MONTHLY FOCUS: BUSINESS ASSET DISPOSAL RELIEF FOR UNINCORPORATED BUSINESSES
Posted on: 23-10-2023
Business Asset Disposal Relief For Unincorporated Business
Business asset disposal relief (BADR) doesn’t only apply to shares, it can also apply to the disposal of an unincorporated business, i.e. a sole trade or partnership interest. How is the relief secured in these situations?
What is Business Asset Disposal Relief?
Business Asset Disposal Relief (BADR) is the new name for Entrepreneurs’ Relief (ER). There has long been a desire by the UK government to foster enterprise and investment, and a suitably low tax on the sale of a business has always been seen as part of this.
Since capital gains tax was introduced in 1965, relief has existed in one form or another. Before ER there was taper relief and before that retirement relief which, although it underwent a number of changes, lasted until 1998. A number of the concepts originally introduced for retirement relief remain relevant for BADR, which is why tribunal and court judgments sometimes refer to earlier rulings regarding retirement relief.
Retirement relief’s successor was taper relief. It worked by reducing (tapering) the amount of gain changeable to tax. The amount of taper relief given depended on how long the asset was owned before it was sold or transferred. Where the asset was used in business, relief was obtained more quickly than assets owned in a private capacity. It was possible to secure a 10% rate of tax on the disposal of any asset used in a business after two years by the end of the regime.
That brings us to 2008 when ER was introduced. The relief now works differently to retirement or taper relief in that it doesn’t reduce a capital gain that is taxed (as it did when it was first introduced), but it applies a lower tax rate of 10% on gains that qualify. However, this is restricted to the first £1 million of qualifying gains an individual makes in their lifetime.
In essence, BADR is simple, but as with all things in tax, the devil is in the detail. Without a proper understanding of the finer points a vendor could easily miss out on this important and valuable tax.
BADR can apply to sales of company shares, as well as unincorporated businesses – which is the subject of this monthly focus.
What is an unincorporated business?
A sole trader is someone who owns a business by themselves and which is not operated through a company. A partner is someone who owns part of a business which is run with others and which is not operated by a company.
What assets qualify?
Only gains made on the disposal of certain assets are liable to capital gains tax (CGT). These include, but are not limited to:
- land and buildings
- goodwill (except where it is sold or transferred after 2 December 2014 by a sole trader or partner to a close company, i.e. broadly one that is controlled by five or fewer individuals, to which they are related)
- shares; and
- intellectual property rights.
If an individual disposes of a business, other than a company, typically they will be disposing of a number of assets, and the gain on each asset must be calculated separately. In its simplest terms, the gain will be the amount the individual receives for the asset, net of selling expenses, when it’s sold for more than it cost them. Part of that cost may include:
- incidental costs on the purchase of the asset
- any costs incurred in establishing or confirming ownership of the asset.
Here is an example of costs that can be taken into account include survey and conveyancing costs, stamp duty land tax and legal costs.
Aaron sells his newsagent business for £200,000. The sale agreement splits this as being £150,000 for the property itself, £30,000 for the stock and equipment, and the remaining £20,000 for the goodwill. He bought the empty premises in 2001 for £100,000 and started the business from scratch. The amount paid for the stock and equipment can be ignored for CGT purposes. As he started the business from scratch the cost of the goodwill was nil, leading to a gain of £20,000 on this. The gain on the property of £50,000 (150,000 – 100,000) can further be reduced by his legal fees on the purchase of the building.
How is the tax calculated?
The rates of tax charged on capital gains are 10% and 20%. Which rate applies depends on how much the individual’s gains and taxable income add up to. The gain is treated as the top part of the total, which is compared to the income tax rate bands. Any part of the gain falling into the basic rate band is taxed at 10%, while any amount above it is taxed at 20%. However, if the gain qualifies for ER, a 10% tax rate applies.
Before gains are added to income to work out the rate of tax they are reduced firstly by capital losses made in the same tax year and secondly by the CGT annual exempt amount (£6,000 for 2023/24). If any gain remains, it’s reduced by capital losses made, but not set against gains for earlier years, i.e. “brought forward” losses.
How does a proprietor qualify?
There are a number of situations where a disposal can qualify for BADR. These are where the individual has:
- disposed of a business as a going concern
- disposed of a recognisable part of a business as a going concern
- ceased a business and sells the assets used in that business when it ceased.
An individual cannot claim BADR where they sell a business asset in isolation. It must be sold with the sale of all or part of the business.
