For some time, the writing has been on the wall for Entrepreneurs’ Relief (ER), which halves the Capital Gains Tax payable when an entrepreneur sells a business from 20% (in the case of a higher rate taxpayer), to 10%.
Then Chancellor, Philip Hammond, signalled a change to the mood music in his 2018 autumn budget speech, saying: “I have received representations that I should abolish Entrepreneurs’ Relief and put the savings towards funding our NHS”. Under new leadership at the end of 2019, it was confirmed that this tax break remained a bugbear of the Conservative Party. In its election manifesto, it pledged to ‘review and reform’ ER, saying it hadn’t delivered on objectives. And as we all know, the Conservative Party won.
Financial journalist and self-confessed ‘ardent HM Treasury watcher’, Dan Atkinson, thinks changes are now a fait accompli. He says: “In the March 2020 budget we can almost certainly expect to see further restrictions on ER, but I think it’s unlikely to be scrapped entirely.”
In terms of what might change, Dan says it is difficult to predict, but there are three main things to look out for. First, further restrictions on qualification for ER could be introduced, but this has already been a trend over the last few years, so is unlikely to provide the scale of reform government is looking for. (New restrictions around share ownership were introduced in 2018 and 2019, with shareholders needing to hold a minimum 5% economic interest in the company and needing to have held shares for at least two years, up from one, to qualify.)
Second, the tax rate could be increased from the current 10%. And third, the lifetime limit on gains that the ER tax rate applies to (currently £10 million) could be reduced.
Dan says the timing couldn’t be more opportune for government: “An election has just been won, so by the time the next one comes around, the issue won’t be fresh in the minds of those upset by the move.”
He continues: “This government can say it was a misconceived Labour tax break (ER was introduced in 2008 when Alistair Darling was Chancellor). And to be fair, it is a tax break that is difficult to defend. In most cases, ER reduces the tax bill for people selling mature businesses. Entrepreneurs do not roll their sleeves up, start businesses, and create jobs because they will eventually get a tax break many years down the line.”
Dan also points out that ER is extremely unpopular with many HM Treasury officials, who consider ER to be mostly used as a ‘financial product’ constructed to reduce tax, rather than as a scheme moulded to the needs of entrepreneurs which in turn drives additional entrepreneurial activity.
Plans will need updating
Steve Hoon, tax partner at BDO, says that, if changes are made, they could be effective immediately and a ‘grace period’ or delay in implementation of any such legislative changes should not be expected. He says recent changes to Capital Gains Tax (and consequently ER) have become effective for disposals taking place on or after the day following the Budget.
But he stresses that a knee-jerk reaction between now and budget day should be avoided: “Selling a business is a major event and in practice is not something that can be significantly rushed.”
Steve also says it is important to keep the scale of the ER tax break in perspective. He says: “Is the difference between a tax rate of 10% and 20% really big enough to fundamentally change a huge commercial decision such as selling a business?” He continues: “And remember that even without ER, the UK has a very attractive Capital Gains Tax environment when selling a business, with 20% being far lower than income tax rates.”
He does however acknowledge that if a business owner is already part-way through a sale process which has a realistic prospect of completing before budget day, then the signalling from government might certainly tip a marginal decision in favour of selling and upping efforts to get the deal over the line.
But, for those owners with exit plans extending beyond March 2020, there is a possibility that they will be paying more than the current ER rate of 10% on their capital gain. Irrespective of any changes to ER, it is worth noting that there are other steps that business owners can take to maximise their net proceeds on a sale. This may include undertaking vendor due diligence exercises to help articulate the value of the business to potential sellers (see Entrepreneur Club article Ten steps to due diligence readiness) or taking steps to improve the working capital requirements of the business pre-sale.
In addition to Steve’s comments above, entrepreneurs may also want to consider revisiting their personal financial planning. Changes may be required – such as adjusting the target ‘exit value’ for their business upwards (to account for the loss of any ER tax break) to provide the same ‘retirement pot’ when the business is sold.
For further discussion on how to incorporate tax and other uncertainties into exit planning, see the Entrepreneur Club article Navigating to exit in uncertain times.
A good place to start when you are preparing your business for sale is to fill in the St. James’s Place Entrepreneur Club app, which will give you a clear picture of your current position.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.
Exit strategies may include the referral to a service that is separate and distinct to those offered by St. James’s Place.
The opinions expressed by third parties are their own and not necessarily shared by St. James’s Place Wealth Management.