Business Asset Disposal Relief: What it Saves and How to Qualify
This article was written by Pete Miller (Technical Director) and Nick Wright (Head of Corporate Tax) of Jerroms Miller, an award-winning UK-based specialist tax advisory.
One of the most common concerns when a person is selling their company is whether they will qualify for Business Asset Disposal Relief (BADR), which reduces the normal 24% rate of capital gains tax to 18% on the first £1 million of chargeable gains, giving a maximum possible saving of £60,000. The £1 million is a lifetime limit for each individual.
The main qualifying conditions are that the company must be a trading company, or the holding company of a trading group; the shareholder must be an employee or director of the company or of a group company; and the shareholder must have at least a 5% interest in the company being sold.
These qualifying conditions must be satisfied for at least 2 years up to the date of the disposal. If the company has ceased to trade (perhaps because the trade was sold and the company is to be wound up), the qualifying conditions must have been satisfied for at least 2 years up to the date the company stopped trading, and the disposal must be within three years of that time.
A trading company must not have more than an insubstantial amount of non-trading activities. A common concern is large cash balances in the company, although, in practice, this is not usually an issue because the test focuses on the activities of the company, and its activities are not usually measured by reference to the cash on the balance sheet. A similar rule applies for groups of companies, where there must be at least one trading company in the group and no more than an insubstantial amount of non-trading activity throughout the group. However, activities that are wholly within the group (such as a group property company that leases premises to trading subsidiaries) are ignored.
Being a director or employee of a company does not usually cause any problems, but HMRC will check publicly available information and the PAYE records.
The 5% test requires a shareholding of at least 5% of the company's ordinary share capital, and that shareholding must also give the shareholder at least 5% of the votes. In addition, that shareholder must be entitled to at least 5% of the proceeds if the company were to be sold. Note that, for example, fixed-rate preference shares do not qualify as ordinary share capital. Similarly, shares with limited voting rights or rights to proceeds on a sale may mean that a holding of 5% of the share capital nevertheless does not qualify because of those restrictions.
Planning ahead: the two-year qualifying period
The two-year qualifying period means there will be cases where it is important to start planning your disposal at least two years in advance. We see a number of common scenarios.
Sharing the allowance with a spouse or family
The £1 million limit applies to each vendor. So if, for example, someone owns 100% of the shares of a company and would like to maximise the amount of BADR available, they could gift shares to their spouse and/or children (but not minors) and make them directors of the company. They will then need to wait two years before their shares can be sold to qualify for the relief.
Adding voting rights to existing shares
Similarly, if someone holds 5% of the share capital of a company but has no voting rights — which might be the case where key employees have been granted shares — their shares should be converted to voting shares at least two years before the sale. In this case it will also be necessary to consider the employment-related securities charge that might arise if the addition of voting rights materially increases the value of the shares, as this increase may be chargeable to income tax as earnings.
Demerging investment assets out of the trading company
Another common scenario is where a trading company has invested its surplus profits in investment assets, such as property, so that the company now has substantial non-trading activities and may not qualify for BADR. The usual planning would be to carry out a demerger, to separate the investment assets into a different company, so that the trading company now qualifies. Again, however, it will be necessary to wait at least two years before BADR would be available.
EMI options for key employees
There is an exception to the two-year qualifying period and the 5% rule where shares are held as a result of the exercise of EMI options. In this case, the qualifying holding period starts when the options are granted, not when the shares are issued, and there is no de minimis holding. So key employees can be rewarded with a piece of the action by granting them EMI options that can only be exercised immediately before a sale. If the options are granted at least two years in advance of the sale, and they are exercised immediately before the sale, the sale of the shares should qualify for BADR.
Key takeaway
The qualifying conditions are applied strictly by HMRC — relief has been denied in a case where an individual only held 4.99% of the shares — and any planning that converts a non-qualifying shareholding into a qualifying shareholding must be undertaken at least two years in advance of the anticipated sale.
About Jerroms Miller: Jerroms Miller is a UK-based specialist tax advisory recognised for its work on corporate reorganisations, demergers and shareholder tax planning. Pete Miller is Technical Director and Nick Wright is Head of Corporate Tax.