The end of Entrepreneurs’ Relief?
We have been made to wait a good while since the last formal budget, with this week’s event essentially having rolled over from Autumn 2019 — due to the small matter of the UK leaving the EU in October (in name only at this stage!).
As is always the case, there is much gossip and rumour ahead of a budget and this time is no different. I have been asked on numerous occasions if we receive any kind of tips or early warning of budget changes, for example new tax or pension legislation, and the simple answer is no. Working in the financial services industry means that we find out the same time as everyone else — when the Chancellor opens up the little red brief case.
What will change this time around?
Pension legislation has remained fairly steady for a number of years now, with no hugely significant changes proposed since the introduction of increased flexibility through ‘pension freedoms’ in 2015 (the further reduction of the Lifetime Allowances in 2016 aside of course). So there may well be some tweaks here and there but nothing particularly ground breaking has been hinted at to date.
What certainly does seem to be on the agenda this time around, is a potential change to, or possibly even the abolishment of Entrepreneurs’ Relief (ER) on the sale of small and medium sized businesses.
What is ER?
ER was introduced by Gordon Brown, when he was Chancellor back in 2008. It cuts the rate of Capital Gains Tax (CGT) charged on the sale of small and medium sized businesses (up to £10 million) in half, from the standard higher rate CGT of 20%, to just 10%. This is an extremely valuable relief for business owners and at the ‘sweet spot’, with a business sold for £10m, could provide £1m in tax savings. The £10m figure is also a lifetime limit and ER can be claimed multiple times, through cumulative sales up to this level.
The idea behind the introduction of ER was to incentivise UK entrepreneurs’ and position the UK as the European Centre for Entrepreneurship. The intention was to encourage individuals to start their own businesses and grow these, perhaps with a view to a bumper pay day in the future. ER allows value built up within a business to be realised in a tax efficient manner. It is not uncommon for us to speak with SME business owners who may have relatively small pension funds for example, who hold the view that “my business is my pension” i.e. following a prospective future sale.
Why is this being challenged?
In theory, the scenario outlined above makes complete sense. Whilst ER is clearly an attractive benefit for individuals who run their own businesses, encouraging small British business should benefit the wider economy and country in general, through higher employment and increased tax revenues for the treasury.
There were 5.8 million small businesses in the UK at the start of 2019, accounting for 99% of the total number of British businesses, employing more than 50% of the workforce*. Whilst it is difficult to compare contrasting scenarios, the existence of ER could well be tax positive for HMRC even if they get a smaller slice of the pie following a sale.
It is suggested that the direct cost of ER to the revenue is around £2 billion a year** and critics argue that this disproportionately benefits wealthy business owners in London and the South East of England for example. The argument here is similar to that put forward to restrictions placed on pension contributions through the introduction of the much reduced annual allowance in 2011 (now £40,000), i.e. that the majority of the tax relief goes toward a small minority of high earners, or business owners in this case.
An additional criticism is that ER encourages individuals who might otherwise be employed, to position themselves as contractors / consultants within their own limited companies. In this scenario, not only is the ‘year on year’ tax position more favourable to the individual, where they have the option to take dividends in place of salary, they may also be able to realise residual value from the company tax efficiently once the company is wound up, by claiming ER.
How might ER be affected?
The Conservatives stated in their 2019 election manifesto that they planned to “review and reform Entrepreneurs’ Relief”, in light of some of the criticism this had come under (outlined above). Jeremy Corbyn and his Labour party by contrast stated outright that they would scrap it immediately if they were to come into power.
It seems fairly certain that there will be some changes to ER announced on Wednesday 11 March, and while there is certainly nothing confirmed at this stage, the options available to the Chancellor and his team could be as follows:
- Abolish ER completely – clearly this would be the most extreme outcome, which would no doubt be met with uproar from the business community, with all manner of negative headlines speaking of an ‘anti-business government’,
- Replacement of ER – it may be the case that a replacement relief is announced, looking to serve a similar purpose, but potentially enabling HMRC to benefit more from SME business sales,
- Amendments to ER – the relief could be halved from 10% to 5% for example (resulting in a 15% CGT bill on business sale), or maybe the value that can be claimed could be reduced from £10m to £5m.
As I mentioned earlier, no one outside of the Government will know the proposals that are due to be announced on Wednesday, until we all know. Whatever these may be, it seems likely that the landscape for business owners will change, with a particular and more immediate focus on those who are thinking about, or positioning for a sale.
In a changing financial landscape, the importance of receiving sound financial advice and guidance cannot be understated. We have a track record of working closely with business owners at various stages of their journey, from a leap into the unknown at the outset, to a realisation of value following sale and all the considerations that comes with this.