Entrepreneur’s Relief – amend or abolish?

25th February 2020

The weeks ahead of any budget are rife with speculation about what changes we might expect. But with a new Chancellor in office only days ahead of the Government’s first budget on March 11th, his promotion is the focus and many wonder what might get through without the scrutiny it deserves.

In amongst all the red herrings though, one thing we should know after the Chancellor speaks is exactly what the government intends to do about entrepreneur’s relief (ER).

Not many taxes manage to inflame the kind of emotions that ER seems to, with it being described variously as ‘the worst tax in the world’ and ‘the most generous tax relief in the UK’ – there appears little grey area in the opinions.

The fact that there’s a chance it may be revised or removed entirely in this budget means it’s probably worthwhile taking a quick look at the tax, the impact it has had, the reasons why it attracts such criticism and what steps should or could be taken if it does disappear in a few weeks’ time.

A real encouragement?

Amongst those recently calling for ER to be scrapped was Sir Edward Troup, former executive chair of HM Revenue & Customs (HMRC), who argued it actually did nothing to encourage entrepreneurship, but had cost the government £2.2bn in lost taxes during the 2017/18 financial year.

He opined it was in effect, little more than a tax scam exploited by already wealthy people to reduce the tax bill on capital gains from 20% to 10%.

His argument appeared to be supported by the Institute for Fiscal Studies, with HMRC data showing the impact of ER had been to allow 9,000 people to pay £1.5bn in tax on £33.7bn in capital gains income during the last year for which figures are available.

This amounts to an effective tax rate of just 14.8%, when compared to the 40% imposed on earnings between £50,001 and £150,000.

Introduced in good faith

It was believed that ER would encourage people to grow a business, by reducing Capital Gains Tax (CGT) from 20% to 10% on the proceeds of selling a company. It was introduced in 2008 by then Chancellor Alistair Darling, as a somewhat panicked response to criticism of the abolition of taper relief.

Initially, ER was limited to £1m per person, but increased under successive governments to reach the current limit of £10m during an individual’s lifetime. In this way the overall cost of the measure to the Treasury has risen from an estimated £200m per year to the current £2.2bn cited by Sir Edward Troup.

The 10% CGT rate imposed by ER applies no matter what the income of the individual is, with no limits being set on how many times ER can be claimed within the £10m allowance.

There are conditions for claiming ER and these are loosely as follows:

  • The business must have been trading for at least 24 months prior to the date on which the shares are sold
  • The person selling the shares must own a minimum of 5% of the ordinary share capital of the business in question
  • The person selling the shares also has to be an employee or officer of the business

It was believed that business owners would use the funds from a sale, to reinvest in start-ups and other early stage businesses. However, critics focus on the fact the relief allows individuals to generate earnings by operating through a limited company, rather than being paid via the payroll.

Taking money out through dividends is highly tax efficient and when a business is ultimately sold, the individual can claim ER on any capital still remaining.

When compared to schemes such as the Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS), which help entrepreneurs get hold of funding, how ER encourages the creation of new businesses and more jobs is difficult to explain.

The numbers do not lie

Defenders of ER argue it rewards those individuals who accept the significant personal and financial risk of actually starting and growing a business, often struggling to earn sufficient remuneration for themselves, as they work to build it up.

Evidence that ER helps to make the UK an attractive location for entrepreneurs can be found in the number of companies registered at Companies House, which rose by 62% in the decade since it was introduced – accessible funding and measures like R & D tax credits have also helped.

The World Bank ‘Ease of Doing Business’ ranking for 2020 put the UK in 8th position with a score of 83.5, compared to New Zealand at the top with a score of 86.8 and the US one place ahead of the UK with a score of 84.

Interestingly, our soon to be ex-EU partners do not fare so well, with one of our harshest critics the Spanish in 30th with a score of 77.9, France is ranked 32nd with score of 76.8 and the much-vaunted German economy ranks 22nd with a score of 79.7. So, if it’s working, why try and fix it?

The Conservative’s manifesto stated ER needed reviewing and given the criticism swirling around it, reform is likely. One suggested option is that ER could morph into a form of rollover relief, with gains not reinvested in a qualifying business within a set period subjected to the standard rate of CGT.

Alternatively, the Chancellor might tweak a few details of ER to show willing, or scrap it entirely, which appears highly unlikely.

Change seems inevitable and any business owner currently making use of ER and planning to sell their company or is sitting on funds currently held within the business will have to consider how they will respond.

Respond before everyone sells

If you’re planning to sell your business, you may have a limited window of opportunity to take advantage of ER, so the best move is to talk to professionals experienced in the sale process and discuss what options you have to protect your tax position, whatever the new Chancellor decides.

Now’s a good time to talk, so speak to Neil Jones, joint head of the Corporate team here at Ansons, who can be reached direct on 01543 431184 or via email