BADR traps for the unwary
Business asset disposal relief may not be the most complicated CGT relief there is but it still sets traps here and there. Our professional clients, in particular, discuss BADR with their clients all the time but the points outlined in this article may still sometimes trip up the unwary.
The 5% tests
Owning 5% of the share capital is not enough in itself. In order to qualify for BADR the owner of the shares must have:
1. 5% of the votes and
2. 5% of profits and assets in a winding up or 5% of sale proceeds; this is often an issue that arises with alphabet and growth shares.
Period of Ownership
Most people are aware that two years of qualifying ownership is required. Shares acquired within that two-year period will not attract BADR. The incorporation of a previously unincorporated business may also resets the two year clock.
Trading status
We often hear talk of the 80/20 rule. However this is not a statutory requirement but an arguably safe harbour HMRC can generally be expected to accept. Surplus cash not required for the trade and investment property are often the main culprits for exceeding the 20% safe harbour.
Officer or Employee
The shareholder must be an officer or employee of the company throughout the two-year period.
Dilution
A shareholder’s percentage holding may drop below 5%, for example, as a result of a capital raise. In those circumstances the shareholder may consider making a dilution election. This gives rise to a deemed disposal of the shares at their market value immediately before the dilution event. The advantage of this is that the tax rate at the time of disposal, including the benefit of BADR, is preserved. A further election can be made to defer paying the tax on the deemed disposal until such time as the shares are disposed of.
Associated disposals
BADR is also potentially available in respect of disposals of assets used in a trading business, provided you are selling at least a 5% interest.
If you charged rent to your company or partnership for use of a personally owned asset, BADR may be restricted. Broadly, the restriction applies to the extent that rent was charged after 5 April 2008. Full market rent can substantially reduce or eliminate relief on the associated disposal, while a lower rent may lead to a partial restriction on a just and reasonable basis.
To qualify the disposal of the asset must be accompanied by a real withdrawal and genuine reduction in your participation in the trading business.
The limit
The lifetime limit is now £1m, a relatively paltry amount by previous standards. Previous disposals which qualified for the old Entrepreneurs’ Relief may reduce this limit.
The list above is not exhaustive. If you or your client would like advice and support on where you stand in relation to BADR, please do get in touch.