Shareholders

How does BADR apply to shareholders?

There are principally two ways in which it can apply:

• in the simple situation where a shareholder sells or gives away shares (although not to s spouse or civil partner)
• where a company is wound up. This is where the company’s assets are passed out to their shareholders in return for their shares before the company is dissolved.

 

Selling shares in a company. Does the gain qualify for BADR?

To qualify the individual must have been an officer (essentially a director or company secretary) or employee of the company for the 24 months before the sale or transfer of shares. There’s no requirement to be paid as an officer or employee, but certainly in the latter case it would be expected. There’s also no requirement to work full time; a part-time employee can claim relief if the other conditions are met.

The company must also have been the shareholder’s personal company. This has a special meaning for tax (discussed below).

Since 29 October 2018, extra conditions apply. To qualify for BADR the shareholding must be at least 5% of the company’s ordinary share capital and entitle the individual to a minimum of:

• 5% of the distributable profits and 5% of the company’s assets available for distribution to equity holders on a winding up; and/or
• 5% of the proceeds if the whole of the ordinary share capital of the company were sold for its market value.

 

What’s the position if the company stops trading?

Usually, the 24-month period as an employee or officer of a company will be that immediately prior to the date of the sale or transfer. However, it could instead be the 24 months immediately prior to the company ceasing to be a trading company.

Example 1

Jim was a director of his own company that he started in May 2018. Due to ill health he stopped working and the company ceased trading in March 2020. Jim waited until June 2020 to sell the shares in the company as he believed that this would qualify for relief. However, as the company had stopped trading the two-year period throughout which he needed to be an employee or officer of the company was ended with the date the company ceased trading, i.e. less than two years from May 2018. Thus the BADR cannot apply to the gain Jim made from the sale of his shares.

Example 2

Hannah’s company ceased trading in October 2020, after almost ten years. It takes her more than three years to sell the shares (by this time the company simply held property). The resulting gain cannot qualify for BADR.

Where the 24-month period starts with the cessation of trade (or the company being part of a trading group), it can’t be a period that ends more than three years before the sale or transfer on which the individual is claiming relief.

If the shares are in a company that’s part of a group, being an employee or an officer of any of the group companies will count as a qualifying employment. Of course, the other conditions must be met, e.g. it must be a personal company.

 

What counts as a personal company?

A personal company is one in which the individual holds at least 5% of the ordinary shares and that this shareholding also entitles them to exercise 5% of the voting rights and, from 29 October 2018, meets one or both of the two additional tests regarding profit entitlement discussed above. Where there is only one class of share, this should be relatively simple to check.

Example

Linda owns 300 shares in a company that has a total of 1,000 ordinary shares. She holds 30% and as such the company is her personal company.

The situation can be far more complex if there are different shares with varying rights though.

Example

Ken holds all 100 “A” ordinary shares in a company. Each share allows Ken to exercise one vote. There are 100 “B” ordinary shares in issue as well. Each of these allows the holder to 20 votes per share. From the total ordinary shares of 200, Ken owns 50%. However, his shares only entitle him to 100 votes out of a total of 2,100 possible votes. This is under the 5% required so his shareholding would not qualify.

However, this will not stop shares qualifying where they do not meet the voting requirement, provided that the shares held in total meet the requirement.

Example

Elaine holds 100 “A” shares out of 1,000. She also holds 3,000 “B” shares from a total of 4,000. The “B” shares carry no right to a vote. If she sells the “B” shares her sale or transfer may still qualify even though on their own they do not meet the 5% voting test. This is because the shares she holds make the company her personal company. Which shares she then disposes of becomes irrelevant.

In summary it’s not the shares that qualify individually but the company as a whole. Once the shareholder has satisfied the criteria for it to be their personal company the shares held can qualify for BADR.

 

What are ordinary shares?

Ordinary shares are any that do not pay dividends at a fixed rate and have no right to share in the company’s profits. So, a share that entitles the holder to a 20p dividend without allowing for any further share in the profits of the company, either income or capital, will not be an ordinary share.

 

Can the shares be owned indirectly?

Anti-avoidance rules say that if a shareholder owns shares via a joint venture or partnership which doesn’t have a trade of its own, BADR isn’t allowed for gains resulting from the sale of the shares in the joint venture or partnership.

 

Is there a minimum period for share ownership?

