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Sarah Laing CTA looks at the facts, background and implications of the proposed new capital gains tax entrepreneurs' relief.

Sarah Laing

A new relief

Following an exorbitant amount of pressure from business representatives and professional bodies across the UK, the Government beat an embarrassing retreat over plans to introduce a single rate capital gains tax regime by announcing plans for a new relief aimed at small businesses. Whether coincidental or not who knows, but the Government chose the same day that Work and Pensions Secretary Peter Hain resigned, to announce details of a new “entrepreneurs’ relief”. Anyway, the “bad news” for the day was shelved and forgotten about, giving us plenty of time to concentrate on the more important stuff.

To start at the beginning, entrepreneurs' relief is a relief from capital gains tax arising on the disposal of a business. The relief will take effect from 6 April 2008 and will run alongside the CGT reform programme announced in the 2007 Pre-Budget Report. Broadly, the programme of change means that from 6 April 2008, there will be a single rate of CGT of 18 per cent. The tax-free annual exempt amount (currently £9,200) will remain, but taper relief and indexation allowance will be withdrawn.

Facts

Entrepreneurs’ relief will apply to:

• gains made on the disposal of all or part of a business; or
• gains made on disposals of assets following the cessation of a business;
• by certain individuals who were involved in running the business.

The first £1 million of gains that qualify for relief will be charged to CGT at an effective rate of 10 per cent. Gains in excess of £1 million will be charged at the normal 18 per cent rate.

An individual will be able to make claims for relief on more than one occasion, up to a lifetime total of £1 million of gains qualifying for relief. The idea of a “lifetime allowance” for capital gains tax reliefs is a totally new concept and, in my opinion, such a cap does not sit well alongside the term “entrepreneur” - since when were entrepreneurs to be discouraged from making money?

Background

The new relief is a kind of resurrection of the old retirement relief, which was phased out between 1998 and 2003, but the new rules will, apparently, be simpler. There will be no minimum age limit for entrepreneurs’ relief (under retirement relief you generally had to be 50 plus, or on your death-bed to get relief). And in general, entrepreneurs’ relief will be available where the relevant conditions are met for a period of one year, instead of the retirement relief qualifying period of up to ten years.

The relief will apply to gains arising on disposals of the whole or part of a trading business (including professions and vocations, but not including a property letting business other than furnished holiday lettings) that is carried on by the individual, either alone or in partnership. Where a business is not disposed of as a going concern, but simply ceases, relief will be available on gains on assets formerly used in the business and disposed of within three years of the cessation of the business.

The relief will also apply to gains on disposals of shares (and securities) in a trading company (or the holding company of a trading group) provided that the individual making the disposal:

• has been an officer or employee of the company, or of a company in the same group of companies, and
• owns at least five per cent of the ordinary share capital of the company and that holding enables the individual to exercise at least 5 per cent of the voting rights in that company.

The terms “trading company”, “holding company” and “trading group” will have the same meaning as they currently do for the purposes of taper relief on business assets (TCGA 1992, Sch. A1, para. 22). Because of this, there will be no requirement to restrict the gains on shares by reference to any non trading assets held, as was the case for retirement relief.

Where an individual qualifies for entrepreneurs’ relief on a disposal of shares or securities under the previous paragraph, relief will also be available in respect of any “associated disposal” of an asset which was used in the company’s (or group’s) business. For example if a company director, who owns the premises from which the company carries on its business, sells the premises at the same time as he sells his shares in the company, the sale of the premises may count as an 'associated disposal' and any gain attract entrepreneurs’ relief. The relief due on an associated disposal will be restricted where the asset in question was not wholly in business use throughout the period it was owned.

A similar rule will allow relief on an 'associated disposal' by a member of a partnership who is entitled to relief on disposal of his interest in the assets of the partnership. (Again, relief will be restricted where the asset in question was not wholly in business use throughout the period of ownership.)

Trustees will also be able to benefit from entrepreneurs’ relief on gains on assets used in a business. In order for trustees to benefit, a beneficiary of the trust with an interest in possession relating to those assets must be involved in carrying on the business in question, personally or as a partner. In the case of shares, such a beneficiary must qualify as an officer or employee of the company in question. The conditions under which trustees qualify for relief will be generally similar to those for retirement relief. In particular, the £1 million maximum limit on gains eligible for relief will apply to the trustees and the qualifying beneficiary jointly.

Reactions around the profession

The changes announced represent a response to the huge amount of pressure that followed the surprise announcements on capital gains tax in the 2007 Pre-Budget Report. But while the Federation of Small Businesses, which had been campaigning for a special rate for entrepreneurs, welcomed the changes, many other business owners will still be facing a materially higher tax burden when the changes are enforced in April this year.

Of particular note is the fact that the new ten per cent rate of tax on the first £1 million of lifetime capital gains is unlikely to benefit the majority of holders of approved employee share options. Business representatives are still therefore calling for capital gains reliefs on employee share schemes to be restored to help employers retain key staff.

Unless they own more than five per cent of the shares in their company, from 6 April 2008, when the new rules are introduced, employees will be paying 18 per cent tax on any gain over their annual £9,200 exemption. Under the current rules such employees could realise gains of up to £36,800 without paying any tax, with a maximum liability of ten per cent. This is going to hit employee share ownership schemes very hard. Ordinary workers who have contributed to the success of a business will be wondering why they are paying for company owners' tax breaks. Many believe it is manifestly unfair.

For most entrepreneurs, the changes will amount to a simple £80,000 reduction in tax they might (based on the proposals originally delivered by the Chancellor in his Pre-Budget Report) pay on gains in their lifetime, which is obviously welcome, but many successful business owners will still face a materially higher tax burden from 6 April 2008 onwards. The absence of any protection for accrued taper relief may also leave taxpayers in a quandary as to whether to consider potentially complex and expensive planning before the changes take effect, to try to benefit from the current beneficial taper regime.

Conclusion

The announcement is a neat short-term political move which will satisfy some SME owners who have felt under pressure to sell up before April to avoid losing taper relief. From that perspective, it is obviously welcome. But rather than simplify the system, the Chancellor is introducing new layers of complexity. One of the Chancellor's original reasons for introducing a flat rate of 18 per cent CGT for both business and individuals was to remove the distinction between personal and business taxation. He's now reintroduced the very anomaly that he was trying to eradicate in the first place and undoubtedly created more red tape in the process.

Finally, back to Peter Hain. I gather he is looking for a job. He also seems to be good at getting voluntary contributions.  Maybe he could take over and abolish compulsory tax altogether?

The above article was first published by CCH, and is reproduced with the kind permission of the author.