In our spring bulletin, we discussed the main advantages and disadvantages of operating a business via an LLP structure and a company. One advantage of the LLP structure is the improved availability of entrepreneurs' relief for owners, particularly those who hold an interest of less than 5%. This relief is not available through a corporate structure if the shareholder owns less than 5% of the share capital.
Due to the value of entrepreneurs' relief, it is worth revisiting this complex relief to consider when it may be available in both an LLP and a corporate structure.
What is entrepreneurs' relief?
Entrepreneurs' relief was introduced in Finance Act 2008 and provides a reduction in the rate of tax applied to a capital gain to 10% from a maximum of 28%.
The relief only applies to certain transactions where some fairly restrictive conditions are met. A lifetime allowance of £10m of gains on which the relief can be claimed applies for an individual.
For the relief to apply, the disposal must fall within one of three categories:
1. material disposal of business assets
2. disposal of settlement business assets
3. disposal associated with a relevant material disposal.
It is the first of these categories that is most often relevant for exit from a holding in a company or an LLP. The third category can also be relevant where personal assets are used in the business but this is not considered further within this article.
The rules for material disposals to qualify for entrepreneurs' relief are strict and must be met in full either:
- for a period of at least one year ending with the date of disposal (whether shares in a company or an interest in an LLP); or
- in the case of a shareholding or an asset used in a business, a one-year period to the date of cessation of trade if that date is within three years before the date of disposal.
Application of entrepreneurs' relief to a holding in a company
For a shareholding in a company to qualify for relief, the following conditions must be met throughout the required one-year period.
- The company must be a trading company or holding company of a trading group. A trading company is one carrying on trading activities where non-trading activities are not carried on to a substantial extent.
- The individual holding the shares must be an employee or officer of the company or of another group company.
- The company must be the individual's 'personal company' being a company in which the individual holds at least 5% of the ordinary share capital and can exercise at least 5% of the voting rights by virtue of that capital.
A relaxation of the 5% rules is proposed for those acquiring shares on exercise of enterprise management incentive (EMI) options on or after 6 April 2012 provided the other conditions are met. However, for those not acquiring through an EMI, it is the requirement for a 5% shareholding that can cause issues for many holdings in a company especially where ownership is spread across a large base of shareholders.
Application of entrepreneurs' relief to an interest in an LLP
As there is no shareholding involved in an LLP interest, a material disposal of an interest in an LLP does not require a minimum level of holding. Neither is there a requirement to be an employee or officer.
A member of an LLP is treated as if they are in business on their own account. This allows entrepreneurs' relief to be claimed where the member disposes of the whole of their interest in the LLP by treating it as a disposal of the whole of the business. Equally, disposal of part of the interest in the LLP would be treated as disposing of part of the business and so would also qualify, whatever the level of interest held in the LLP (in contrast to a shareholding where the minimum 5% holding must be in place for the relief to apply).
The rules remain complex. As for shareholdings, the relief for interests in LLPs is limited to those that undertake a trade, profession or vocation. Relief is also restricted to the disposal of 'relevant business assets', as defined.
Conclusion
The fact that the member of the LLP need not hold a 5% interest in that LLP can open up the availability of entrepreneurs' relief to a wider number of business owners than in a corporate structure.
For the same reason, tax-efficient exit over time may be planned more flexibly from an LLP than from a company. Entrepreneurs' relief on exit from a company may potentially not be available on the final rounds of disposal where the shareholding has fallen below 5%.
Conversely, the restriction to relief for gains on relevant business assets for LLP holdings could make the corporate route more attractive where the business holds assets that may not meet this requirement but which would not be 'substantial' when considering the company's trading status.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.