There’s no minimum period of ownership as such; it’s more about how long the shares have qualified for BADR. It is the company that qualifies (as opposed to each individual share), therefore a shareholder may be able to own shares for a very short time prior to their sale or transfer and still obtain BADR. Once the company is a personal company, it has to remain that way for the 24 months (twelve months for transactions on or before 5 April 2019) that the individual is an officer or employee. The example below illustrates this point.

As long as the personal company condition is met, other shares can be acquired at any time before sale and qualify for relief.

Example

Derek has owned 25% of a company for a period of years. His wife, who does not work for the company, owns another 25%. His business partner owns the remaining 50%. Derek now wishes to leave the company and sell to his business partner. His wife intends on doing the same. The company is Derek’s personal company, but not his wife’s. If she sells her shares she will not qualify for BADR. However, if she transfers them to Derek and he subsequently sells all the shares, he will receive BADR on all of them, i.e. his original 25% and the 25% transferred from his wife.

 

Can a shareholder sell or transfer shares over a period of time and qualify for BADR?

It depends on whether or not they satisfy the criteria at the time of the disposal. As long as they are still an officer or employee and the company is their personal company, any sale or transfer can qualify for relief.

Example

Freda owns 100% of her company and has done for some time. She decides that someone who works for her should become a part owner of the company and sells half to her. This sale or transfer will qualify. Six months later she decides she wants to leave the business to try something new. She sells the remaining 50%. This sale or transfer will also qualify as she has been an employee or officer and the company has remained her personal company.

 

Can shares in all types of company qualify?

For a company to be a qualifying one it must be a trading company or the holding company of a trading group throughout the 24 months (twelve months for transactions on or before 5 April 2019) ending with the date of the sale of the shares. A trading company is one that exists mainly for the purpose of carrying on a trade.

 

What’s the definition of trading company?

The definition isn’t easy to sum up. It’s easier to identify what is definitely not a trading company. Examples of these are a company that only lets property, manages investments or trades in shares.

The legislation states that trading activities are anything done:

• in the course of carrying out a trade
• in preparation for commencing a trade
• with a view to acquiring or starting to carry on a trade; and
• with a view to acquiring a significant interest in a company that is a trading company.

The position is less clear where a company carries on a trade and is also involved in other activities.

 

What are the problems with the definition?

There are two main problems. These are where a company:

• holds investments or lets property as well as trading
• has a lot of cash in the bank.

Where these activities form a large part of the company’s income or use a similarly large part of its resources, HMRC will argue that it is not a trading company.

Example

Gillian runs a successful small business. Each year the company makes about £60,000 profit after a small salary is paid to her. Dividends of approximately £30,000 have then been paid to her each year. The remaining £30,000 is left in the company bank account earning interest. After five years the company’s balance sheet shows total assets of £155,000, approximately £153,000 of this is represented by cash earning interest in the company’s bank account.

 

Is a company trading if it also owns investments?

A trading company can have investment elements and still be a trading, as long as the non-trading aspects do not amount to substantial activities. HMRC has suggested that substantial is 20%, but it doesn’t say what the 20% relates to.

HMRC’s own internal guidance gives five possible factors to consider:

• income
• assets
• expenses incurred
• time spent; and
• company history.

 

How should these factors be taken into account?

A good starting point is to examine how much income is generated by trading and non-trading activities. If the income earned on the investments, be it land or cash on deposit, exceeds 20% of the total income of the company, the shareholder might have a problem claiming BADR when they dispose of shares.

Next, consider the value of the company’s assets and if investments make up more than 20% of the total net assets of the company; that too might be a problem.

Analyse how much of the company’s costs are involved in generating the income. For example, a deposit account earning interest is unlikely to cost much to maintain, perhaps filing a few bank statements, whereas the cost of generating trading income will usually be much more significant.

Also examine the amount of time spent in generating the income. Again, it’s unlikely that any time is spent on producing interest from a bank account compared to that which the company devotes to trading.

Finally, the company’s history should also be considered. There may be very good reason why a cash sum is being accumulated. It may be the case that the company has substantial expenses regardless of the level of its income and a fund is being amassed to ensure it can trade through difficult times. This may have happened before, e.g. during the recent coronavirus pandemic. There may be other capital plans which the company is saving money for, e.g. the purchase of premises. Where this is the case it’s recommended that this fact is documented somewhere.

Once all these factors have been examined no single factor takes priority over another; the position has to be viewed as a whole.

 

Are cash investments non-trading assets?

