Entrepreneurs Relief

While the Coronavirus has rightly taken all the headlines over the last week, the first budget since the election has also been a big story – In particular, the new Chancellor highlighted some changes to the ‘Entrepreneurs Relief’. Entrepreneurship is at the very heart of product design, and so we thought we would take this opportunity to explain what the Entrepreneurs Relief is, and how the recent changes affect it.

What is Entrepreneurs Relief?

Entrepreneurs Relief is a tax incentive first introduced by the Labour party in 2008 with its primary aim to encourage people to set up new businesses and stimulate innovation. In short, it reduces the amount of Capital Gains Tax (CGT) an individual is required to pay when they sell all, or part of their business. CGT is a tax which is payable by any individual when something is sold for a higher price than that which was originally bought for. If you pay higher rate income tax, CGT can be as high as 28%, but is usually 20%. Under Entrepreneurs Relief, this rate of CGT is reduced down to 10%. Clearly this represents a significant saving, so is certainly worth being aware of if you are a business owner, or employee with a share of the business. So just who can claim?

Who can claim it?

In order to be eligible to claim Entrepreneurs Relief you must fulfill a range of qualifying criteria. The full details of this can be found here. There are different qualifying criteria depending on whether you are selling a business, or selling shares etc. however as a guide you should meet the following requirements for at least the 2 year period before selling:

You are either a sole trader, an officer, or an employee of the business
You have held 5% or more of the share capital of the company, & 5% of voting share capital
You haven’t exceeded you £1 million Entrepreneurs Relief lifetime limit

How has it changed since the March 2020 Budget?

While intended to incentivise entrepreneurs to setup new businesses or ventures, much criticism has been levelled at the program for benefitting people far outside the generally considered term ‘entrepreneur’. Put simply, many people feel the scheme has been left open to abuse from wealthy business owners wanting to reduce their tax bill. As such, pressure has been applied to recent governments to reduce, or indeed scrap the scheme all together. In the March 2020 budget, the new chancellor didn’t go as far as scrapping the scheme, but did reduce the total lifetime limit of relief from £10million, down to £1 million.

An example of Entrepreneurs Relief

Here is a case study from ‘The Entrepreneur Handbook’ to demonstrate how the scheme works in practise:

“Mr Knight owned some shares for 20 years in a company where he was the director. He owned 10% of the shares of the company, which entitled him to 10% of the voting rights. In October 2017, Mr Knight disposed of the shares, making a gain of £740,000.

In this example, Mr Knight still qualifies for entrepreneurs’ relief. Mr Knight fulfils the qualifying conditions for entrepreneurs’ relief in that he holds over 5% of the company shares and voting rights. In this scenario, instead of paying £207,200 in Capital Gains tax (28% of his net gain) he will only pay £74,000 in CGT after claiming for ER. Entrepreneurs’ relief has saved him £133,200!”