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James Bailey provides some useful tax pointers for business entrepreneurs.

Planning Ahead When Setting Up in Business

It is important to consider your exit strategy when you are setting up a business.

You should consider the following questions:

• Do you expect that you are going to build the business up and eventually sell it as a going concern to somebody else?
• Would you want to pass the business on to employees and have them pay you for it?
• Is it going to be a true family business and be passed down through the family, perhaps to your children?
• Are you going to liquidate the business and take the cash and the assets out of it when the time comes to retire?

Depending on which of the above strategies you are likely to use as your exit strategy, there may be different ways of structuring the company which might be to your advantage.

Consider the following example.

Utilising The ‘Substantial Shareholding Exemption’

If you have one trading business and you decide to set up a new trading venture, and you expect the new venture is going to be something that will grow fairly quickly and that you will be able to sell as a going concern to another entrepreneur, then it might well be a good idea to set that up as a subsidiary company of your original trading company.

The reason for this is that there is a tax exemption, which only applies to companies, called the ‘Substantial Shareholding Exemption’.

This means that broadly speaking, if the subsidiary company has been owned for at least 12 months by the parent company and has been trading throughout that time, the parent company can then sell the subsidiary and the parent company is not treated as making any capital gain on that sale.

You will then have your original trading company, which will have substantial amounts of cash in it and you can either extract those by paying dividends (as I’ve previously described) or you could consider liquidating the company. However, it is important to remember this only works if both of the companies (the parent company and the subsidiary that is going to be sold) are trading companies. It is no good if the only thing the parent company does is to hold the shares in the subsidiary.

Benefiting From ‘Entrepreneurs' Relief’

Something all owners of trading companies need to be aware of is Entrepreneurs' Relief, which was mentioned earlier in this report.

This is a relief from Capital Gains Tax on up to £10 million of capital gains for each individual during his or her lifetime.

If the company is a trading company then after one year, the effective rate of Capital Gains Tax is no more than 10%.

The Importance Of ‘Entrepreneurs' Relief’

By contrast, the rate of CGT on other assets is 28% for a 40% Income Tax payer.

This is why it is very important to make sure your shares in your trading company qualify for Entrepreneurs' Relief.

The relief applies to the shares in a company (or the parent company of a group of companies) that is entirely devoted to trading and has no “substantial” non - trading activities.

“Substantial” here means 20%.

Consider the company’s turnover and profits. If more than 20% of the turnover (or the profit) is not from a trading business - for example, if the company has investments in listed shares, or the company has bought a property which it doesn’t use itself but just lets out – the company might not be treated as a trading company for Entrepreneurs' Relief.

The 20% test can also be applied to the company’s assets. So you could have a trading company, but if it purchased say, a letting property, and if the value of that letting property represented more than 20% of the value of the company’s assets, then there is a danger that company would not be treated as a trading company.

If your company has anything beyond a very minor amount of non-trading activities, then you need expert advice to make sure you are not prejudicing this valuable relief.

In order to qualify for Entrepreneurs' Relief, the shareholder must be able to exercise at least 5% of the votes in the company’s shares, and must be an “officer or employee” of the company. There is no need to be a full-time employee – a non-executive director would qualify.

The above article is an extract from Tax Secrets for Entrepreneurs and Family Businesses, published by Tax Insider.