HMRC is taking a more lenient stance on surplus cash than it has in the past. Although there has been no formal statement on a change of policy regarding surplus cash, it appears it will consider a company is trading unless there is a strong reason not to. So, money held in a bank account earning interest should not cause an issue. But placing this on long-term deposit or actively managing the investment may give HMRC more reason to consider the company has non-trading activities and if these are significant HMRC might take the view that it is not trading.

It’s possible to approach HMRC in advance to seek its opinion on whether a company is trading or not. If there are substantial surplus funds, it would be advisable to do so under the non-statutory business clearance procedure. This should only be an issue when it comes to winding up a company as it’s unlikely anyone will pay for cash contained in a company. By seeking an advance ruling the shareholders are able to actively plan for withdrawal of the cash by other means if necessary.

 

A company uses only part of a building for its business. Is this a problem?

Again, the 20% test is relevant; however, HMRC has stated that the following will not be regarded as non-trading activities:

• letting part of the trading premises
• letting properties that are no longer required for the purpose of the trade, provided the intention is to sell them
• subletting property where it’s impractical or uneconomical for the trade to assign or surrender the lease; and
• the acquisition of property where it can be shown that it’s intended it will be brought into use for trading activities.

This should cover most accidental non-trade activities involving property. But it will not help companies that rent property as part of their business as this will be seen as an investment activity.

 

Are holding companies trading?

For a group of companies, the rules apply in a very similar way as they do to companies operating on their own, but it’s the position of the group as a whole rather than just one company that must be considered.

To qualify for BADR:

• the holding company must hold more than 50% of all the companies that it has shares in
• one of the companies must be a trading company
• and, looking at the group as a whole (treating it as if it were one company), the 20% test should be met.

The fact that all the companies should be treated as being one for this purpose means that transactions between the group companies are effectively ignored. For example, there may be a number of subsidiaries, and one holds all of the property in the group, letting it out to the other group companies at full market rent. Normally this would be considered an investment activity, but in this situation, as it is within group companies, it’s effectively ignored.

 

Assets used by companies

A company uses buildings a shareholder personally owns, does BADR apply?

Land or buildings that a company uses for its business are referred to as associated assets for the purposes of BADR. When a shareholder disposes of shares in their company and also sells the land or buildings BADR may be allowed on both. The same principle applies to other assets they own which are used in the company’s business. Naturally, there are additional conditions they need to meet.

 

What are the BADR conditions for personally owned assets?

When a shareholder makes an associated sale or transfer it must be either as part of their withdrawal from the company or a business carried on by a company which is part of a trading group. A withdrawal from a business means the sale or transfer of at least 5% of a company’s ordinary shares or 5% of a share of a partnership. Also, they must be able to show that the asset has been used in the company’s trade for the 24 months ending with the date they dispose of the shares or the cessation of the company’s trade, if that is earlier.

Example

John and Jess are married and together own “John’s Jobs Limited”, a company providing handyman services. The machinery for this business is stored in a lock-up unit that they also own jointly, having kept this one when they moved house. John works in the company, but Jess does not.

They sell the shares in the company making a capital gain each of £50,000. The lock-up is also sold at the same time to the buyer and they each make a gain of £20,000. So each has total gains of £70,000. Both have used their CGT annual exemptions for the year and both pay income tax at the higher rate.

John will qualify for relief on his sale or transfer of the shares and his share of the lock-up. He will pay tax at 10% on the total gains of £70,000, i.e. £7,000. Jess will not qualify for either sale or transfer as she was not an employee or officer of the company. She will pay tax on the gains at 20%, £14,000.

If Jess had transferred her shares and her share in the property to John before the sale John would have qualified in respect of both gains in their entirety, saving £7,000.

 

What counts as “withdrawing from participation” in a company?

There is no requirement in the BADR legislation for the shareholder to actually leave the company to qualify for relief, only that they dispose of shares in it. HMRC accepts that the sale of shares is taken to be a withdrawal from the business.

Example

Kelly sells her company to BigCo plc, but BigCo wishes to keep her in place to run the company for at least the next two years. Kelly also sells the office and warehouse to BigCo so that they can trade without any interruption. Kelly’s sale of her shares qualifies for relief and so does the sale of the premises. The fact that she is continuing to work with the new company has no bearing on the relief.

 

Can a shareholder sell some of their shares and claim BADR for other assets?

A part sale or transfer of shares can count as a withdrawal from the business meaning that an asset could be disposed of at the same time and any resulting gain qualify for BADR. There is no rule as to how many shares have to be disposed of to count as a withdrawal, so care should be taken.

