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BADR - Business Asset Disposal Relief or “Be Aware of Defective Rounding” - the 5% tests

Where business asset disposal relief (BADR) is available and claimed, it reduces the rate of capital gains tax (CGT) on the sale of the asset (e.g. shares), subject to a lifetime limit of £1 million of gains. Based on the rates of CGT currently in force, the rate of CGT drops from 20% to 10%, so the saving is significant.

As with all reliefs, a number of conditions have to be satisfied in order for a claim to be successful. As a refresher, for a sale of shares the conditions are that, throughout the period of two years ending with (and including) the date of disposal of the shares:

· the company must be a trading company or holding company of a trading group; and

· the individual selling the shares must:

O be an employee or director of the company (or a member of its group);

O hold at least 5% of the share capital of the company by nominal value;

O be entitled to exercise at least 5% of the votes in the company by virtue of that holding; and

O be beneficially entitled to at least 5% of the economic rights in the company (a detailed condition but typically being satisfied by virtue of entitlement to at least 5% of the proceeds if the entire ordinary share capital of the company were sold).

It is very important to make sure that the shareholder does not hold less than 5%, even fractionally so. In particular, if the shareholder only holds 5% as a result of rounding up to that number (noting that spreadsheets will typically do rounding by default), technically the requirements for BADR will not be met.

Great care therefore needs to be taken when calculations are made to determine whether the 5% threshold will be met – especially if an individual already has 5% or more, and the company’s share capital is being reorganised or additional shares are being issued. If using a spreadsheet and the relevant shareholding is on the borderline, our recommendation is that you always go to further decimal places until you see “5 point something that is higher than a zero”. To take an extreme example, 480,011 shares out of 9,600,223 is 5.00000% to 5 decimal places, but if you keep going it drops to 4.999998% to 6 decimal places. So, a shareholder would need 480,012 shares which is 5.000009%. If satisfying the criteria to claim BADR is important to the client, it will be necessary to consider what can be done to ensure that the individual’s shareholding remains at 5% or more as that threshold needs to be maintained for at least 2 years prior to the sale. Of course, in doing so, care will need to be taken that other shareholders who already hold 5% or more are not diluted so that they drop below that level.

Perhaps surprisingly, in a very recent first tier tax tribunal decision, the court in effect allowed a BADR claim where the shareholder had a 4.99998% shareholding due to such a spreadsheet rounding error. The tribunal decided that the high court would have entertained and given effect to a rectification application because, on the evidence presented, the parties’ intentions were very clear and the individual had been at pains to demand a minimum 5% shareholding at all times and to stress to the company the importance of him being eligible for BADR. For now, this case should be viewed with caution as it was clearly specific to its facts and we think it is very likely HMRC will appeal.

As always, if you have clients who may require further advice, please don’t hesitate to get in touch.