Entrepreneurs’ Relief - How much is it costing?
In the run-up to every Budget in recent years, there have always been rumours around whether there would be changes to, or even the abolition of, Entrepreneurs' Relief.
Entrepreneurs' Relief (ER) means that owners of businesses pay capital gains tax (CGT) at 10% on all capital gains up to a lifetime limit of £10 million, when they sell qualifying business assets such as shares in an unquoted trading business. Gains in excess of the £10 million lifetime limit will generally be charged to CGT at the main rate of 20%.
ER was introduced with effect from 6 April 2008 as the successor to Business Asset Taper Relief and part of the wholesale reform of CGT which the Labour government of the time said was designed to deliver a sustainable and straightforward system, which is internationally competitive and provides a focussed tax relief for entrepreneurs.
Initially ER applied to the first £1 million of qualifying gains but that lifetime limit was increased progressively and has been at £10 million since 6 April 2011.
Why is ER at risk?
The Office of Tax Simplification (OTS) has said they believe the various tax charges and reliefs which apply at various points in the business lifecycle need an overhaul to reduce complexity, make reliefs more accessible and to encourage UK businesses to fulfil their potential.
They have said the cost of tax relief on claims to ER is greater than that of any of the other reliefs considered in their review and that the relief does not appear to encourage investment in young or growing businesses or preserve existing businesses from break up in the event of succession, so therefore warrants a closer look.
HMRC estimates that the relief cost £2.7 billion in 2017-18 and it has recently been estimated that the total cost over the first 10 years has been £22 billion. This is significantly more than was forecast.
Whilst successive governments have been broadly supportive of ER, the OTS comments and the obvious need to look for additional tax revenues suggests that restrictions to ER might be on the horizon.
What could change?
In the current climate, where it is imperative that the UK continues to have an attractive business regime, one hopes that careful research and consultation would be commissioned before any drastic changes are made.
However, there are some soft spots within the rules which could be altered to restrict the relief in areas where it might be too generous, arguably without affecting the overall policy objective. These might include:
The lifetime limit of £10 million could be reduced. HMRC statistics show that in 2015-16 about 12% of ER claimants made claims on gains of over £1 million, but this group accounted for around 69% of the total gains on which ER was claimed. This shows the lifetime limit could be reduced without affecting the majority of potential claimants.
The qualifying conditions currently include a requirement that the claimant is an employee or director and has a 5% minimum shareholding (with associated voting rights) for at least a year before the disposal. The 5% minimum shareholding could be increased to say 25% or a minimum working time requirement could be introduced to target the relief at those most significantly involved in the business. It should be noted that there are already other reliefs (EIS/SEIS) that encourage passive investment into young and growing businesses.
There could be a restriction to ER where a business holds significant cash balances. If a business retains cash in excess of normal working capital requirements, unless this is actively invested it should not generally taint the trading status of the company and jeopardise a claim to ER on a sale or a voluntary liquidation following a cessation of the trade.
It is clear that ER and other capital tax reliefs are under review, so it is vital that business owners take advice and plan accordingly.
The government will be wary of doing anything to discourage entrepreneurs from setting up businesses in the UK, but there are some areas of ER that could be changed quite easily to reduce the cost of the relief to the Exchequer whilst still maintaining the policy objective of encouraging entrepreneurial investment.
If you require tax planning advice around ER please do not hesitate to contact your local Tax Partner. Alternatively, send us an online enquiry to contact one of our business experts.
This Insight is part of exclusive content being provided by our experts on the run up to the Autumn Budget. View our special Autumn Budget 2018 coverage to read more commentary and upcoming analysis to help your business plan for any outcome.