Entrepreneurs’ relief (ER) was introduced in 2008 by Alistair Darling with the purpose of encouraging entrepreneurialism and the promise that the relief would “represent significant help to a lot of small businesses” by providing a significant capital gains tax (CGT) break for business owners on the sale of their businesses.
More than a decade on, the Conservatives pledged in their manifesto for the General Election on 12 December 2019 to “review and reform” ER because it has not “fully delivered on [its] objectives” (i.e. it is seen as benefitting owners of large businesses, whom Boris Johnson referred to as the “staggeringly rich”, rather than encouraging “real entrepreneurship”, in the words of Sir Edward Troup, the former executive chair of HMRC) and presumably also because the cost of the relief to the Exchequer is now £2.4 billion a year according to the Institute for Fiscal Studies (rising from the projection of £200 million a year in 2008).
It is with this, and the Government’s mandate (and the need to raise revenue to part-fund its proposed spending plans), in mind that speculation is mounting that it is likely the relief could be curtailed, or even completely abolished, in Rishi Sunak’s Budget on 11 March 2020. Despite the Prime Minister saying recently that “the Treasury is fulminating against [ER]”, Sunak’s predecessor, Sajid Javid, had reportedly shown signs of wavering on making any changes to ER in recent weeks, but with a new Chancellor at the helm, it may well mean that making changes to this relief is back at the top of the Chancellor’s list of priorities on Budget Day.
In the midst of the current uncertainty as to if and when any changes to ER will take place, it would be wise for those who currently qualify for ER to review their position and consider implementing some planning options now to “lock in” the 10% rate before any potential future reform or abolition of the relief. This could be particularly applicable to those who had been planning on relying on the relief when selling their business to fund their retirement (rather than investing into a pension).
This article sets out some suggested planning options dependent on a variety of circumstances. Please do be in touch if you think we might be able to advise you in the weeks leading up to the Budget on 11 March 2020.
How does the current relief work?
ER can cover disposals of shares or securities in a trading company, as well as the transfer of the whole or part of a business, and is subject to various conditions. Broadly, the conditions applicable to a disposal of shares or securities are that the individual is an employee or officer of a trading company or group who owns at least 5% of its shares, and has satisfied each of those conditions for at least two years immediately prior to the disposal.
If the above requirements are met, ER reduces the usual CGT rate (20%) on any capital gains arising on a disposal of shares in that company to 10% on qualifying lifetime gains of up to £10 million, thus producing a maximum saving to the taxpayer of £1 million.
What could the changes be and when might they take effect?
If not scrapped in its entirety, the relief could be recalibrated so that the Exchequer recovers some of the £2.4 billion in “lost tax” by:
• reducing the lifetime relief limit of £10 million (which has been in place since 2011) perhaps back to the original limit of £1 million for instance (the most likely change); or
• increasing the lower tax rate of 10%; or
• making further changes to the qualifying conditions (in addition to those already introduced by the Finance Act 2019) such as to reduce the range of qualifying assets or to increase the ownership requirements to qualify; or
• transforming the relief (in keeping with the historical iterative nature of business tax reliefs) into a form of rollover relief.
Any such change could either take place from the day of the Budget itself (11 March 2020) or from the start of the new tax year (6 April 2020), or at a later date announced in the Budget Statement.
There is therefore no time like the present for those who might qualify for ER to consider and take advice on whether it is worth triggering a CGT disposal on their accrued gains now to ensure that they can crystallise the above benefits of ER whilst there is certainty about the current qualifying conditions, the reduced rate and the lifetime relief limit.
How one might be able to lock in the current benefits pre-budget?
If one is considering, or currently engaged in, an imminent sale of a business:
Ensure the disposal of ER qualifying business, shares or assets is made before Budget Day
Exchanging an unconditional contract of sale with a view to complete it at a later date fixes the date of the disposal for CGT purposes at the date of exchange and so it is important that exchange takes place before there is a change in the law.
The parties should therefore aim to do this before the Budget Statement on 11 March 2020 in the event the changes are made from that date (i.e. to avoid the risk of anti-forestalling provisions), or, failing that, by the end of the current tax year, i.e. no later than on 5 April 2020, if the changes are due to take place from the start of tax year 2020/2021 (i.e. from 6 April 2020).
This unconditional contract could also be made rescindable, so that if certain circumstances arise, the contract may be rescinded.
It is important that the contract is a genuine, unconditional contract and care must be taken in the drafting to avoid the contract becoming conditional and other traps that could prevent ER applying.
If one is not able to sell a business before 11 March 2020 / 5 April 2020
However, whilst one may still want to take advantage of ER whilst it still exists in its current form, it may not be practical or possible from a timing or a circumstance perspective, for a sale of a business to take place before Budget Day or the end of the current tax year. In these circumstances, there are other planning methods one might undertake as follows.
Dispose of shares in the trading company (Tradeco) to a new holding company (Newco) by way of a share for share transaction in anticipation of a sale of the business at a future date
This may work for business owners who are not ready to sell their business in the next few weeks / months but plan to sell their shares at some point in the next tax year (such as early 2021) and who know that such a disposal will give rise to a large gain and that gain would qualify for ER in its current form. If ER is no longer available at the time of the sale, the business owner runs the risk of his / her potential tax on that sale increasing to 100% as opposed to 50% of what it might have been with ER.
To mitigate against this risk, the business owner can set up a wholly-owned Newco and provided the transaction is for bona fide commercial reasons, implement a share for share transaction on a carefully crafted contract basis now. Once a third party buyer for the business has been found later in the year, the business owner can elect to trigger a capital disposal on the date of the original share for share transaction (assuming the ability to make an election remains available post-Budget) which was subject to ER and thus bank ER and the lower tax charge. The tax on the gain is then due by 31 January 2021 and ideally the sale of Newco to the third party buyer would be completed by this date so that he / she has the funds to pay CGT.
