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Entrepreneurs' Relief - a Budget 2016 U-Turn?

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Entrepreneurs’ Relief – a Budget 2016 U-turn?  

We have written previously for Legal Abacus on the various changes that have been made to the availability of Entrepreneurs’ Relief on the value of goodwill when incorporating (July/August 2014 and March/April 2015). Budget 2016 has seen a U-turn by the Government on restrictions it introduced in The Finance Act 2015 – a U-turn which could be useful to larger practices looking to incorporate.

Goodwill is an important business asset – it might not be a physical asset but it represents various aspects of your business which you have worked hard to create such as your good working relationships with clients, your client lists and, as importantly, your reputation. A practice looking to incorporate would often look to attribute a value to its goodwill and effectively sell this to the new limited company. The partners involved would recognise a capital gain on the sale of their proportion of the goodwill and, prior to 3 December 2014, the partners could secure Entrepreneurs’ Relief (assuming relevant conditions for the relief were met) and the gain they realised on the sale of goodwill would be taxed at just 10%. This was a common and tax efficient way to realise some of the value of the business on incorporation.

George Osborne threw a spanner in these tax planning works with his Autumn Statement 2014. He announced that from 3 December 2014, Entrepreneurs’ Relief would be denied when selling goodwill to a related company. Unfortunately the definitions here (and perhaps we should change the old phrase to “the devil’s in the definitions”) meant that initially even retiring partners were denied their 10% tax rate where their retirement was simultaneous with the incorporation. At that same time the Chancellor took off the table any prospect of Corporation Tax relief for the company acquiring the goodwill.

While the 2014 changes removed in many instances the option to release value from the business at 10%, there has for many years been aspects of the legislation which have meant that incorporation can be effected on a tax neutral basis, so it was to these provisions that business incorporations reverted.

The Autumn Statement Entrepreneurs’ Relief restrictions were later redrafted to secure a favourable position for retiring partners but at Budget 2016 Mr Osborne took an unexpected step to unwind further the December 2014 changes.

In essence, the definitions have been redrawn for incorporations. Where a partnership incorporates and an individual partner owns personally, or through a corporate or trust holding, less than 5% of the ordinary share capital and voting rights in the newly incorporated business, this restriction will no longer apply. And the change has been backdated to 3 December 2014.

This could be useful to minority partners or larger partnerships or LLPs where a greater number of partners mean lower percentage interests. We have referred to partnerships throughout as clearly this incentive is not available to a sole trader incorporating their practice and becoming the sole shareholder – they will own more than 5% of the new limited company!

While this change could put tax efficient value release back on the table in some incorporation scenarios, we will never be where we were pre Autumn Statement 2014 with the loss of Corporation Tax relief in the acquiring company (although perhaps that was always too good to be true).

It’s important to remember that there is a wider range of factors in the incorporation decision than just taxes! If you are considering incorporation for your practice we can help you understand the tax implications.

Published in Legal Abacus May/June 2016

The content of this document is intended for general guidance only and, where relevant, represents our understanding of current law and HM Revenue and Customs practice. Action should not be taken without seeking professional advice. No responsibility for loss by any person acting or refraining from action as a result of the material in this document can be accepted and we cannot assume legal liability for any errors or omissions this document may contain.  © McBrides Accountants April  2016

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