Business Asset Disposal Relief (BADR) – Introduction
For many entrepreneurs, a share sale represents the culmination of years of hard work and perseverance.
Naturally, they will want to ensure that as much of the reward as possible ends up in their hands, minimizing the tax bill on the disposal of their business.
It’s crucial for those selling shares in their business to consider whether Business Asset Disposal Relief (BADR), formerly known as Entrepreneurs’ Relief, will be available.
What is BADR?
BADR can reduce a seller’s capital gains tax rate to 10% (down from the usual rate of 20%) on the first £1 million of their lifetime qualifying capital gains, potentially saving up to £100,000 in taxes.
It’s important to understand how to utilise this relief and avoid potential pitfalls.
Who Can Benefit from BADR?
BADR may be available on the disposal of shares (or securities) of a trading company (or the holding company of a trading group) if the seller has, for the two years leading up to the disposal, satisfied each of the following:
- Been an officer or employee of the company (or another company within the trading group);
- Held 5% of the ordinary share capital of the company, conferring at least 5% of the voting rights in the company;
- Been beneficially entitled to at least:
- 5% of (i) the profits available for distribution to equity holders of the company and (ii) the assets available for distribution to equity holders on a winding up of the company; OR
b. 5% of the proceeds of sale, in the event of a disposal of the whole of the ordinary share capital of the company.
- 5% of (i) the profits available for distribution to equity holders of the company and (ii) the assets available for distribution to equity holders on a winding up of the company; OR
Enterprise Management Incentive (“EMI”) schemes
In respect of the two “5% tests” above, they do not apply if the shares being sold were acquired after 5 April 2013 under an EMI option.
In such cases, the EMI option must have been granted at least two years prior to the date of disposal of the shares. If so, there is no minimum shareholding nor any minimum holding period in respect of the shares themselves.
While this article primarily focuses on the applicability of BADR on a share sale, BADR may also be available for the disposal of the whole or part of a business carried on by a sole trader or in partnership.
How to Benefit from BADR
Given that the conditions detailed above must be satisfied for the entire two-year period prior to the disposal of the business, if you intend to sell your business at any point in the next few years, we recommend instructing an adviser to review your eligibility for BADR relief and planning for BADR compliance sooner rather than later.
Even after establishing a BADR-compliant structure, it’s important to keep these conditions in mind until the business is sold to ensure this valuable relief is not lost.
BADR will not apply automatically upon a sale, even if a seller meets the required conditions. It must be claimed on an individual’s tax return on or before the first anniversary of the 31 January following the tax year in which the share disposal occurs.
For a share disposal in the tax year 2024-2025 (ending on 5 April 2025), a claim must be made by 31 January 2027.
BADR Bear-traps
General
Failure to comply with the conditions outlined above throughout the two-year period leading up to the payment of sale proceeds can result in the loss of the relief. Common pitfalls include:
Dilution of Shares
Issuing new shares during fundraising which dilute existing shareholders such that they no longer satisfy the 5% tests. Elections can be made to claim BADR up to the date of dilution, but it is preferable to ensure that BADR applies up to and including the point of sale.
Granting Share Options
Exercising share options in advance of a sale without considering their impact on existing shareholders’ ability to satisfy the 5% tests.
Differential Share Rights
Failing to realize how differential share rights can affect the availability of the relief, such as other investors having a preferential return on a sale.
Complex Consideration Structures
Not considering how BADR will apply in complex consideration structures (e.g., where shares are exchanged for other shares or loan notes or there are deferred/contingent consideration arrangements like earn-outs). The timing of relevant tax charges may be delayed, and BADR conditions may no longer be satisfied at such a later time.
Missing the Claim Deadline
Failing to claim BADR by the relevant deadline.
Business Asset Disposal Relief (BADR) – Conclusion
Given the value of this relief and the potential pitfalls which can prevent its application, it is crucial to work with advisers who understand the BADR rules, both well in advance of, and during, the sale process.
Final thoughts
If you have any queries about this article on Business Asset Disposal Relief (“BADR”), or UK tax matters in general, then please get in touch.