HMRC’s guidance does not state any number or proportion just that the share sale or transfer and sale or transfer of the assets must be part and parcel of a withdrawal from participation. This in turn means that there should be no significant interval between the two events.

Example

Larry is looking to sell a unit his company uses to a developer. At the same time he transfers half of his shares in the company to his son. As the share sale or transfer qualifies for relief so will the asset sale or transfer as it forms part of a withdrawal from participation.

It’s possible to time the sale or transfer of shares to ensure an asset sale qualifies for relief. However, care should be taken in terms of the size of the share disposal; selling a very small part of a shareholding may look like unfair tax avoidance and be challenged by HMRC. If the shareholder can show that there was a genuine reason for the sale of the shares then HMRC is unlikely to pursue the matter further.

 

What if the company has ceased trading?

There may be occasions when a company has stopped trading but a shareholder still holds property used in its trade. Strictly, the time between the cessation of trade and the sale or transfer of the asset may be sufficient to suggest that the two are not as a result of a withdrawal from the business.

However, HMRC guidance states that it will accept that the two are linked where the asset is disposed of within:

• one year of cessation of trade; or
• three years of the cessation where the asset has not been used or leased since.

The same guidance goes on to say that where the business has not ceased, a time limit of three years will be accepted provided the asset has not been leased or used in the meantime.

 

What if the property has not always been used by the company?

This is where one of a number of restrictions might apply. If the shareholder owned the asset but only used it for the company’s business for part of that time, only part of the gain will qualify for relief. The legislation states that a “just and reasonable” amount of the gain should be eligible for relief. In this situation it seems that the most just and reasonable way to calculate this will be on a time-apportioned basis.

Example

Barry sold all his shares in his company and qualified for BADR. At the same time he sold the premises the company traded from. He owned the property for a total of ten years, but the first three years he rented the property out, before the company started. If the gain on the sale of the property was £40,000, 7/10ths will be eligible for relief (£28,000). The remaining gain of £12,000 will be subject to the usual rate of CGT.

It should be remembered that if the asset is not used in the business when it ceases or the shares are disposed of, no BADR is allowed.

Time apportionment may not be the most just and reasonable way to deal with this restriction; a different method may be used if it’s fair and reasonable.

Example

Kai runs a plumbing company operating from his house. He also owns a retail unit that he has let out for three years to a third party. During this time he has been working to get planning permission to convert the shop and grounds to its rear into flats and houses. When he achieves this, the value of the property rises from £200,000 to £1 million.

His accountant suggests that he uses the property in his business for a year in order to gain at least some relief. So the company opens a showroom with a handful of bathroom displays in it. After a year Kai sells the property to a property developer for £1.1 million. In order to secure relief he also makes a sale or transfer of half of his shares to his son. He bought the property for £150,000.

Based on the time-apportionment method the following would be true:

Proceeds of sale		1,100,000
Less: Cost		150,000
Gain		950,000
Time-apportioned gain eligible	one year/four years	£237,500

This will have the effect of reducing the tax on the gain by 10% on £237,500, a total of £23,750. However, HMRC may take the view that the correct way to apportion the gain is based on the market value of the property when the business starts to use it. This would result in only £100,000 being eligible for relief (£1,100,000 – £1,000,000), rather than £237,500.

 

Summary

Tax if no action had been taken	£190,000
Tax under time apportionment	£166,250
Tax if valuation used	£180,000

 

What if not all of the asset was used in the company’s business?

Relief is restricted, in a just and reasonable way, where only part of the asset is used for the company’s business. The way this is done will depend on the property. For instance, if it’s a workshop that has been subdivided, part of it being used for the company’s business and part being put to other uses, a simple floor space division of the gain may be appropriate.

Example

Joe’s company ran a garage when he sold the shares and the workshop. Approximately one quarter of this had been used by his brother in his courier business. As such, 75% of the gain will qualify for relief.

There may be occasions when a floor space apportionment does not give a fair evaluation of the gain of each part of an asset. For example, if there are two parts of a property that have distinctly different uses, the respective values of each part of the property may be more appropriate.

Example

Sandra ran a retail outlet through her company from premises that had a large, separate workshop at the rear. The company didn’t require the extra storage space that the building provided so she let the property to a neighbouring business. The shop front is on a prime corner part of town with a lot of passing foot traffic. Although the two units are similar sizes it could easily be argued that the portion that is used for the company’s business is worth significantly more and as such the relief should be based on the valuations of the two elements.

