Are you thinking of winding up your limited company – possibly as a result of retirement, or due to the Off-Payroll (IR35) rules? Perhaps you want to sell all or part of your business to someone else?
Your business is a valuable asset. So, inevitably, HMRC will want a slice of the proceeds. Which means capital gains tax will apply.
The good news is that you might qualify for business asset disposal relief. And if this is the case, you’ll pay capital gains tax at a discounted rate and keep more of the profit.
Here’s a look at the criteria you need to meet to qualify for business asset disposal relief, plus a rundown of how it works and how to claim.
What is business asset disposal relief?
Business asset disposal relief applies capital gains tax at a discounted rate of 10% on profits of up to £1 million if you close down or sell your business. This is significantly lower than the capital gains tax rates you’d pay otherwise. Without business asset disposal relief, capital gains tax would apply at a rate of up to 28%.
Until 6 April 2020, business asset disposal relief was known as entrepreneurs’ relief. Chancellor Rishi Sunak renamed it during his first budget speech in March 2020.
Entrepreneurs’ relief and business asset disposal relief operate on the same concept and have the same eligibility criteria. The main difference is that, where entrepreneurs’ relief was capped at £10 million over a person’s lifetime, business asset disposal relief caps it at a much lower £1 million.
Entrepreneurs’ relief was first introduced in 1998 with the aim of rewarding entrepreneurs for putting in the time and effort to build a business and create employment opportunities. Gordon Brown, who was chancellor at the time, called it ‘taper relief’ and explained it this way:
“We must do more to increase the quantity and quality of long-term investment. The capital gains tax regime that we inherited rewards the short-term speculator as much as the committed long-term investor.”
The measure proved unpopular, and has often been criticised as an unfair tax break that mainly benefits the wealthy. By slashing the lifetime allowance by 90%, chancellor Sunak aimed to strike a compromise — raising more money for the exchequer, without abolishing the tax relief altogether.
“We need more risk taking and creativity, so we are not going to fully abolish entrepreneurs’ relief but we will reduce the lifetime limit from £10 million to £1 million. This will save £6 billion over the next five years and this money will be invested straight back into innovative businesses and technology.”
Who is eligible for business asset disposal relief?
The eligibility criteria for business asset disposal relief are different depending on what you’re disposing of:
- If you’re closing or selling all or part of your business:
- You must have owned it — or been part-owner — for at least two years
- If you’re closing down the business, you must also sell all your business assets within three years. So if you close your business in 2021, you must sell your equipment and other assets by 2024
- If you’re selling shares in a company you’ve invested in:
- The company must be a trading company. This means that “non-trading” activities such as investments don’t make up more than 20% of its income. If a company goes from being a trading company to a non-trading company, you’ll still be eligible for business asset disposal relief as long as you sell your shares within 3 years
- You must own at least 5% of the company’s shares and voting rights
- You must’ve owned the shares for at least 2 years before claiming business asset disposal relief
- You must be entitled to at least 5% of the profits if the company is sold or dissolved
- You must’ve been an employee or office holder of the company for at least two years
In practice, most IT contractors who trade through their own limited company qualify for business asset disposal relief. This is because you’re your company’s sole director and employee. Even if you’re partnered with someone else, you probably have more than the requisite 5% of shares and voting rights.
If you’re one of the rare IT contractors who work as sole traders or are in a partnership, you also qualify for business asset disposal relief. Again, provided you’ve been a sole trader or a partner for at least 2 years before selling your business.
Sadly, you won’t qualify for business asset disposal relief if you work through an umbrella company. This is because no umbrella company gives you an ownership stake. Technically, you’re just an employee.
How does business asset disposal relief work?
Imagine you’ve decided to close down your contracting business and call it a day. After settling your liabilities, there’s £150,000 in the company’s business bank account. And selling off your equipment brings in another £100,000.
This leaves you with a profit of £250,000.
