the changes to CGT announced at Pre-Budget Report is also available on the HMRC website.

Further advice

25. If you have any questions about this change, please contact the Capital Gains Tax Team on 020 7147 2764 (email: capitalgains.taxteam@hmrc.gsi.gov.uk). Information about Budget measures is available on the HM Revenue & Customs website at www.hmrc.gov.uk.