Changes to Capital Gains Tax Rates – What should the entrepreneur do?

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Jim Shaw, Founder and Partner at Shaw & Co, responds to the latest report from the Office for Tax Simplification (OTS) which recommends a rise in Capital Gains Tax (GCT) in 2021.

Many of you will be aware that the Office for Tax Simplification (OTS) has now reported to the treasury on Capital Gains Tax (CGT). This report was received and made public in early November prompting concern from business owners that having received a jab in the ribs on Entrepreneurs Relief in March, when up to £900,000 of benefit was stripped away, that the left hook is coming with an alignment of Income Tax and CGT rates. Indeed, this is the report’s somewhat over simplistic conclusion.

This means that an entrepreneur selling their business in Feb 2020 for £10m would have paid £1m in tax, benefiting fully from the 10% tax offered on a £10m lifetime allowance by Entrepreneurs Relief. The same business selling in April 2020 would have paid £1.9m in tax as this lifetime limit was reduced to £1m. If CGT rates are aligned with Income Tax but Entrepreneurs Relief is untouched, for a sale in March 2021 this tax would rocket to £4.15m an increase of over 4x in tax in just over a year on the same transaction. 

For many this sort of ‘potential’ increase is enough to motivate a move to sale, to get in before the changes, and when you think about it you can see why. Selling the above business today, even after the Entrepreneurs Relief is all but withdrawn, will net the entrepreneur £8.1m, a tidy sum delivering financial freedom for all but the most lavish.

To get to the same net return in a tax environment where CGT and Income Tax are aligned, a sale price of £14.1m or +41% will need to be achieved. For many this looks like many years of hard work just to get to the same place. The average SME simply does not grow in value that quickly year on year. However, if the rates are aligned before the business can be sold, a net return of £5.8m on the same deal would likely put some restrictions on the retirement bucket list and lessen the possibility of generational family wealth.

Many would consider these ‘first world problems’ and the vast majority of the voting public will have little sympathy for the entrepreneurs impacted. However, when you bring my example down to business values of £5m or less, you start to get to the point where entrepreneurs cannot afford to sell their business as the annuity value of the asset becomes significantly greater than the capital value.

With the backdrop of a relatively stable CGT regime stretching back to business asset taper relief, the forerunner to Entrepreneurs Relief for those old enough to remember the tax regime in the 1990’s, many Entrepreneurs have sacrificed income, time and often their sanity to struggle through the often-thankless task of building a business in the expectation of the ‘payday’. All the time they have been creating jobs, driving GDP, paying PAYE, NIC and Corporation Tax. Yet now they face the prospect of a material raid on that value they have been diligently building up for many, many years.

The majority of the voting public won’t understand this, we have to hope that the government does.

Nevertheless, there is another dynamic to all this making the situation yet more challenging for the business owner. Buyers are savvy and with so much supply coming to market it is inevitably impacting pricing. The closer we get to March and the budget, without confirmation rates will remain untouched, the more apparent that this will become. Many conversations with buyers at present remain cordial, but as time ticks and options for sellers start to reduce, expect buyers to be turning the screw and reducing pricing.

Rumours around CGT increases have been present since mid-summer. If you go back far enough, you will find the changes to Entrepreneurs Relief set out in the Conservative Party manifesto for the last election. Go back further still and you will find column inch after column inch about private equity partners paying less tax than the cleaner. So, the smarter business owners have already ‘bagged’ the more favourable tax rates in early 2020 before the CGT overhaul got underway and buyers got cute.

So, is it too late for anyone just waking up to this news? Sadly, it’s close to yes. A proper M&A process can easily take 9 months some 35-40 weeks. With Christmas afoot, there are no more than 13 working weeks until the beginning of March. This gives you an idea of the sort of process compression that is needed to get a deal done inside any change.

Add to this that the market is swamped and getting buyer attention is going to be near on impossible unless of course you are offering them a ‘bargain’ which is where all this could come down to a zero-sum game for business owners.