William, who runs a printing business, moves premises during the year. He sells his old print shop. This will not qualify for relief. If William had decided to close his business and then sell the premises this would potentially attract relief.
To qualify, the business can be any trade, profession or vocation provided it has been conducted on a commercial basis with a view to making profits. This means that a hobby, or a business that has no prospect of making profits, will not qualify.
When a business is sold, how much of the gain qualifies for BADR?
Where a business is sold as a going concern it will consist of a number of elements.
The goodwill of the business. Goodwill is the value of the business above the value of the physical assets it has. This might be down to its location (such as a pub), a list of contracts that are transferred or a trading name. However, gains made from the sale of goodwill on or after 3 December 2014 by a sole trader or partner to a company controlled by them do not qualify for BADR.
Capital assets of the business. An example is the trade premises. If there is more than one such transaction, the gain on each is worked out separately. So if there are a number of shops, for instance, there will be a calculation for each one.
Stock and equipment. Any gain made on the sale of stock will usually count as profit liable to income tax and so will not attract BADR. The sale of equipment used in a business is also an income tax matter, except in the rare event it’s sold for more than what was originally paid for it, in which case the excess counts as a capital gain which can attract BADR.
Jill has run a beauty salon for a number of years and a potential buyer for the business has approached her offering £120,000.
The offer document breaks this down as:
1. £85,000 for the property the business operates from
2. £1,000 for the stock she has on hand
3. £4,000 for the equipment; and
4. £30,000 for the goodwill of the business.
Any gain made on the property and goodwill of the business may attract BADR. The payment for the stock will be treated through her final accounts as a sale and subject to income tax. The amount paid for the equipment will be accounted for through the capital allowances system and will result in an income tax adjustment.
Can the sale of a business owned for a short time get the relief?
The relief can only be claimed where the gain relates to the sale of a business, or part of it, which was owned for at least 24 months. The date the ownership ceases is the date that the contract for sale or transfer is signed by both the buyer and seller (transferee and transferor), not the date the deal is completed.
However, where only part of a business is sold, the seller does not need to have owned that particular part for any length of time, provided that the business as a whole has been owned by the seller for at least 24 months.
NOTE. If the business has been owned for only a short period of time be careful that the date of the contract is late enough to give ownership for 24 months. It’s insufficient for a contract to be concluded short of 24 months with the date of actual transfer being after.
What about only selling part of a business?
This is a potential minefield for sole traders. HMRC might contend that there has been a sale business assets only and not part of a business. If that’s the case BADR will not apply to any gain made.
There has been a raft of case law regarding the question of whether a sale is of part of a business. Some go back to the days of retirement relief. We’ve summarised some of the important decisions.
McGregor v Adcock 1977. A farmer sold part of his farmland to a third party. This part of the farm had been given outline planning permission for development and as such was worth a significant sum. In this case it was decided that selling a portion of land was not the disposal of an identifiable part of a business and retirement relief was refused. There are a number of similar cases involving farmland with similar results.
Barrett v Powell 1998. A taxpayer ran a farm under a tenancy arrangement. He sold the tenancy but continued to operate the farm with only a licence to occupy the land. Although his interest in the land had diminished to a less secure one, the business itself continued in the same manner and the gain made from the sale of the tenancy did not count as a sale of part of the business.
Jarmin v Rawlings 1994. A farm constituted 64 acres of land, a milking parlour and a yard. The taxpayer sold the parlour and yard, and in the following three months also sold a proportion of his own cattle at auction. The remaining cattle were moved to another farm belonging to the taxpayer’s wife. The land that was left was used by the taxpayer to rear and store cattle, although he retained his milk quota, the farm produced no more milk after the sale. The court ruled that part of the business had been sold, rather than just some of the farm’s assets as the milking business ceased when the parlour and yard were sold.
NOTE. The differences between McGregor, Barrett and Jarmin can easily be seen. In the first two cases the businesses continued in the same way, whereas in the third case the business changed its identity completely.
Russell v HMRC 2012. A farming partnership sold part of its land for development purposes. The taxpayer sought to rely on comments made in the McGregor judgment which said that where the majority of land is sold it could constitute the disposal of a business where, by necessity, it changes the character of the business. The example given was selling 190 of the original 200 acres.
HMRC also sought to rely on the same comment to deny relief. The court decided that it was not just the sale of the land (or the amount of it) that mattered, but the way in which the business had changed as a result. The simple loss of income as a result of having less to farm and produce from was not sufficient to show a change in the business.
