When you dispose of a business, you want to do this in a way that maximises your return and keeps you as tax-efficient as possible. But what's the best way to achieve this?
The answer may well be to make use of the new Business Assets Disposal Relief (BADR). This was previously known as Entrepreneurs' Relief, but was renamed and reworked as BADR in Finance Act 2020. If the gain you make when disposing of a business qualifies for BADR, the first £1M of your lifetime gains can be taxed at 10% instead of 20%.
That's a substantial tax benefit if your capital gain happens to be eligible. However, some of the rules are open to interpretation and good guidance will be needed to ensure your eligibility.
Understanding the BADR rules
If you can reduce the capital gains tax (CGT) due on your disposal down from 20% to 10%, that ends up saving you a considerable amount in lost cash.
But understanding and adhering to the BADR rules can be tricky, especially if you don't have the assistance of an experienced tax adviser to guide you.
Key elements to factor in include:
- BADR applies to disposal of the assets of a business you own as a sole trader or partnership, but NOT on disposal of goodwill to a close company where you own 5% or more of the shares.
- The relief is NOT available on goodwill arising on incorporation of an unincorporated business. And it's also NOT available on any investments held by the business.
- The relief can also be used in relation to assets that you own personally but that are used in the business or your personal company - and which are sold within three years of the business ceasing - or in association with the disposal of your interest in the business or sale of shares in your personal company. For example, you might personally own a workshop that's used by the company for business purposes.
- When talking about shares in your 'personal trading company', the following is the definition of a personal company: it's a company in which you own 5% or more of the ordinary shares, where you're entitled to 5% or more of the profits available for distribution and of distributable assets in the event of a winding up. You must also be either an employee or officer of the company.
- There are no requirements in the BADR rules about hours or salary, but you must have some demonstrable evidence that you work in the company.
- A trading company is one which doesn't have 'substantial' non-trading activities. Although not defined in legislation, HMRC considers 'substantial' to be 20% or more. This applies to asset values, sales, profits and management time. An overall view taking all factors into account needs to be established.
- As an example, if your company has surplus cash equal to over 20% of total assets, that may be considered to be a non-trading asset. HMRC's default view is likely to be that it should have been extracted and taxed as dividends, which would taint the company's trading status. It may however be possible to argue that the company needs to carry large cash balances for trading purposes.
- In the event of a company being wound up, BADR will be denied if the shareholder operates in a similar trade within the following two years. This is to prevent the owners taking advantage of the relief with no intention of permanently exiting the trade.
Talk to us about your eligibility for BADR
If you currently own shares in a company and are thinking of disposing of the business (whether by sale or winding up), we can guide you through the process and help you avoid the pitfalls.
If your situation is complex - for example, you have multiple share classes and significant non-trading aspects to the business - there's real value in getting expert advice. The rules in this area change and getting it wrong can be an expensive mistake!
Get in touch to discuss your BADR eligibility.