If it transpires that ER remains available post-Budget, or no third party buyer materialises, the business owner may put in place planning to unwind the disposal so that no CGT disposal has taken place. This all depends on careful planning at the outset and just as importantly carefully drafted documents.
The advantage of this option is that it provides some more breathing space for selling a business than with the option above and also allows the business owner to retain an element of control as a shareholder of Newco (as opposed to the options below), though careful attention will have to be paid to valuation, the application of anti-avoidance provisions and overall planning.
If one is not in a position to sell a business before 11 March 2020 / 5 April 2020
For some, the option above would not work as it is predicated on the subsequent commercial sale of the business and some business owners do not wish to dispose but do want to take advantage of ER whilst it still exists. In order to capitalise on ER without selling their business, one can do so but this often involves triggering a CGT charge now without any sale proceeds to pay the tax (i.e. you must be able to fund the tax bill so from your own resources). This option is called “re-basing” meaning that only future gains would be charged to tax under a forthcoming regime which may change the current ER rules. Care needs to be taken that these are not undertaken for artificial means otherwise it may be challenged by HMRC under GAAR (as described below).
1. Transfer ER qualifying business, shares or asset to another person by way of gift
An alternative method of triggering a CGT charge would be to transfer the ER qualifying asset to another person (though not to one’s spouse or to a charity as these transfers are exempt from CGT).
One could gift shares in a company to one’s children outright, for example, and claim ER on the resulting taxable gain, if the qualifying conditions are met. This will be appropriate in some cases but not for example where young children are involved.
2. Transfer ER qualifying business, shares or asset on trust by way of gift
Another alternative to create a disposal for CGT purposes could involve trust planning.
A transfer to a trust is a disposal for the purposes of CGT, but there should be sensible non-tax reasons for establishing the trust, such as succession planning, and it must be suitable for your particular circumstances. Other tax consequences (and set-up and administrative costs) would also need to be considered if a trust is set up.
In some cases, the transferor (i.e. settlor in trust law terms) may also be entitled to claim holdover relief if he/she is gifting shares on which IHT is chargeable (even though it is subject to relief via BPR). The effect of this is that the settlor does not have to pay any tax on disposing of the asset, but instead passes on the gain to the donee and this is deducted from their base cost.
This allows flexibility as between banking ER or, holding over the gain if there is no need to trigger a gain to “lock in” ER (because ER is retained or extended or the changes do not affect the settlor), and again detailed advice is essential to make sure the flexibility is maintained.
A key aspect is the trust structure and making sure that it does not fall foul of the ‘settlor interested rules’ which could prevent holdover relief being available. This tends to mean this planning is best suited to settlors with adult children – and that detailed advice and careful drafting is essential.
This option may be more favourable than option 1 above in some cases according to who the settlor is comfortable will own and have influence over the business after the transfer. The trustees must hold the assets for a reasonable period of time in order for the trust to have integrity and be effective for triggering ER. Again, there is a potential ‘dry’ tax charge.
If a sale has already taken place
Where there has been a third party sale and the consideration consists of shares and / or loan notes, one should consider whether to make an election to disapply the share reorganisation provisions (which otherwise provide that a reorganisation is not treated as involving a disposal of the original shares), the effect of which would be to trigger a CGT disposal in order to secure ER. It would be wise to think about doing this as the power to make such an election could disappear (the Office of Tax Simplification has just announced that it is undertaking a review of claims and elections for instance).
In addition, if part of the consideration you received from the sale of your business is structured as an earn out which is to be satisfied in shares or loan notes, the share reorganisation rules generally apply. A chargeable gain would generally arise when shares are later sold and ER may be available. Therefore you may wish to consider making an election to disapply the share reorganisation principles in the event of adverse changes to ER.
Again timing is critical in this planning and detailed advice will be important..
Considerations before taking any of the above options
It is important to take detailed advice before putting any of the above planning in place, and of course bespoke advice is needed in each case to make sure what, if any planning, is best suited to you, your business and your general objectives.
Liquidity (in particular for transfers by way of gift or on trust)
Have you got sufficient funds available to cover the CGT liability arising on the disposal, particularly if the asset is transferred by way of gift (i.e. nil consideration is received)? The liability will fall due by 31 January in the following tax year (i.e. by 31 January 2021).
General Anti-Abuse Rule (GAAR)
This was introduced in 2013 and intended to counteract “tax advantages arising from tax arrangements that are abusive”. Advice needs to be taken to ensure artificial schemes are not employed to trigger gains which could be challenged under GAAR.
This can be avoided by demonstrating genuine estate planning considerations to take advantage of ER, such as transferring value to the next generation or because a sale will not complete before the Budget. Advice would need to be taken in light of specific circumstances and objectives.
General tax consequences
While we have focussed on ‘banking’ ER here, a key element is making sure this does not accidentally have other undesirable tax consequences, and looking at potential planning from all angles.
Broader corporate and commercial considerations
It is also absolutely vital to make sure that a business has the ability to enter into any potential planning, that drag and tag along, pre-emption and similar rights are properly catered for, and that e.g. any third party finance providers, are aware and able to enable such planning if relevant.
We encourage Rishi Sunak to stick to the post-Brexit messages that the UK is open for business, and to continue the approach taken by policymakers in recent years of encouraging enterprise and incentivising individuals to invest more (and to re-invest) in new or growing businesses (with other investment reliefs such as EIS and VCTs) by not scrapping ER in its entirety.
For more information please see this article written by Sophie Dworetzsky.