M Gilbert t/a United Foods v HMRC 2011. In this case the taxpayer sold food for nine different suppliers, receiving commission independently from each one. He came to terms with one of the suppliers that ended his relationship with the supplier’s customers, receiving £285,000.
The tribunal allowed a claim for BADR (then known as ER) in this case as it considered that the taxpayer had in essence sold part of his business by way of selling the customer database in relation to that particular supplier. This amounted to the sale of goodwill, and this is a crucial asset when looking at the difference between the mere sale of an asset and the sale of part of a business.
What does HMRC say about it?
Just to show how complex this situation can be, HMRC’s own internal guidance is less than clear. For instance, it highlights the possibility of someone running two shops in different towns. It then gives no clear guidance other than it’s possible the two shops are run as separate businesses but that ultimately it will depend on the facts. It says it could be that the shops are run independently with only the owner in common or they could be far more intertwined so as to be one business. However, it seems likely that in such a situation, selling one shop would be selling part of a business and so qualify for BADR.
NOTE. When considering if BADR is due, it’s important to look at what the business was prior to the sale and what it is afterwards. If these two are the same, it’s unlikely that part of a business has been disposed of.
Also consider the position from the purchaser’s point of view. Can they start to operate immediately using only what has been sold to them? If they can, it’s likely that an identifiable part of a business has been sold. HMRC doesn’t necessarily accept this view, but the decision in the case of Gilbert can be used to counter its argument.
Can a business be sold in stages and still qualify?
In terms of selling part of a business this can be a question that is often raised. Again, there are a number of cases on this.
Pepper v Daffurn 1993. A farmer sold a large portion of his farm at the same time as he changed his farm from rearing cattle to grazing them. This was considered the disposal of a business. A cattle yard was retained and, once planning approval was obtained, this was then sold two years later. The court reversed the tribunal’s original decision and refused relief on the sale of the cattle yard. In its opinion the taxpayer had changed his trade in such a way that meant the cattle yard was no longer required in his new trade.
Purves v Harrison 2001. A coach and minibus operator decided to sell his business as part of his retirement. The business was advertised from 1989 and in the following year he sold the business premises, but was granted a licence to remain on the premises. Over a year later he sold part of his fleet in an attempt to make the business more attractive to potential buyers. This proved to be a success and his business was then sold. Originally it was decided that the sale of the land formed part of an overall sale of the business. However, the final decision was that the mere intention to sell both the land and business together was insufficient to tie the two together, especially as the eventual disposals were to different people and many months apart.
NOTE. Even where part of a business (or even a whole business) is sold over a period of time, it may not be considered to be eligible for relief.
In order to avoid doubt over qualifying for BADR for a sale of a business in stages, the owner could first transfer all of it to a company theyown, which will trigger a single gain against which relief can be claimed.
How is the tax on a qualifying disposal calculated?
As each disposal of a business (or part of one) will likely include the disposal of a number of assets on which capital gains tax is charged, the gains or losses for each asset sold must be added together before working out BADR. Where the CGT annual exemption is available, this is also deducted before applying the BADR rate of tax (10%).
Dave sold his business in March 2024 having acquired it in April 1990. The relevant details, and gains arising on each asset, are shown below:
|Purchase cost April 1990||Proceeds March 2024||Gain|
This makes the total gains on the disposal of the business £155,600. From this the annual exemption is deducted (£6,000 for 2023/24), leaving a taxable gain of £149,600. This is multiplied by the BADR rate of 10% to give a final tax liability of £14,960.
The sale of a business must be considered as a whole. Therefore, if the sale of any assets of the business results in a loss, it can only be set against the gains from selling the business, i.e. the seller can’t treat the loss separate from the gains. This means they can’t use such a loss to reduce the tax payable on capital gains made from the sale of assets not connected to the sale of the business.
Jess sold her business in July 2023 after a difficult trading period. As a result, she sells her shop for a gain of £30,000, but makes a loss on the goodwill of £10,000. Also, in the same tax year she sold a flat she had let, making a gain of £50,000.
The annual exemption (£6,000) will be offset against the gain made on the sale of the flat reducing the taxable amount to £44,000, as this will save Jess the most tax (because the tax on that gain is payable at a higher rate than on the gain relating to the goodwill). The gain and loss on the business sale are combined and the tax rate of 10% is applied to £20,000 (£30,000 – £10,000). She can’t apply the lower rate to the gain on the shop and offset the loss on the goodwill against the gain on the flat.
What if business assets are sold after ceasing trading?
It’s not uncommon for businesses to be sold after trading has stopped. This means the condition which says BADR is due only where the business has been trading for the 24 months before sale will not be met. However, the good news is that BADR is not necessarily lost in that situation.