As with income tax, there’s a yearly tax-free capital gains tax threshold called the annual exempt amount. This is currently £12,300 per year.
But, without business asset disposal relief, you’d have to pay capital gains tax on the remaining £237,700 on a sliding scale, depending on which tax bracket you fall in.
A profit of £237,700 would put you in the higher rate income tax bracket. As a result, you’d pay 20% capital gains tax. And if your business assets included a residential property, you’d pay 28% on the profit from the sale of that property.
Now imagine your business sold for much less — or, more realistically, you’ve decided to sell only a portion of your business — and the profit left you within the basic income tax rate. Here, you’d pay:
- 10% on your profit from the sale
- If the sale included a residential property, 18% on the profit from the sale of that property
By contrast, with business asset disposal relief, you’d pay 10% on the lot in both scenarios, that is regardless of whether the profit puts you in the higher income tax bracket or keeps you within the basic rate.
This is a huge saving.
Let’s say your sale didn’t include a residential property, which means the whole £237,700 profit is taxed at 20%.
This would mean you’d pay a whopping £47,540 in capital gains tax.
Business asset disposal relief would halve your outlay. You’d pay £23,770 in capital gains tax, leaving an extra £23,770 in your pocket.
How do you claim business asset disposal relief?
You can claim business asset disposal relief in one of two ways:
- On your self assessment tax return for the tax year in which you’ve closed or sold your business
- Alternatively, by filling in Section A of the Business Asset Disposal Relief Helpsheet
You can claim as many times as you like, provided your total profits don’t exceed £1 million over your lifetime. Once you hit the £1 million lifetime cap, you can no longer claim it and will need to pay capital gains tax at the usual rates.
That said, if you’re closing down your business, you can’t be involved in a similar trade or activity for at least two years, or HMRC will treat your profit as an income distribution rather than a capital gains distribution. And this could put you in the additional dividend tax rate of 38.1%.
The aim of this rule is to prevent “phoenixing”, the practice of closing down a business to avoid tax.
Let’s say you have £200,000 in your company bank account.
If you were to withdraw this money as a dividend, it would put you in the additional dividend tax rate, so you’d have to pay HMRC £76,200.
So you go for an alternative. You:
- Close down the company
- Claim business asset disposal relief and pay 10% capital gains tax after deducting your annual exempt amount, which would work out at £18,770
- Open a new company and continue serving your current contracting clients
The alternative is the exact scenario the two-year-rule is targeted at. Business asset disposal relief is meant to benefit those who want to withdraw from the business, not those who want to continue but don’t want to pay tax. By applying the dividend rate instead of the business asset disposal relief rate, the rule treats your income as it should be treated based on your true intentions.
It’s worth noting that this rule, known as the Targeted Anti-Avoidance Rule (or TAAR), can put contractors on murky ground.
In particular, if you close your limited liability company and start contracting through an umbrella company, does it come into play?
While the answer to this question isn’t clear cut, the text of the rule has been amended to say that:
- It’s up to you, the business owner, to decide whether it’s “reasonable to assume” that the main purpose of closing your business is tax avoidance
- The onus is on HMRC to prove your decision was unreasonable
- Most importantly, if you continue being active in the trade as an employee, not as a business owner (this would be the case if you start working through an umbrella company), it will be “less likely” that the main purpose of closing your business is tax avoidance
Final word: what lies ahead for business asset disposal relief?
Entrepreneurs’ relief has the dubious distinction of being one of the few issues Labour and Conservatives agree on.
In their 2019 election manifesto, Labour proposed abolishing it altogether. Similarly, there were rumours the Conservative government would scrap it. But while they’ve renamed it and slashed it by 90%, they’ve stopped short of abolition.
Moving forward, further changes are looking likely. So if you’re thinking of selling or closing your contracting business, best do it while you can still take advantage of this generous tax break.
Want to learn more about business asset disposal relief and what it could mean for your business?
An accountant can walk you through the ins and outs in more detail and give you advice based on your individual circumstances.