Capital Gains Tax Update – Jamie Johnson

December 9, 2020

On 11 November, the Government’s own tax advisors, the Office for Tax Simplification (OTS), released their first Capital Gains Tax (CGT) report. Commissioned by the Chancellor in July, the purpose of this report was to advise on how to simplify the taxation of capital gains and to identify areas where current tax rules can distort behaviour or don’t meet their policy intent. The Chancellor also expressed interest in hearing the OTS’s thoughts on the current regime of tax exemptions and reliefs and specifically asked them to review the difference between how gains are taxed compared to other types of income.

In response, the OTS, in their report, has made a number of recommendations, at least two of which, if implemented, would have a major impact on business owners:

  • A recommendation to more closely align Capital Gains Tax with Income Tax rates
  • A recommendation to remove Entrepreneurs’ Relief

CGT Rates

CGT is currently taxed at 20% on the disposal of business assets. However, Entrepreneurs’ Relief, if available, results in an effective rate of 10% of the first £1m an individual disposes of in their lifetime. The highest income tax bracket, charged for income earned over £150k, currently sits at 45%. The OTS asserts that this disparity between CGT rates and standard income tax rates is a source of unnecessary complexity for taxpayers. They also argue that it incentivises creatively re-characterising income as capital gains, and that therefore, since most gains are concentrated among a relatively small proportion of taxpayers who tend to have greater flexibility about disposal of their assets, lower CGT rates unfairly benefit the wealthy.

The OTS also makes the case that increasing CGT rates will potentially raise a substantial amount of tax for the Exchequer, although they admit that the subsequent negative impact on people’s willingness to dispose of assets will materially reduce this benefit.

Based on the above, they have recommended raising CGT rates to align with Income Tax rates. Unfortunately, if this is implemented, business owners who are planning to exit their businesses could have to pay in taxes more than double what they would have had to previously!

Entrepreneurs’ Relief

Entrepreneurs’ Relief was introduced in 2008 to encourage business owners who sell their businesses to reinvest their profits into other start-ups and growing businesses. It also had a secondary objective, which was to provide relief for business owners upon retirement, as an alternative avenue to a standard pension. In his 2020 Budget, the Chancellor reduced the lifetime limit to £1m, claiming that it had had little effect on entrepreneurial activity and that it mostly benefited a small number of affluent taxpayers.

The OTS reported that their findings had similarly shown Entrepreneurs’ Relief to be ineffective, and that incentives for investment would be better applied at the time the investment decision is made. They additionally suggested that an alternative relief could be introduced that focuses on retirement.

Given the increasing requirement to balance the public finances as a result of the pandemic, and the fact that the Chancellor has already slashed Entrepreneurs’ relief by 90%, it is widely expected that CGT rates will indeed be raised and that what remains of Entrepreneurs’ Relief will be removed when the Chancellor announces the Spring Budget in March.

Mitigating Exposure

If you are a business owner and you want to mitigate the impact these policies may have on you, you could seek to crystalise the value of your businesses now, secure the current lower tax rates and take advantage of the reliefs while they are still in place. While selling your business outright is an option, this process normally takes at least six months to complete. Any attempt to escalate this timeframe could risk an acquirer using the looming deadline to reduce the value. Therefore, three options remain for you to sell your business and maximise the profits you receive:

  • MBO (Management Buy-Out)
  • VIMBO (Vender Initiated Management Buy-Out)
  • EOT (Employee Ownership Trust)

MBO

In an MBO, instead of finding a third-party buyer for the business, the owner sells directly to the existing management team, who are usually backed by an investor to fund the purchase. In normal circumstances the investor would have a majority stake in the business, with the management team having a material minority position.

VIMBO

Whereas in an MBO the management team must find an outside investor to fund the purchase of the business, in a VIMBO The vendor agrees to fund the transaction by allowing the purchase price to be settled by deferred consideration, using future company profits.

EOT

An Employee Ownership Trust is a trust company, formed on behalf of all the employees of a business, to which the business is sold. Giving all the employees a stake in the business, has been found to incentivise them to work harder and be more engaged, driving up business performance.

Like in a VIMBO the consideration for an EOT transaction is normally settled with deferred consideration generated from future company profits however with an EOT, a major benefit is that it is a CGT free transaction for the vendor.

The chart below shows a brief comparison of the main ideas of an MBO, VIMBO and EOT.

 

Summary

The Covid-19 pandemic has hit everyone hard and the Chancellor, who is already seeking to find a way to keep the country’s finances afloat, has received recommendation to greatly increase taxes on capital gains and remove major reliefs for entrepreneurs. This would have material implications for every business owner, significantly reducing their retirement pot.

There are options to help you secure the hard-earned value of your business, and there is time to implement them before these measures come into effect.

A vendor’s personal tax liability is a material element to be considered when exiting your business. Seeking the necessary advice is always recommended at an early stage. If you would like to discuss how any rise in CGT might affect you, please feel free to call me on 07929 389 720 or email me at jamie.johnson@fspg .co.uk.

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