Business Asset Disposal Relief

What Is Business Asset Disposal Relief?

Introduced in April 2008 as Entrepreneurs’ Relief, BADR allows individuals to pay a reduced rate of CGT on gains made from the sale of qualifying business assets. Initially, this relief was designed to support entrepreneurs in growing and selling their businesses by reducing the tax burden on disposal. As of the 2020–21 tax year, the lifetime limit on gains eligible for relief was decreased significantly from £10 million to £1 million, reflecting changes in the economic landscape and government policy.

The primary benefit of BADR is the reduction of CGT to 10% on qualifying gains, compared to the standard CGT rates of 10% (for basic rate taxpayers) or 20% (for higher rate taxpayers). This relief can, therefore, result in substantial tax savings, making it a crucial consideration for business owners planning their exit strategy.

Qualifying Criteria for BADR

To benefit from BADR, certain conditions must be met. These conditions are designed to ensure that relief is available to genuine entrepreneurs who have actively participated in the running of their businesses. The critical criteria are as follows:

1. Qualifying Person: The individual claiming BADR must be a sole trader, a partner in a trading business, or hold at least 5% of the ordinary share capital and voting rights in a company. Additionally, they must be an officer or employee of the company or a company in the same group.
2. Qualifying Business: The business being disposed of must be a trading business. BADR is unavailable for investment businesses, although businesses with minor non-trading activities may still qualify.
3. Qualifying Period: The qualifying conditions must be met for at least two years up to the date of disposal. This period is crucial as it ensures that only those who have contributed significantly to the business can claim the relief.
4. Material Disposal: The disposal must be of all or part of a business, shares in a personal company, or assets used after cessation. Disposals can include sales, gifts, or even liquidation of the business.

Practical Implications and Planning

For business owners, understanding and planning for BADR can be a complex but rewarding process. Proper planning is essential to ensure all qualifying conditions are met and to maximise the tax benefits of the relief. Here are some practical considerations:

1. Structuring Ownership: Ensuring that ownership structures meet the 5% shareholding and voting rights criteria is critical. This may involve reorganising share capital or altering the roles of shareholders within the company.
2. Active Involvement: Maintaining an active role in the business is necessary to meet the officer or employee condition. Business owners should ensure they are formally appointed and involved in the company’s operations.
3. Documenting Compliance: It is vital to keep detailed records that demonstrate compliance with the qualifying criteria over the two-year period. This includes documenting roles, shareholdings, and the nature of the business activities.
4. Partial Disposals: For those considering partial disposals, it’s important to understand how they are treated under BADR. Partial disposals can still qualify, provided they meet the material disposal criteria.
5. Post-Cessation Assets: Assets disposed of after the cessation of the business can qualify for BADR if they were used in the business at the time of cessation and the cessation occurred within three years before the disposal.

Changes in Legislation and Lifetime Limit

The most significant change in recent years has been the reduction of the lifetime limit for BADR. The reduction to £1 million means that the amount of gains on which individuals can claim relief is now substantially lower than in the past. This change, effective from 11 March 2020, impacts the strategic planning for business disposals, particularly for those with substantial gains.

Business owners must be aware of this limit when planning their disposals, as gains exceeding £1 million will not benefit from the reduced 10% CGT rate. Instead, the standard rates will apply to the excess. This reduction underscores the importance of early and detailed tax planning to optimise the use of BADR.

Case Studies

To demonstrate the application of BADR, consider the following case studies:

Sole Trader Disposal

John has been operating a retail business as a sole proprietor for over ten years. He decides to sell his business for £500,000. John meets all the qualifying conditions for BADR, including the two-year holding period and the nature of his business as a trading entity. By claiming BADR, John’s gain is taxed at 10%, resulting in a tax liability of £50,000, significantly less than it would be at the standard CGT rates.

Shareholder in a Personal Company

Emma holds 10% of the ordinary shares in a tech start-up and serves as a director. After five years, the company was sold, and Emma’s share of the sale proceeds was £2 million. Emma qualifies for BADR on the first £1 million of gains, which is taxed at 10%, resulting in a £100,000 tax liability. The remaining £1 million of gains is taxed at the higher CGT rate of 20%, resulting in an additional £200,000 tax liability. Emma’s total tax liability is £300,000.

Common Pitfalls and How to Avoid Them

Despite its benefits, claiming BADR can be fraught with potential pitfalls. Here are some common issues and how to avoid them:

1. Non-Qualifying Periods: Failing to meet the two-year qualifying period is a common issue. Business owners should ensure they meet all criteria for the requisite period before contemplating a disposal.
2. Inactive Participation: Not being actively involved as an officer or employee can disqualify a claim. Maintaining a formal role and documented involvement in the business is essential.
3. Investment Businesses: Disposals of businesses primarily involved in investment activities do not qualify. It is crucial to ensure the business is primarily a trading business.
4. Changes in Shareholding: Shareholding changes that reduce ownership below 5% can disqualify a claim. Careful management of share structures and rights is necessary.

Conclusion

Despite recent changes in scope and limits, business asset disposal relief remains a vital tool for entrepreneurs and business owners. Understanding the qualifying criteria and planning accordingly can result in substantial tax savings, making it a critical consideration in any business disposal strategy.

At DLS Solicitors, we are committed to helping our clients navigate the complexities of BADR. Our team of experienced professionals can provide tailored advice and support to ensure you make the most of this valuable relief. Whether planning a full or partial disposal, our expertise can guide you through the process, ensuring compliance with all qualifying conditions and optimising your tax position.

By staying informed and proactive, business owners can effectively utilise BADR, fostering continued growth and investment in the UK’s entrepreneurial landscape.