Introduction »

Qualifying business disposal or not?

It is easy to assume that if you build up a successful unincorporated business that you will be entitled to Entrepreneurs’ Relief (ER) on disposal. This valuable relief reduces the tax liability to 10% on qualifying gains up to a lifetime limit of £10 million. However, there are various conditions which have to be met and a lack of attention to the detail may leave you exposed to 28% tax instead.

The essentials

An individual must have ownership of a business for the 12 months leading to a qualifying material disposal. A disposal includes sale, gift, incorporation, transfers (for example to a trust) and cessation. Ownership means either you are a sole trader or you have a partnership interest including membership of a Limited Liability Partnership. Other criteria for qualification apply with regard to companies and their shareholders which are not considered further in this article.

Trading businesses only

Only trading businesses qualify for ER. This means that ER will mainly be due on the gains arising from property used for trade purposes and business goodwill. Investment assets will not be eligible for the relief. This means that a general property investment business does not qualify even though this may be how you earn your livelihood through active management of your properties. This applies whether the property is commercial or residential. Certain property based businesses may qualify as a trading business such as a hotel or caravan site. In addition an exception exists for residential properties which are deemed to be a trading business for capital gains tax (but not inheritance tax) under the special rules for Furnished Holiday Lettings (FHL).

Strangely there is no specific law requirement to disqualify part of the gain on an asset where there has been other use of the trading asset during the period of ownership. The need to consider an apportionment between qualifying and non-qualifying purpose is though specifically required on what is known as an associated disposal. This is the disposal of an asset, frequently premises, owned by an individual outside of the business or company but used in the trade of the business or company. For the unincorporated business this would mean where a partner personally owns the property which is used by the partnership rather than being held within the partnership business.

It therefore appears that full ER may be available on an asset which, at the time of disposal, is not held as an investment but is owned for the purpose of the trade (and the trade has been carried on for the requisite one year period). An example could be of a property originally used as an investment property which has subsequently been used in a trade, for example a residential property which then subsequently qualifies as a FHL.

What about a part disposal?

For ER purposes there is a clear distinction for there to be a qualifying material disposal between the disposal of a trade or part of a trade as opposed to disposing of just an asset used for the purposes of a trade.

When an unincorporated trading business ceases there are special conditions which, if they apply, allow assets to be separately disposed of and ER obtained. Disposals of assets used in the trade at the time at which the business ceases to be carried on can be disposed of within three years of the date of cessation of the trade. ER applies even where the assets are subsequently used for another purpose in the intervening period such as being rented out.

However if the business continues then the sale of an asset used in the business will generally not qualify even if it is a substantial asset. A recent tax case on ER concerning the sale of farming land has confirmed this point. The Tribunal found for HMRC on the basis that it was a disposal of part of an asset used in a business, not part of a business. The facts concerned the sale of 35% of the land asset used to grow barley crop which naturally led to a similar decrease in turnover and profit. This was not considered to be a part business disposal as there was no identifiable change in the nature or conduct of the business carried on by the partnership after the sale. The fact that there was a material reduction in the same activity was not considered to be a material business disposal. Where there are several distinct trading activities and one is sold off as a going concern then that should qualify as a part business disposal.

As you can see ensuring ER is obtained can be a tricky business and this may require forward planning so do contact us to review your current position with regard to securing this valuable relief.

Introduction »