Investors’ relief: A guide to unlocking capital gains tax savings
Investors’ relief can provide capital gains tax relief for investors disposing of shares in unlisted trading companies. It is effectively a gateway for external investors to access the tax benefits available to employees and directors under business asset disposal relief (BADR).
Below, we’ll tell you everything there is to know about how investors’ relief can be highly beneficial for external investors, and how it can impact business asset disposal relief, plus so much more.
What is investors’ relief and why was it introduced?
Investors’ relief was introduced by George Osborne in 2016 to encourage patient capital investments. Investor relief is seen by many tax advisers as the investors’ equivalent of entrepreneurs’ relief, helping to encourage external investment in companies that were deemed too large for Enterprise Investment Scheme (EIS) relief.
Eligibility criteria for investors’ relief
To qualify for investor relief, certain conditions must be met. While there are several capital gains tax relief qualifying criteria, here are the main ones that you should be aware of:
- The shares must be ordinary shares that were issued on or after 17 March 2016;
- The shares must have been subscribed for and fully paid up in cash;
- The disposal of the shares must take place on or after 6 April 2019;
- The shares must have been held by the shareholder for at least three years before the disposal;
- The company that issues the shares must be either a trading company or the holding company of a trading group throughout the shareholding period; and
- Neither the shareholder nor any persons connected to them can have been an officer or employee of the company or a connected company at any time during the period of holding the shares (subject to some limited exceptions for unremunerated directors or individuals who subsequently become employees).
By being aware of the investors’ relief qualifying criteria, you can give yourself the best possible chance of qualifying for capital gains tax relief, helping you maximise your returns without falling foul of the strict rules and regulations, even if it’s unintentional.
How investors’ relief works: a step-by-step explanation
If you have ordinary shares that were issued on or after 17 March 2016, and they were paid for fully in cash, you may qualify for investors’ relief. While this process may appear complicated at first, it is relatively simple if you take the time to understand its core principles.
Next, you must make sure that they were disposed of on or after 6 April 2019. However, during the period between the shares being purchased and sold, they must have been held for at least three years.
To qualify, the shares must have been issued by either a trading company or the holding company of a trading group, and this must remain the case for the entire shareholding period.
Finally, the person who purchased the shares in question must not, in any way, have a connection to the relevant company, whether that be as an employee or office. If you were an unpaid director, there may be some flexibility, but this should not be taken as a given – the same goes for anybody who became an employee after purchasing the shares.
Once you are ready to sell the shares, after they have been held for at least three years, and wish to benefit from capital gains tax relief, you should enlist the assistance of a financial or tax expert to ensure that you have successfully met the investors’ relief qualifying criteria.
Comparing tax rates: standard CGT vs. investors’ relief
Capital gains tax is charged at the rate of either 10% or 18% for basic rate taxpayers, while for higher or additional rate taxpayers, the rate is either 20% or 28%. This is why many investors look to take advantage of capital gains tax relief incentives wherever possible – it is a clear way to reduce their tax liabilities while remaining on the right side of the law when investing in private sector businesses.
With investors’ relief, qualifying gains are taxed at a reduced rate of 10%, which can represent huge savings when investments are well into the seven-digit region. By working with financial and tax experts, investors can take advantage of these schemes and drastically reduce their tax liabilities, which in theory, allows them to invest more in the future.
Claiming investors’ relief for shares
If you sell a qualifying share, you should be able to benefit from the investors’ relief scheme. This scheme is aimed at encouraging private investment in UK businesses, and it was first introduced back in 2016. You must have held these shares for at least three years, but for long-term traders, this is unlikely to be an issue.
It’s important to note that capital gains tax is only paid on the profit from your sold share, so you won’t need to pay the reduced 10% rate on the full amount. If you purchased a share for £10 and then sold it for £20 three years later, you would pay a 10% tax on the £10 profit, which would be £1. In some cases, depending on your tax bracket, you could otherwise be liable for a tax payment of £2.80 (at 28%).
Maximising tax benefits: lifetime cap of £10,000,000
A maximum lifetime amount of £10 million of qualifying gains can benefit from the relief. While this amount may seem small to some, this lifetime amount is unlikely to be reached by most investors. Over a 40-year investing career, you can comfortably invest £250,000 per annum and still qualify for this reduced rate of tax, which is why investor relief is such an attractive option.
Understanding ‘trading company’ and ‘trading group’ definitions
In the context of UK investors’ relief, a ‘trading company’ and a ‘trading group’ are defined concerning their activities.
Trading company
The definition of a trading company in the context of UK tax reliefs like investors’ relief and business asset disposal relief (BADR) involves reviewing certain factors to establish whether there is substantial overall non-trading activity. These indicators include:
- Income from non-trading activities.
- The asset base of the company.
- Expenses incurred, or time spent, by officers and employees of the company in undertaking its activities.
- The company’s history.
Trading group
A trading group generally refers to a group of companies with a holding company at the top, where these companies are engaged in trading activities. The holding company of a trading group is also eligible for investors’ relief under the same conditions as a trading company.
A group, for the purposes of certain tax reliefs, including capital gains tax relief, is defined as a group of companies that are 51% or more subsidiaries of each other.
Interactions with BADR
Business asset disposal relief (BADR) reduces the rate of capital gains tax (CGT) on disposals of certain business assets to 10%. While this may at first seem very similar to investors’ relief, the key difference is who is eligible and the nature of their involvement with the company in which they own shares.
When looking at business asset disposal relief, it’s important to note that its main purpose is not to provide relief for the sale of current business assets, but for the partial or full sale of the business that has been owned for a two-year period, or for the sale of assets within three years of the business ceasing to operate, after being owned for a two-year period.
The key difference is that for investors’ relief, the qualifying shareholder must not have any connection to the business, while for business asset disposal relief, the disposing shareholder may have a greater degree of involvement.
How to apply for investors’ relief
If you want to gain the full benefits of external investors’ relief, working with a financial or tax expert will ensure that you don’t miss any crucial details, which can have the potential to derail all your hard work, potentially making you liable for a higher tax rate. This will provide you with a greater sense of security, giving you added peace of mind so you can focus on your investments without worrying about your tax liability.
While you can apply for investors’ relief without the help of an expert, the various hoops that one must jump through could make this a difficult and time-consuming endeavour. While you may have a sound understanding of your investments, an expert will understand how the investor relief scheme has changed over time, ensuring that you aren’t working with outdated information.
Frequently asked questions about investors’ relief
How do you qualify for investors’ relief?
To qualify for investors’ relief, you must have held your shares for at least three years, and they must have been issued on or after 17 March 2016. You must not have any connection to the company.
What is the difference between BADR and investor relief?
To qualify for investors’ relief, the investor can’t be connected to the company in which they hold their shares. This is a key difference to business asset disposal relief, where being an employee is necessary.
How much is investor relief?
Investors’ relief reduces your tax liability from 28% for those on a higher tax rate to a basic rate of 10% and has a lifetime cap of £10 million.
How Moore Kingston Smith can help
The rules for investors’ relief are complex, so please contact us if you wish to discuss this further and explore how the Moore Kingston Smith tax team can assist you in reviewing your current assets and liabilities, as well as advising on any future investments or disposals.