Our job as accountants and tax advisers is to explain often-complex rules to our clients.
The current focus on Entrepreneurs’ Relief (ER), and tax-relief schemes such as the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS), is very topical. Start-up rates are rising and returns on savings are derisory, so clients want to know what tax breaks are available, and the finer (and sometimes confusing) details that are sure to come up. When it comes to ER and tax-relief schemes, our advice can be very valuable.
ER and Investors’ Relief
ER’s function is simple: to reward entrepreneurs, via the tax system, on the sale of their business. Instead of paying the main rates of capital gains tax (CGT) on their gains (18% and 28% up to April 2016), they can enjoy a lower rate of 10%. The main conditions are that the entrepreneur must have had the business for at least a year, be an officer or employee of the company, and hold at least 5% of the ordinary share capital (with those shares giving the individual at least 5% of the voting rights). ER has been a great help in the traditional incorporation of a business, a task undertaken by many AAT members. For example, Fred the plumber, incorporating into Fred Ltd, could sell his internally generated goodwill to his own newly formed company and pay the 10% ER tax rate in exchange for a nice tax-free director’s loan. We lost this in the Autumn Statement 2014. From that point, internally generated goodwill would no longer qualify for ER, so the main rates then applied. To some extent, this situation has been ameliorated by the reduction in the main rates of CGT from April 2016 (to 10% and 18%) and a partial U-turn on the restrictions (in the Finance Act 2015) in the Budget 2016 (and backdated). One surprising about-turn in the Budget was the chancellor’s announcement that he would provide another form of ER for unconnected ‘business angels’ who invest in unlisted trading companies: Investors’ Relief (IR). The new rules for IR, which apply to investors who are not allowed to be officers or employees, enable them to have the 10% CGT rate as long as those shares are subscribed for on or after 17 March 2016, and are held continuously for three years. As with ER, there will be a £10m lifetime limit for the relief, and this is in addition to the £10m ER allowance for directors and employees. I’m pleased that the chancellor has introduced this variant of ER. It offers more choice to entrepreneurs and investors who are considering start-ups and who are seeking tax breaks – great news for us and our clients.
EIS and SEIS
The EIS offers investors both an incometax relief (30% of the value of the shares subscribed for in a small, higher-risk trading company) against their tax liability in the year of investment and an exemption from CGT if the shares are held for three years. The maximum investment per person is £1m. However, an individual investor cannot be ‘connected’ with the qualifying EIS company. They are connected if they hold more than 30% of the shares, voting rights or assets in a winding up (directly or indirectly). Individuals can also be connected if they are paid as an employee or a director, but that can include an unpaid director, such as a business angel.
Another option is the SEIS, designed to help small, early-stage trading companies raise equity finance by offering tax reliefs to individual investors who purchase new shares in those companies. It complements the EIS, but offers an even higher income-tax relief (50%). If you have received income-tax relief on the cost of the shares, and the shares are sold after they have been held for at least three years, any gain is free from CGT. The maximum annual investment in an SEIS company is £100,000, but it can be topped up with EIS later. The restrictions on working and being paid are similar to those of the main EIS relief. You can’t have a “substantial interest” in the company (more than 30% of the shares for the investor and family) and you can’t be an employee, although, strangely, you can be a director. So the rules of these schemes can be odd, but, for the most part, the reliefs are incredibly valuable for small-business and start-up clients. This is what reliefs are meant to do, and it’s nice to be able to get away from the negative public opinion on tax dodging, and to do something positive.
Investors’ Relief in brief
- Investors may qualify for the 10% CGT rate
- The rate applies to shares issued from 17 March 2016
- There is a £10m lifetime limit for the relief
Michael Steed is co-chairman of the ATT's tax Technical Steering Group and columnist for Accounting Technician magazine.