How may the changes to BADR over the coming years affect SMEs looking to sell

Business Asset Disposal Relief

Business Asset Disposal Relief, formerly Entrepreneurs‘ Relief

Business Asset Disposal Relief (BADR), renamed from Entrepreneurs’ Relief (ER) and updated in the Finance Act 2020 reduces the rate of capital gains tax (CGT) on disposals of certain business assets from 20% to 10%.

The change in name of the scheme came into effect on 6 April 2020.

What changes to BADR were announced in the Autumn Budget 2024?

The Autumn Budget introduced a general rise in the rate of capital gains tax with immediate effect.
BADR and Investors’ relief (IR) rates will remain unchanged for the remainder of the 2024/25 tax year, rising to 14% for the tax year 6 April 2025 to 5 April 2026 and to 18% for the tax year 6 April 2026 to 5 April 2027.

One of the greatest changes that will affect SME businesses will be BADR. The relief offers access to lower rates of CGT on lifetime gains of £1 million on certain disposals by business owners of their business, or shareholders in unlisted trading companies. The Chancellor announced that the rate will increase, but gradually – so that businesses have time to adjust to the measures. Both BADR and IR rates will rise to 14% from 6 April 2025 and then to 18% for disposals on or after 6 April 2026.

Read more about the changes to CGT in our article here.

BADR relief rates will increase 8% in the next two years, how can I benefit from BADR currently?

BADR is available for the disposal of a business for sole traders, partners in a trading partnership and shareholders in an unlisted trading company, all subject to a number of specific conditions. This article focusses on shareholders in unlisted trading companies.

When closing down a limited company, the final distribution of funds can be treated as either an income distribution or a capital distribution. The distinction is important, and a capital gain is usually preferable to dividend treatment. Dividend tax rates are 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers. Dividends also count towards total income and can reduce the personal allowance available where an individual has total income of over £100,000. This compares with capital gains tax paid on a capital distribution of 18% and / or 24% (for higher rate taxpayers) – and if the gain qualifies for BADR, the balance is taxed at just 10% currently. So, for example, an additional rate taxpaying shareholder receiving £100,000 on the liquidation of his company would pay around £39,350 if taxed as a dividend, but would face a capital gains tax bill of just £10,000 if BADR is available.

Ensuring funds are treated as capital distribution

One route, which can ensure that any funds to be distributed from a business you are closing down are treated as capital, has been to enter into a formal liquidation of the company, known as a ‘members voluntary liquidation’ or MVL.

To complete an MVL, the shareholders of a solvent company must adopt a voluntary winding up resolution, and appoint a liquidator to realise the assets of the business, with the proceeds distributed to company members. Alternatively certain assets of the business may be distributed to the members. A company is considered to be solvent when it can meet all of its financial obligations, and when the value of its assets exceeds the sum of all its debts and liabilities.

The amount that can be saved by distributing funds as capital rather than income are usually significantly greater than the costs of the liquidator’s fees involved in completing an MVL.

It is important to be aware of ‘anti-avoidance’ regulations, designed mainly to target ‘phoenix’ businesses – where one company is closed, and shortly afterwards a similar company is formed by the same individual doing the same work. Under these rules, if a person who received a capital distribution from a closing company launches a similar trade or activity (whether as a company, sole trader, in partnership) within two years of receiving the funds, then those funds will retrospectively be treated as income rather than capital.

Other areas covered by these rules include capital reduction schemes, particularly where the capital has been reduced to below £25,000 (at which point no formal liquidation is required).

What is ‘moneyboxing’?

Furthermore, HMRC will carefully review the position where a trading company contains a large cash balance, particularly where this has been done to avoid paying income tax on taking salary or dividends with a view to claiming BADR and paying just 10% tax. This is known as ‘moneyboxing’.

So it’s important to take expert advice about entering into an MVL well in advance, and to take into consideration your long-term business plans.

Will I qualify for BADR?

If you opt to close your business down through an MVL, and the monies within the business are paid out via capital distribution, under normal circumstances you will have to pay CGT on the money distributed, at a rate of either 18%, or 24% (these rates are effective from 30 October 2024). You may be able to claim BADR on the disposal of business assets or shares in your personal company however, provided that you meet the relevant qualifying conditions, and have done so for at least 24 months – reducing your tax burden to a flat 10% (BADR will rise from 6 April 2025 to 14%).

For a company to be considered a personal company you must hold at least 5% of the ordinary share capital, and those shares must give you at least 5% of the voting rights in the Company. These conditions must be met in the two years prior to sale, or two years prior to the company ceasing to trade. Where the trade ceases, BADR can still be claimed on distributions made within three years of that date.

The process is also relatively simple. Once a company is placed into MVL, the liquidator will make a capital distribution to shareholders, who can then make a claim on their personal tax return for the funds that are received (or the value of assets that are received) to be taxed at a rate of 10%.

It’s clear that as a route to access assets in a company that you a wishing to close down, MVL and BADR is a tax-efficient pathway to go down. Not all companies can enter into an MVL, and there may be other BADR qualifying issues to consider if the disposal or closure of the business is not so straightforward. So as always, it’s important to seek expert advice as early in the process as possible.

Business owners looking to sell may need to act now

These changes to BADR could dramatically impact business owners looking to sell in the coming years.

With the rate of CGT under a BADR claim increasing from 6 April 2025, now may be a good time for business owners looking to exit due to the aforementioned benefits. The progression in CGT rate over the next two years represents a significant difference in proceeds from a business sale when the CGT rate on the first £1million of lifetime gains under BADR will increase from 10% to 18%.

We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.

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