BADR – change is coming…
Business Asset Disposal Relief (“BADR”) is the tax relief everyone still refers to as Entrepreneur’s Relief.
It is the tax relief which currently means that, if you sell a trading business or company, the capital gains tax rate you pay will be 10% on the first £1 million of the capital gain you make on the sale.
Please be aware that this is £1 million “allowance” is a lifetime limit, rather than a limit per business disposal.
BADR is regularly claimed to be on the brink of being abolished, and yet it is still with us.
However, change is definitely coming as announced by the Chancellor in her Budget on 30 October.
How do I qualify for BADR?
Before looking at what will change it is useful to remind ourselves of what needs to happen for a capital gain to qualify for BADR.
There is a tendency for business owners to think that BADR is automatic but actually there are a number of conditions which must be met before BADR is available – and HMRC are pretty hot on checking that these are met.
Trading companies
The overriding requirement is that we must be talking about a trading business – so, for example, businesses which comprise a portfolio of residential or commercial lettings will not qualify.
If the business is mainly trading but has substantial non-trading activities then again BADR will not be available (although what “substantial” means is this context is a matter of some debate!).
For an unincorporated business it must be clear that the sale is of a business or part of a business – not just an asset used in a business.
This is not always as easy to determine as it might sound but for example simply selling one of the premises from which the business operates will not typically attract BADR unless part of the business is sold with it.
Business ownership
The business must also have been owned by the individual for at least two years ending on the date of the disposal.
For shares in a company, the individual must own at least 5% of the ordinary share capital of the company and must have 5% of the voting rights attaching to those shares.
They also have to be in line to receive at least 5% of the income and/or 5% of the capital of the company.
Again this seems simple but if the share capital of the company is a bit more complex than a simple £100 of ordinary shares then there are some bear traps that the unwary can fall into.
Role in the business
The last condition for the company is that the individual must be a director (or other officer) of the company or an employee.
All of these conditions must be met for at least two years ending with the sale.
HMRC will strictly enforce these conditions, so 4.9% of the shares won’t cut it, nor will resigning the day before the sale.
There are some other quirks in the rules which can help (or hinder) the individual to qualify but the main lesson here is that qualifying for BADR is not a given, and care needs to be taken not to trip up and lose what continues to be a valuable tax relief.
So what is going to change?
Until 5 April 2025 the simple answer is “nothing.”
The Chancellor confirmed the relief will remain in its current form until the end of the tax year – a big relief for those who tried but failed to complete a sale by the date of the Budget in the expectation that BADR would disappear.
Ironically, with the main capital gains tax rates increasing from Budget day then BADR is actually a more generous relief than it used to be, in the short term at least…
When will changes to BADR come into effect?
However, from 6 April next year we see some changes which will progressively make the relief less valuable.
From 6 April 2025 the BADR tax rate will increase from 10% to 14%, and then from 6 April 2026 the rate goes up to 18%.
The £1 million limit remains the same but as at todays’ date the maximum BADR tax saving is £140k (when compared to the current main rate of CGT of 24%) which will drop (back) to £100k from April 2025 and drop again to £60k from April 2026.
So in practice what does that mean?
In some ways the good news is that it seems like BADR is here to stay, at least for a while and even if it will be less valuable.
What the Budget has created though is another bright line – if you qualify for BADR and sell your business on or before 5 April 2025 you will pay up to £40k less per shareholder in tax as opposed to selling it on 6 April.
On the flip side to that you will also pay your tax a whole year earlier by selling on the 5th as opposed to the 6th.
Because dates are so important it is critical to understand what date the sale takes place for tax purposes.
For tax purposes the sale takes place at the date the contract becomes unconditional and not necessarily when you receive the cash.
In house buying terms you can think about it that the sale takes place for tax purposes on exchange rather than completion (it’s more complicated than that of course but this is a decent rule of thumb).
This sets the tax rate payable on the gain, but the tax is payable by reference to the date the sale completes.
In practice for the vast majority of business sales then exchange and completion will take place on the same day.
Beware anti-forestalling legislation
It can seem tempting to try to get to a point where the deal exchanges before the end of the tax year but does not complete until after.
Beware however that HMRC are alive to this and rules exist which could mean that you lose the benefit of the better BADR rate if you try to be too clever!
The other point to bear in mind is not to do a bad deal in order to secure a lower tax rate.
The actual cost of missing out on the lower rate is not insignificant, but if you accept a lower price just to get the deal done you risk being worse off overall.
If your buyer thinks you are overly keen to sell by 5 April they may well try to use that to their advantage to force though a lower price.
You need to be very clear on what the overall position is and not just focus on the tax bit!
In summary, BADR is not as simple as it first appears
And certainly there have been plenty of tax cases over the years where a seller thought they qualified for BADR but were disappointed.
If you do meet the criteria to qualify then understanding how the changes will impact you is critical – but so is making sure that you don’t rush to complete a deal to obtain a tax benefit while potentially losing out in overall terms…
If you would like any advice regarding BADR or selling your business, please contact us and the team will be more than happy to help.
For more from HMRC on BADR please see: https://www.gov.uk/business-asset-disposal-relief