 

What if the company has not always been a personal company?

The gain resulting from a sale or transfer must be apportioned to arrive at the part which can qualify for BADR. This is done by time apportionment according to the length of time the company has been a personal company.

Example

In January 2019 Tim and his wife bought a company, Tim taking a 25% share. At the same time he purchased the premises that the company operated from. He continued to work elsewhere and was not involved in the company as an employee or director.

When his wife fell ill in January 2021 Tim took over running the business until it could be sold. In January 2023 both Tim and his wife sold their shares, and Tim sold the property. Tim’s total period of ownership of the property was four years, but the company was only his personal company from January 2021 (i.e. from when he starting working for the company) until the company was sold. Therefore, only one half of the gain on the sale of the property will be eligible for relief.

This sort of situation may occur when property is held jointly by a married couple, but it’s not a qualifying company for one of them; for example, where only one works in the company as an employee or officer.

 

What if the company ceases to be a personal company because of a takeover?

Since April 2019 if ashareholding was 5% or more of the company’s ordinary share capital but as a result of a new share issue falls below that percentage (i.e. diluted), and so falls below the qualifying condition for BADR, the shareholder is entitled to relief for gains accruing up to the time the new shares were issued. To claim the BADR they must make an election for the shares to be treated as if they had been sold and immediately repurchased at market value just prior to dilution. BADR can apply to the resulting gain.

Two conditions must be met to be eligible to make the election. The first is that as a result of a relevant share issue, the company ceases to be the individual’s personal company, i.e. the shareholding is diluted below 5%. The second is that the individual would have secured BADR if immediately prior to the share issue they had disposed of their interest in the company for the relevant value.

 

What’s the position where the company has paid rent for use of the property?

This situation can be a stumbling block for BADR. The shareholder might have been advised to charge rent because it’s a tax-efficient method of taking income from a company. This is primarily because rent is not liable to NI.

However, where they receive rent a problem arises when they dispose of the property in conjunction with selling shares in the company. If they have allowed the company to use the property rent free, BADR can apply to any gain made when it’s disposed of. However, where they have rented to the company, it counts as an investment asset and relief will be restricted.

The restriction is worked out according to the extent the property counts as an investment and a business asset. This split is worked out by comparing the amount of rent received with that which the shareholder could expect to have received had they rented to an unconnected third party, i.e. actual rent versus open market rent. The closer the rent charged is to the market rent, the less relief will be available.

Example

Emily has rented the property her company trades from to it for the five years she has owned it. She has been told that the market rent of the property would be £800 per month. She has been charging the company £600 per month throughout the five-year period. The gain on the property when it is sold is £20,000. The gain that is eligible for relief will be £15,000 (600/800 x 20,000). The remainder of the gain will be subject to the usual rates of CGT.

 

Does the period of rental make a difference?

Yes, but the period that the rent is received for is the main factor. Rent paid for a period ending before 6 April 2008 can be ignored when looking at the potential restriction of BADR.

Example

Josh’s company started trading in April 2003 and began renting a property to it at the market rent. In April 2020 he sold the company and the property, both were potentially eligible for BADR.

However, the property didn’t qualify for relief for the period from April 2008 to April 2020 as it was let to the company for the market rent. When working out the taxable gain the periods before 6 April 2008 (5/17) will qualify for relief.

This point is often missed. The payment of market rent throughout ownership will not necessarily result in relief being completely lost. The use of the property throughout the period of ownership must be taken into account.

 

The rent has changed year on year. How does this affect things?

In the past HMRC has used the average rent over the period of use of the asset as the benchmark. This should iron out the differences in both the market rent and the rent paid over the years. That way it’s of less importance how much rent was paid at a given point in time. If the average rent paid was one third of the average market rent over the period, then one third of the gain will not qualify for BADR, but the remaining two thirds will.

 

What if there is no rent but the company covers mortgage repayments?

The shareholder might not call it rent, but the definition of rent can include other arrangements which financially benefit them. Where the company is making the loan repayments on their behalf, this will count as rent and a restriction of BADR will apply.

Note. Just because the company makes loan repayments from its bank account this does not necessarily mean it is ultimately meeting the cost. That will depend on the accounting entries made in the company’s records. If the amount is charged to the company’s profit and loss account, it will count as rent. However, if, for example, the cost is then recharged to the shareholder personally through the director’s loan account, it will be them that is meeting the expense and not the company and their claim for BADR will not be affected.