In such cases, provided the business was carried on for at least a year, the disposal of assets used when it ceased will be eligible for relief for a period of three years following the date of cessation.
The assets must be in use in the business at the time it ceases. If they are not, relief will not be available on gains made from selling them.
The asset can be used in any way between the date the trade stops and the time it’s sold, for example it could be used in a new trade, rented out or left unused. For the purposes of BADR it’s irrelevant. The key point is that it was used in the trade at the time it stopped trading.
After many years of trading as an osteopath James decided to cease trading and re-open the surgery as a coffee shop. As the shop is busy someone makes him an offer for the business after just six months. The business itself will not qualify for relief as it has not been carried on for at least two years, but as the property was used in his previous business, and the disposal is within three years of that business ceasing, he will be able to claim relief on the gain made on the property.
Sometimes the sale of a business does not qualify for BADR, but the later sale of its assets after trading has stopped does. This might be so where relief was not allowed for the main disposal because the time limit for ownership was not met, i.e. to qualify the owner must have owned the business for at least 24 months before they sell or transfer it.
However, where they sell assets that were used in the business later than the business itself, it’s only necessary to consider the qualifying period by reference to the date that the trade ceased.
In order to put beyond doubt any issues with the timing of the disposal and cessation the proprietor should ensure that the sale of the business takes place at a time when it has been trading continuously for at least the qualifying period of ownership.
If assets are sold after selling part of a business, will they qualify for relief?
The rules explained above mean that BADR can apply to gains made from the sale of assets after the sale of a business but not to gains following the sale of part of a business.
It may be possible to link the disposal of an asset to the disposal of part of a business if they are sufficiently close together.
What if one of the assets isn’t fully used in the business?
Where the proprietor owns an asset and use it in their business and for other purposes, there’s no requirement for an apportionment of the gain between the business and non-business use. If the asset is used in the business to any extent, the whole gain qualifies for BADR if the conditions are met.
Bert has run a garage for many years. He has downsized his business and so there is an area in his large workshop that is unused. He decides to allow his son to run his new panel beating business from the vacant area. Bert has had an offer for the business and the premises. As the premises was used in Bert’s business and sold as part of his business the full gain on this will qualify for relief.
What if the asset was owned before using it in the trade?
The answer is similar to that for the previous question. No matter the length of ownership of the asset, or how it was used, provided it is used in the business when the owner sells it, or ceases trading, the asset will qualify for relief.
Gilly has run a small boutique for a number of years from a large shop, while she has been letting another, smaller, shop nearby. When her tenants leave the smaller shop she decides to downsize her business and move into the small unit. She sells the larger unit and has no BADR available as this sale doesn’t qualify. After several months she sells her business, including the smaller unit. As this is the disposal of a business she will qualify for relief and the once rented shop will qualify for the relief in full.
HMRC might try to argue that an asset is excluded as it was previously an investment asset and therefore BADR is not applicable for that period. However, the legislation is worded so that it only takes account of the use of an asset at the time of sale.
Consider if an asset that is going to be sold in any event could form part of a business prior to disposing of it or ceasing to trade in order to secure the maximum relief possible.
How does BADR apply to business partners?
Largely speaking, the relief applies in the same way to partners as it does sole traders. In fact, the legislation states that transactions of a partner are to be treated as if they were made by a sole trader. But there are additional factors to consider when the seller does not own an entire business.
Even though a partner is in partnership they are treated as being a sole trader for their share of the business and its assets.
The partnership of Dodds & Co, a four-partner law firm, is sold to a competitor. Each partner in Dodds & Co will be treated as having sold their own interest in the business and its assets. Provided they satisfy the normal conditions for BADR, any gains an individual makes will qualify for relief.
If a partner sells their share in the partnership but the other partners retain their shares will the sale qualify?
If a partner sells or transfers their partnership share to someone else they can qualify for relief on any gain made if the conditions are met, i.e. there is no need to the whole partnership to be disposed of. Also, where the share of the partnership is reduced, say, by the introduction of a new partner and this results in a gain, BADR can apply to it.
Donna and Delilah are in partnership together sharing profits equally. They admit Davy to the partnership after a number of years trading. They each reduce their share in the partnership to 40%, giving 10% to Davy. Both will have made disposals for CGT purposes, and these will qualify for relief.
There are specific provisions in the BADR rules that state the reduction of a partner’s share is a qualifying disposal.
What if a partner has owned some of the partnership share for less than two years?
