What is the difference between Capital and Income ? A brief guide to entrepreneur's relief

Most small business owners don’t differentiate between the money they receive every month. But in reality the UK tax system does and to ignore this could cost you tens of thousands of pounds.

The two types of receipts that we will consider are Income and Capital, and particularly the relevant tax rates which differ between 40% for tax on Income to as little as 10% for Capital Gains Tax (“CGT”) where Entrepreneurs Relief is available and claimed.

Entrepreneur’s Tax Relief (“ETR”)

Frost Group Limited does not provide tax advice and you will need to liaise with your tax accountant with regards to claiming ETR before finalising the strategy; but in summary, ETR enables shareholders to pay just 10% on capital gains over the lifetime of the business against the prevailing basic or higher rate of income tax they may otherwise have to pay. It must be claimed at least 12 months from the 31st January following the tax year in which the business is sold off or wound up.

There is no limit on the number of times an entrepreneur can claim ETR however there is a lifetime ceiling of £10m. This means all the businesses that an individual sets up in their lifetime will be included in the £10m limit.

ETR can be claimed by an entrepreneur’s spouse provided they own at least 5% of the business and work there in some capacity. In theory, at least, this enables an entrepreneur to claim up to a further £10m simply by transferring their shares to their spouse at least a year before they plan to sell off the business.

Business owners can also claim ETR on capital distributions to shareholders when the business is closed down via a Members’ Voluntary Liquidation (MVL).

So, if you wind up your company with an MVL and take all the remaining money in the business bank account as a capital distribution rather than a business dividend, you’ll make huge savings in tax under the ETR.

Everyone’s financial affairs are different so we would recommend you speak to you tax accountant with regards to benefitting from ETR if you intend to sell or wind down your business.

In order to qualify for ETR you must:

  • be an individual, rather than a company
  • work as an officer or employee of that company
  • own at least 5% of the company and have at least 5% of the voting rights. (This minimum 5% ownership must have been in place for at least 12 months prior to claiming Entrepreneur’s Relief, or at least 12 months before the business ceased trading.)

Further information relating to ETR is available at https://www.gov.uk/entrepreneurs-relief