Entrepreneurs’ Relief (ER) on Retained Earnings (RE)

When you close down your limited company and you have retained earnings (RE) in your company, you could possibly claim entrepreneurs relief (ER). There are potentially big tax savings in doing this.

What are the qualifying conditions that need to be met in order for you to be able to claim Entrepreneurs' Relief (ER)?

  • Your company has to have traded for at least one full year.
  • You hold at least 5% of the shares and voting rights for at least 12 months.
  • You are a director, office holder or paid employee for at least 12 months

What are the advantages of claiming Entrepreneurs' Relief (ER)?

  • The total RE in your company is seen as a capital distribution, which is taxed under the Capital Gains Tax (CGT) rules in your self assessment tax return.
  • In the UK you are entitled to a CGT free allowance of £11,300 for the 17/18 personal tax year.
  • Any RE above this amount is taxed at 10% when claiming ER.
  • If you don’t claim ER, the RE in your company will be taxed at the CGT rates of 10% (basic rate taxpayers) or 20% (higher rate taxpayers). Before 6Apr’16 the CGT rates were 18% and 28% respectively.
  • If you choose to declare the retained earnings as dividends instead of leaving it in the company as RE, then this will be taxed as income in your self assessment tax return. For higher rate tax payers this will be at a minimum rate of 32.5%.

Example if your Retained Earnings (RE) are below £25k:

Say for example the RE in your company are £24,750. The CGT you will have to pay in your personal tax return is calculated as follows:

Total capital gains

£24,750

Less: Tax free allowance (17/18 tax year)

£11,300

Net Taxable Capital Gains

£13,450

Capital Gains Tax on ER at 10%

£ 1,345

So, the total tax you pay on the £24,750 capital distribution is only £1,345.

If you are a higher rate tax payer and you distribute the above as a dividends, you will pay a minimum of 32.5% dividend tax:

Total Dividends distributed

£24,750

Income Tax on Dividends at 32.5%

£8,043.75

 

Example if your Retained Earnings (RE) are above £25k:

Please note that if your ER is more than £25k you need to formally liquidate your company to claim ER. So the cost of formal liquidation has to be taken into consideration to see if you’ll be better off claiming ER or rather taking the RE as dividends.

Say for example the retained earnings in your company are £85,750. The Capital Gains Tax you will have to pay in your personal tax return is calculated as follows (ignoring any liquidator fees):

Total capital gains

£85,750

Less: Tax free allowance (17/18 tax year)

£11,300

Net Taxable Capital Gains

£74,450

Capital Gains Tax on ER at 10%

£ 7,445

If you are a higher rate tax payer and you would distribute the above as a dividend, you would pay a minimum rate of 32.5%:

Total Dividends distributed

£85,750

Income Tax on Dividends at 32.5%

£27,868.75

Tax implications

Whether you distribute the RE in your company as a dividend or as a capital distribution will not make any difference to the Corporation Tax in your company. The big difference comes in with your personal tax, as you can see in the examples above.

Please note that if your total personal earnings are higher than £100k, you will pay more than 32.5% tax on dividends, because you would be in an even higher tax bracket.

If you’ve claimed ER, then the amount of RE as per your company’s closure accounts will have to be disclosed in your next personal tax return as such.

Retained Earnings (RE) on BeanBalance

If your BeanBalance is up to date, you can at any time see what your current retained earnings (after Corporation Tax) are, in the Business Position Module.


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