Where a partner increases their share in a partnership and soon after either reduce this or dispose of it completely meaning they have held some for 24 months and some for less, it’s believed that HMRC will allow BADR for the entire gain. However, the legislation is not clear on this and so different HMRC inspectors might take different approaches.
Jack has been in partnership equally with three others for a number of years. Two partners retire and Jack and the remaining partner buy these shares out so that they each now hold 50%. Six months later they are approached to sell the partnership business, which they do so. As such, Jack has held one half of his own interest in the partnership for more than the qualifying period and one half for less. However, it appears that the entire gain will qualify. This is similar to what happens in the case of shares in a company.
Does BADR apply if a partnership sells its assets?
The same rules apply as for sole traders. If the partnership sells assets that amount to part of a business, then this could qualify for BADR. Likewise, if the trade ceases and then assets are sold later.
A partner treated as if they are carrying on their own trade. So, if the partnership sells assets that form part of a business and one partner has a 10% share in the partnership, if all the conditions are met they will qualify for BADR on their 10% share of the gain.
A partner personally owns assets the partnership uses. What’s the BADR position?
Assets may be held by some partners and not others. For example, the property the partnership trades from was bought by the original partners and when new partners join they do not get a share of it. Typically in that situation rent is usually paid by the partnership to the property-owning partners.
To qualify for BADR a disposal of the property (or part of it) must be linked to a withdrawal from the partnership, i.e. a reduction in a partner’s share of the business. However, the reduction must be meaningful and not artificially engineered to obtain relief.
As the withdrawal and sale must be linked to qualify for relief, it’s important to ensure there’s no significant gap in time between the disposal of the property (or a share in it) and a disposal or reduction of the individual’s share of the partnership.
If the partnership ceases and is disposed of, and the disposal qualifies for BADR, HMRC has stated that the disposal of partnership assets within the next twelve months, or three years if the asset is not used in that time, can still qualify.
A partner rented assets to the partnership. Does BADR apply if they sell them?
While BADR may be entirely lost when a partner makes a gain from the sale of an asset if they rented it to a partnership of which they are a member, it might only be reduced. The reduction is based on the ratio of the rent charged compared to the market rent.
Timothy sells his partnership interest and sells the office that the partnership traded from. He charged the partnership £500 p.m. although the market rent was considered to be £1,000 p.m. When working out the gain on the disposal of the property that is eligible for relief, this will need to be restricted to one half (500/1,000).
What if the assets weren’t always used by the partnership?
If the asset has only been used for part of the time the partner has owned it, the gain that is eligible for relief will be restricted. This restriction will be on a time-apportioned basis.
Titch’s partnership uses a factory unit he owns. He has owned it for eight years, but the partnership only moved in after two years had elapsed. The gain that can be eligible for relief on the unit’s disposal will be limited to 6/8 of the total gain.
This will also be the case where an individual partner owned the asset and has always let a partnership use it, but only later become a member of it. This is quite often the case in family situations.
James inherited a shop from his father and considers selling it. However, his wife, Jemima, decided that she would like to open a dressmakers in it. After five years Jemima’s business has grown and it is decided that James should become a partner in it. Three years later the business, along with the shop, is sold. As the property belongs to James only he can be eligible for relief on the sale of it. His relief will be limited as he has only been a partner in the business for three out of the eight years.
What if only part of a property is used by the partnership?
Again, the gain eligible for relief will be restricted. Typically, the eligible gain will be worked out according to the floor space; that is only the area used by the partnership will qualify for relief.
If there is a significant difference in the value between different areas of the property, the gain can be apportioned based on the respective values if that produces a better result for seller.
How is the relief claimed?
Once a taxpayer has worked out the amount of gain which qualifies for relief, it must be claimed in the tax return relating to the year for which the gain was made.
When a capital gain is made it must be reported on an additional set of tax return pages called SA108. If software is used to complete the tax return, the provider’s SA108 is the equivalent on the system. These pages, entitled “Capital gains summary”, should accompany a computation of how the gains are calculated. Box 4 on this form allows details to be entered as to the amount of the total gains that qualify for BADR.
If the individuals forget to make the claim in the same return all is not lost. The time limit for making a claim is the 31 January twelve months after the end of the tax year in which the gain was made.
For example, if the seller made the gain in the year ended 5 April 2024, they have until 31 January 2026 to make the claim. However, assuming they have already filed the tax return and paid the tax on it by 31 January 2025, they will have overpaid. They therefore have two options. They can either amend the return or submit a separate claim, by completing the form on HMRC’s helpsheet HS 275.