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Tax reliefs: killing tax’s sacred cows?
As announced in the Summer, taxpayers are going to be asked to pay for a £20bn injection in to the NHS by 2023.
Rumour has it that, where possible, this will take the form of a paring back of tax reliefs rather than huge direct tax increases.
This is a lot of money.
As such, it will be necessary for much of the heavy lifting to be done by the reform or scrapping of one of the tax relief ‘big beasts’ – or, perhaps more accurately, one of the sacred cows.
Business Property Relief (“BPR”) on AIM shares
As I wrote earlier in the Summer, I can see no reason why there should be a general exemption against inheritance Tax (“IHT”) where someone holds shares in an AIM company.
This position stems from the fact that an AIM company is ‘unquoted’ for BPR purposes. As you may know, if one holds shares in an unquoted trading company for two years then they are exempt from IHT. Totally exempt.
Now, policy-wise, it makes sense (whether you agree with it or not) that shares in family businesses can be gifted in lifetime or on death without being ravaged by IHT.
But how can the same be said for, say, a pensioner who has simply invested some of his or her own retirement funds in to portfolio with an investment business?
My view is that the general exemption for AIM shares should be removed and replaced by a qualified one that would also require the individual to hold, say, 5% of the shares and / or work in the business (such that it mirrors Entrepreneurs’ Relief).
The issue with this is that I suspect this would create a hole in the AIM market. This has been confirmed to me by financial advisers who have said that a removal of AIM shares from qualifying for BPR would remove the most attractive part of the market. There are companies who are receiving investment mainly as a result of this status.
As such, it might be necessary to phase out the relief over, say, a seven-year period to prevent the market from falling off a cliff.
Entrepreneurs’ Relief (“ER”) is one of a long line of CGT reliefs aimed at the retiring or exiting entrepreneur and business owner.
Most commonly, ER will apply to a business owner selling his or her shares. The Company must be a trading company (not investment) and he or she must be an officer or employee in the Company and hold 5% of the shares. In addition, he or she must meet these conditions for at least 12 months.
The impact of the relief is that it provides for a 10% effective rate of tax on qualifying gains. The current lifetime cap is £10m.
ER ‘costs’ the Government £2.7bn per year and it should be said that the Resolution Foundation is not a huge fan of ER.
What is getting Resolution’s goat? It is the expense and the fact that the relief costs three times the amount originally forecast.
This seems pretty bad doesn’t it?
However, there are too main defences. First, is that the cap of £10m was originally pegged at £1m. As such, the maximum benefit a person can receive has potentially increased ten-fold.
Secondly, the ‘cost’ is highly sensitive to the rate of CGT. Originally, the 10% rate compared to a top rate of 18%. In the meantime, we had a top rate of 28% before this fell in 2016 to 20%.
As such, any reference to the original forecasts is redundant.
In addition, a recent further expansion of the relief applies to those who hold shares in their company which employs them (waiving the 5% requirement) under the EMI scheme, something which has also increased the cost of the relief.
However, a relatively recent survey undertaken by the Government shows that almost nobody (8%) took ER into account when setting up a business and not many more (16%) considered it when considering the timing of any disposal.
This seems to suggest that ER does not influence behaviour to any great extent. If it doesn’t, then is there really any point of having it?
My view is that there is a clear policy of successive governments that entrepreneurs should pay less tax when they sell their business than they would have done if they had, for instance, invested their cash in Banksy’s artwork. Before ER, we had Taper Relief and, even earlier, there was Retirement Relief.
Indeed, it can be seen that in its last year (2007-’08), it was estimated that Tape Relief cost about £7.8 billion.
If the Government was to abandon an apparently long-standing commitment to those responsible for business growth it would, in my opinion, send a very negative message to those who have fuelled Britain’s start-up boom in recent years.
Research and development (R&D) tax credits
And, finally, I move on to the top dog… or our most sacred cow; namely, the R&D relief scheme.
Under this initiative, when an SME incurs expenditure on qualifying R&D, it can receive up to 230% tax relief.
So, if the Company spends £100,000 on qualifying R&D, then it will get a deduction against tax of £230,000 against its tax bill. If it is making a loss or the claim takes it in to a loss-making position, then that loss can be ‘sold back’ to HMRC for 14.5%.
There is also a similar but separate regime for large companies.
Recent statistics show that the current cost is about £3.5bn a year – quite a bit more than ER.
I raise two questions about this relief which I find troubling:
1. The nature of some of the claims do not constitute what the average person would consider R&D; and
2. A significant proportion of this relief leaks in to the hands of claims companies and other advisers by means of contingent fees
There is of course a degree of connection between the two.
The first point is that many would consider a claim could only be made where you had armies of people in white coats or people tapping away at their computers bashing out a new computer code, for instance. It is true that the BIS guidelines require that there be some scientific and technological advancement.
Although, of course, most claims are valid, it is clear that there are claims going in for bakers and breweries with new recipes, restaurants with newly-created dishes and manner of customer relationship management systems that hardly extend the boundaries of human ingenuity to any great degree.
Why is this? Well, this brings me on to the second point mentioned above. For many years, there have been R&D claims management companies who ring up clients, make them aware of R&D tax credits and then make the claim in respect of expenditure.
For this service, it seems that the starting point is 25% of the benefit claimed. In our example above, if the company received a deduction of £230k and it was paying tax at 19% – or £43,700 – the fee charged for doing this might be £10,925. Often, the client will be tied in for multiple years to use the same company.
This might not seem like good value for the Government.
Indeed, they have tried to cut out the middleman by allowing an SME owner to agree their relief for a number of years in advance. However, this does not seem to have gained much traction – as it involves the business owner speaking directly to HMRC (something most accountants would advise against) and the fact that most business owners will get their information about R&D through middlemen anyway.
Of course, there are accountants and other tax advisers providing this service on different charging bases.
Clearly, having a tax relief encouraging investment in R&D is probably something that most people can support. But should it be 230%? Should a company be able to sell its trading loss back to HMRC for 14.5%?
The relief garners massive support from Government, as can be seen from Ministers fanfares last week about what this means for productivity and growth. However, it is questionable whether the increase in R&D relief over the years – in both number and value – has signalled any similar upwards movement in either productivity and growth.
HMRC still (surprisingly) operates a light touch – nearly non-contact – approach in this area. It is noticeable how favourably they treat this relief when compared to both Seed EIS and EIS claims. It is perhaps only a matter of time before the wheel turns.
That aside, my view is that the R&D regime should be tightened. However, I do not think it will be and, for the time being, this remains an untouchable sacred cow…for now.
Out of the three reliefs mentioned above, I can only see that BPR on AIM shares is likely to be scrapped in the upcoming Budget at the end of this month. However, this must include a carve-out for family businesses who find themselves sitting on AIM.
In firm second on the endangered list is ER. Again, I cannot see any sweeping changes on the basis that the policy rationale is so firmly ingrained in to our tax policy. If ER is scrapped, it will be replaced by something similar.
Finally, we have the R&D relief. This is a very costly relief but still has massive support from Government, so I doubt we will see any reining in of the relief.
If you have any queries regarding tax reliefs or on tax matters in general then please do get in touch.