Business Sellers and Entrepreneurs’ Relief
As the upcoming Budget planned for the 11th March 2020 approaches, business sellers are faced with the question of whether to sell in order to capitalise on Entrepreneurs’ Relief (ER) in its current form. Speculation on the future of this particular tax break originated from the Conservative Party election manifesto where ER was targeted as an area for ‘review and reform’.
The Prime Minister gave a further indication of likely changes in the rules in the upcoming Budget, when addressing a group of female entrepreneurs in January 2020 where he referred to the failings of ER as a tax break making the ‘staggeringly rich’ people even wealthier. The Prime Minister emphasised that the Treasury was vehemently against Entrepreneurs’ Relief, which is reported to have saved business owners and investors £2.4 billion in 2018 by enabling them to take advantage of a discounted form of CGT upon the sale of their businesses.
Entrepreneurs’ Relief in its current form
Entrepreneurs’ Relief consists of a reduced CGT rate of 10% to the first £10m of qualifying gains. This discount represents a saving of £1m for business owners, compared with the present CGT rate of 20%. Under current rules, qualification apples to those who for two years leading up to the disposal of the business hold an office in and own a business, either as a sole trader, partnership or hold more than 5% of shares in a company.
The tax break introduced by the Labour government in 2008 by Alistair Darling was intended to 'encourage small business to expand' and 'help people who have reached retirement'. ER was initially limited to £1m per person, but the cap was increased on a number of occasions and raised to £10m in 2011, under the Conservative-Liberal Democrat coalition.
The current legislation deems that when an asset is sold, the date of disposal for CGT purposes is the act of exchanging contracts – this is, when the contract is signed by all related parties. This is distinct from the date of completion, when the business is transferred, and payment is received by the seller. This means that for a business sale to qualify under the existing rules, the seller must exchange contracts with the buyer prior to a change in the law – namely as soon as possible and in advance of the 11th March Budget and certainly no later than the 5th April 2020.
For sellers who have yet to begin the sale process, there may be an option to go for an interim disposal to a ‘Newco’ structure specific to the sale before 6th April 2020, followed by a sale at a future date. This option provides the seller with the opportunity to take advantage of the existing rules. Ideally the sale and completion should take place before 31st January 2021, when the CGT on the interim disposal would be payable.
Entrepreneurs’ Relief: The Likely Changes
The changes in legislation likely to be announced in the upcoming Budget have been subject to a great deal of speculation and debate. There is uncertainty over what the proposed governmental changes will consist of and to what extent the government will consult with interested business groups ahead of any proposed changes to the existing regime.
In response to the proposed reviews, small business owners and the British Chambers of Commerce have expressed concerns as to the potential detriment or benefit new measures may have. These concerns centre around small-business owners in particular who say they have invested money into their businesses as opposed to a pension in order to benefit from the current tax break. Industry groups in defence of ER also point out the importance of the UK being seen as a favourable environment for businesses to start up and scale as stated by Suren Thiru, Head of Economics at the British Chambers of Commerce who said that ‘Any reduction risks undermining some of our most promising young firms and entrepreneurs by stifling investment’.
Support for the current position to be maintained is echoed by Mike Cherry, Chairman of the Federation of Small Businesses, claiming that ‘Making big changes to the relief at this juncture would hit many small business owners who have been planning for their retirement with the relief in mind’.
Critics of the current position, such as the Institute of Fiscal Studies contend that ER has failed to encourage business investment. The high profile think tank reported that in reality, the relief has minimal effect on the income that businesses create and can ‘limit the government’s ability to raise revenue’. This sentiment was echoed in late 2019 by Former HMRC boss Sir Edward Troup who has called to abolish the ER in favour of business owners paying the full rate of CGT and dismissed the idea that the discount was a factor in business creation.
Although tax experts claim that ER is unlikely to be abolished altogether, they expect reforms, such as a decrease in the lifetime allowance to £1m. According to Torsten Bell, Chief Executive of think tank, Resolution Foundation, lowering the allowance could protect the interests of smaller business owners, rather than rewarding the most successful.
The Time to Act is Now!
In light of the uncertainty surrounding how and when the rules will change, the focus for business owners planning to sell is to take advantage of the existing regime, ideally before the Budget announcement takes place on the 11th March.
With a new regime in whatever form it takes likely to take place from the 6th April 2020 at the earliest, at this stage it is only business sellers who have agreed a deal in principle and are in the process of due diligence and transaction, who are likely to be able to benefit from the current regime. However, they should ensure completion by 5th April this year.
The upshot is that time is short for sellers who wish to capitalise on the current position of Entrepreneurs’ Relief and immediate action is required.