Finally, it might not even happen. The recommendations from the OTS are far from a statement of intent from the government. The OTS has made numerous radical proposals in the past that the government has chosen to ignore. The country is facing a huge tax burden arising from spending to combat Coronavirus. But Rishi Sunak’s spending review delivered in the commons yesterday indicates a Thatcherite approach to recovery, promoting economic growth, individualism and entrepreneurship to drive tax income and GDP over an immediate raid on the taxpayer. This rhetoric is encouraging for our entrepreneurs and business owners who may be spared the axe in March.

Also, bear in mind who is now resident at number 11. Chancellor Rishi Sunak was not in post at the time when the Conservative Party manifesto was written and the changes to Entrepreneurs Relief were set out. Cynically I might suggest, this manifesto pledge was only there to persuade the ‘red wall’ that this Conservative Party is not ‘just for the fat cats’ by taking a swipe at the traditional Conservative voter. A safe tactic when the only other option for those voters was the ultra-left opposition of Jeremy Corbyn and John McDonnell. The Conservative faithful were hardly likely to defect. Of course, Rishi had to follow through when he got to the dispatch box, but now with a free hand the ex-Goldman Sachs banker can follow his own agenda.

Finally, the OTS report is a two-stage process. A bit like the inheritance tax review where the first stage report was issued in November 2018 and the second in November 2019, and yet still no government response. So, there is little evidence to suggest that the government will move quickly. March 2021 could easily be a false dawn.

Does CGT need to be overhauled? Yes, is my honest view. There is clear evidence that the annual disposal limit is being abused through disposal timing. The peak of CGT returns at just under the annual limit of £12,300 per annum gives you all the evidence you need. The housing market is overinflated as an asset class meaning that many young people cannot afford their own property, and this is not helped by offering CGT rates to investors in the property market. Remove CGT on these assets and you will take some heat out of this essential commodity. And yes, there is definitely some abuse going on commuting income to capital through share schemes and carried interest, despite the best efforts of the Employment Related Securities legislation.

I urge the government, and particularly Chancellor Rishi Sunak to have a good look at CGT but in doing so, not only to spare any tax increases on the entrepreneur but to reverse the changes made to Entrepreneurs Relief in March. One radical idea floating around our office is to abolish the concept of CGT entirely but to offer an Entrepreneurs Relief against Income Tax to an uncapped level for those individuals who truly pass the test of building UK PLC. Why uncapped? Because whilst I make the argument that it is the smaller business owner that will be unfairly hit by a ‘rate alignment’ and a generation discouraged from taking the risks needed to build a business, the larger business owners will have the ability to simply ‘off-shore’ their assets and the UK government will miss out on any tax income altogether. With the surge in remote working thanks to coronavirus and the enabling technology surrounding it, don’t be surprised to see huge numbers of UK business run by entrepreneurs sat on Caribbean islands…. Mr Branson, yet again you may have been ahead of your time!

As an entrepreneur, what do you do? If there is a sensible deal on the table that you would have taken anyway, then it would seem logical to proceed. But if you are faced with compromises, possibly because of buyer action, or maybe because of coronavirus affected trading in the last 9 months, it would be sensible to take a balanced view of the impact v the probability of a tax rate change in the relatively near future. Ultimately however, this is a decision only the individual can take.

If you are thinking of selling your business and need advice, our advisory team are available to discuss your options. For more information please visit our Trade Sales page.

Jim Shaw – Founder & Partner, Shaw & Co

Jim founded Shaw & Co around his kitchen table in 2011. Since then his business has formed one of the largest specialist advisory teams in the South West. Jim has a deep expertise in mergers and acquisitions and advises clients across multiple sectors on complex M&A transactions. He has completed more than 70 M&A deals with a combined transaction value exceeding £0.5bn. He is a Fellow of the Institute of Chartered Accountants and has received several awards and industry recognition including South West Young Deal Maker of the Year in 2013 and nomination for South West Deal Maker of the Year in 2018. He is also listed as one the regions’ 42 entrepreneurs under 42 to watch.