Entrepreneurs’ Relief – A Dead Man Walking?

Author

Andy Wood

Andy is a practical, creative tax adviser who assists a variety of clients in achieving their personal and commercial objectives in the most tax efficient manner.

Entrepreneurs’ Relief (ER) in 2020 – Background

Once again, newspapers have recently been running stories about the potential demise of Entrepreneurs’ Relief (“ER”).

What is ER?

ER is one of a long line of capital gains tax reliefs targeted at those either retiring or exiting from a business.

Most commonly, ER will apply when a business owner sells his or her shares to a third party or family member.

In this context, broadly, the business must be a trading company – as opposed to an investment company – and he or she must:

  • be an employee or officer (eg Director) of the Company; and
  • hold 5% of the shares.

He or she must meet these conditions for at least 24 months.

For further details of the requirements please see here.

The relief is highly attractive as it provides for a 10% effective rate of tax on the relevant gain.

Each person has a lifetime limit which is currently set at £10m.

What’s the problem with Entrepreneurs Relief?

The problem is the perceived cost of ER.

The Resolution Foundation suggests that ER ‘costs’ the Government £2.7bn per year. This is more than three times the amount that was originally forecast. Other think tanks have also made the same point along with former HMRC big cheese Sir Edward Troup.

Enter the case for the defence.

It is not a surprise that the ‘cost’ of the relief has exceed the forecasts when the shape of the relief has changes significantly in two respects.

Firstly, the £10m referred to above was originally set at £1m. As such, the maximum benefit a person can receive has potentially increased ten-fold.

Secondly, the ‘cost’ of a tax relief is clearly highly sensitive to the headline 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%.

In addition, a 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.

As such, any reference to the original forecasts seems largely redundant.

Does ER act as an incentive to create businesses?

A relatively recent survey undertaken by the Government shows that:

  • Only 8% took ER into account when starting their business; and
  • Only 16% considered it relevant when timing a disposal.

This seems to suggest that ER does not influence behaviour to any great extent.

So, the verdict appears to be that ER is both expensive and relatively pointless

This seems pretty damning, doesn’t it?

What is the future of ER?

Both the Labour Party and the Conservatives made it clear that ER would not survive in its current form in the future.

Certainly, there has been a clear policy of successive governments that entrepreneurs should pay a lower rate of tax than, say, if someone sells Banksy’s latest artwork.

I am not saying whether this is right or wrong. It is just a statement of fact.

Before ER, we had Taper Relief which was divided in to non-business asset and business asset taper relief.

Before that, there was Retirement Relief.

In 2007/08, its last year of operation, taper relief ‘cost’ the Exchequer as follows:

Type of asset Chargeable gain Tapered gain Amount of relief ‘Cost’ of relief at 40%
Business Asset £28.7bn £9.3bn £19.4bn £7.8bn
Non Business Asset £13.65bn £6.4bn £7.25bn £2.9bn
Total £42.35bn £15.7bn £26.65bn £10.7bn

Of course, if when one compares taper relief to ER, ER starts to look very good value indeed!

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 business.

So, what is the likely outcome?

For cost reasons, I cannot see a return to taper relief.

I would therefore suggest that ER will be kept but perhaps the conditions are further restricted similar to the changes which have taken place over the last couple of years including a narrowing of the definition of personal company and also the extension to the period for which one must satisfy the conditions.

A further, obvious change might be to cut the £10m lifetime limit.

I am an entrepreneur – should I try and ‘bank’ ER now?

I am not one to try and scare people in to action but considering whether a ‘friendly’ sale could be triggered is certainly something that entrepreneurs might consider exploring where losing ER might be a significant concern.

 

If you have any queries about ER, or banking ER ahead of any potential changes, then please do get in touch.

 

3 Comments:

  • C johnson / Reply

    I need to refer a sale oft a gust house for 1 million to a tax consultant

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