Jennifer Adams provides an overview of a strategy for closing an unincorporated business tax-efficiently.
There comes a time in every business owner’s life when retirement looms and thoughts turn to exit planning. Planning should ideally start many years before the actual date to give time to consider and implement the available options.
Selling the business
If all options have been considered and it is decided to sell the owner's interest in at least part of the business, planning needs to start at least two years before the date of disposal to claim business asset disposal relief (BADR) for capital gains tax (CGT) purposes.
BADR is not a ‘relief’ but a special rate of CGT applying to gains realised on the disposal of certain qualifying business assets. A successful claim provides for CGT at 10% (on lifetime gains of up to £1 million) and is therefore particularly beneficial for higher-rate and additional-rate taxpayers who otherwise would be taxed at 20%.
Invariably, disposal will be of the whole business but, importantly, this need not be the case as only part of the business needs to be disposed of for a claim to be made. However, if only part is disposed of, this part must represent a business capable of being carried on in its own right; consequently, the disposal of a single asset is unlikely to qualify.
BADR must be claimed on or before the first anniversary of the 31 January following the tax year in which the disposal takes place.
Assets used in a business
Very often, a sole trader or partnership business will be sold but there is a delay between cessation and the disposal of the assets used within the business.
In such circumstances, BADR will be available on the sale of assets where the taxpayer has owned the business throughout the two years before cessation, and the asset is sold within three years of the date of business cessation.
Strategic planning for a property portfolio
Property businesses are not eligible for BADR except furnished holiday lettings (FHLs). However, it should be noted that to claim BADR, an asset needs to have been in use by the business at the time of cessation, not necessarily throughout the required two-year ownership period. This point could produce a tax planning strategy for landlords with non-FHLs if implemented with the correct timing.
For example, if a landlord plans to retire in (say) four years, the residential lettings could be converted to FHLs now, and then in two years revert to long-term residential lettings. At that point, the FHL business will have ceased, but crucially it will have become a deemed trading business; so long as the properties are sold within three years, BADR can be claimed.
How long is BADR likely to exist?
The thinking behind BADR (or entrepreneur’s relief, as it was initially called) was that it would encourage business owners (entrepreneurs) to reinvest the tax saved from selling the enterprise into starting up a new venture or investing in others. Statistics show that this has not worked.
Therefore, rather than abolishing the relief altogether, the overriding limit claimable by any individual, referred to as the taxpayer’s 'lifetime allowance', has been substantially reduced from the original £10m to £1m. This reduced cap has now been in place for two full tax years (i.e., 2020/21 and 2021/22) and some taxpayers have inadvertently exceeded this allowance.
In May last year, HMRC wrote to taxpayers who had overclaimed BADR in 2020/21 reminding them of the limits requiring amendment of return and this year, HMRC is repeating this 'nudge' exercise.
Practical tip
The moral is that many business owners thinking of retirement in the next few years might have to face the possibility that at least some of the gain made will not be covered by the BADR lifetime allowance (if the relief remains in place at all) so will be charged tax at 20% rather than the BADR percentage of 10%.
