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In a Budget that carried the slogan ‘getting it done’, ironically it was something that the new Chancellor didn’t do that turned out to please freelancers and contractors most. Despite the announcement of plans to protect the economy from the threat of coronavirus, a freeze to Income Tax and VAT, and at-the-time ignoring the pressure to delay IR35 reform in the private sector, the most significant development for independent professionals during the 2020 budget was Rishi Sunak announcing that Entrepreneurs' Relief would not be abolished.
The Chancellor explained that The Institute for Fiscal Studies had criticised Entrepreneurs' Relief while The Resolution Foundation described it ‘the UK’s worst tax break’. But even so, Mr Sunak refused to scrap it. The Chancellor said “we shouldn’t discourage those genuine entrepreneurs who do rely on the relief”, arguing that “we need more risk-taking and creativity in this country, not less”, before revealing plans to reform it instead.
In this article, we’ll explain what Entrepreneurs' Relief is, how it’s changing and why - in the current climate - it matters that freelancers and contractors will be able to use it going forward.
Entrepreneurs' Relief is a tax break which means you pay a lower rate of Capital Gains Tax when selling shares in your business or disposing of it. In the case of many contractors, it’s a vital tax break when you stop trading and close down your Personal Service Company (PSC). Assuming you meet the qualifying criteria, you’ll pay Entrepreneurs' Relief on any capital gain you receive when dissolving your business. You can claim this tax relief as many times as you like in your life up to the allowance which, as we’ll soon explain, has just been reduced to £1m.
If you qualify for Entrepreneurs' Relief you will pay a flat rate of 10%, whereas Capital Gains Tax - a tax on profit made on the disposal of an asset - can reach 28% for higher rate taxpayers. So needless to say, this contributes to big tax savings for freelancers and contractors who are shutting up shop.
Dramatically, but not to the extent where it should stop the majority of contractors benefitting from it. The Chancellor revealed that as of 11th March (Budget day), the lifetime allowance for Entrepreneur's Relief will fall from £10m to £1m.
Granted, a 90% slashing of this tax break isn’t ideal, but the Chancellor did claim that “80% of small business owners are unaffected” by the changes. So assuming that you haven’t used up a large part of your allowance already, you should be well-placed to qualify for it when you wind down your business.
To qualify for Entrepreneurs' Relief, you must have owned at least 5% of your business for two years or more - this is to prevent people from forming companies only to close them soon after and pay less tax. If you’re dissolving your business, you need to make sure you dispose of its assets within three years to be eligible.
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While not directly linked to the IR35 rules, Entrepreneurs' Relief may soon become even more important for contractors from 6th April 2021 onwards. When IR35 reform is rolled out, it is predicted that some contractors could retire early or stop working through their limited company. If this happens, it’s crucial that contractors who cease trading can still make the most of this tax break. Without doubt, if the Chancellor had bowed to pressure and scrapped Entrepreneurs' Relief completely, it would have felt like a ‘double-whammy’ for contractors. But fortunately, common sense prevailed on this occasion at least.
If you have questions about Entrepreneurs' Relief, please get in touch with us or speak with your SJD Accountant.
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