Jim Shaw, eponymous Founder and CEO of Shaw & Co, the specialist corporate finance advisory firm, reflects on the potential impact of the changes to Capital Gains Tax (CGT) recommended by the Office for Tax Simplification (OTS) to the Treasury, and offers his insight into how he believes entrepreneurs should respond.
He comments: “The Office for Tax Simplification (OTS) has now reported to the treasury on Capital Gains Tax (CGT). This report was 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.
“So, an entrepreneur selling their business in February 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 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 a tax increase in excess of 400% 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. Selling the above business today, even after the Entrepreneurs Relief is all but withdrawn, will net the entrepreneur £8.1m, a tidy sum delivering financial freedom for all but the most lavish.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 is likely to take many years of extra graft 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 be seriously disappointing by comparison.”
“However, more scarily, if you consider 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, 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 and paying taxes. Yet now they face the prospect of a material raid on that value they have been diligently building up for many, many years.
“There is a further dynamic making the situation yet more challenging for the business owner. With so much supply coming to market it is inevitably impacting pricing, and the closer that we get to March and the budget, without confirmation rates will remain untouched, the more apparent this will become.“
So, is it too late for anyone just waking up to this news? “Sadly, it’s close to yes”, adds Shaw.
“Proper M&A process can easily take 9 months and with Christmas afoot, there are no more than 13 working weeks until the beginning of March. 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.
“Despite these valid concerns the recommendations from the OTS are far from a statement of intent from the government and a March 2021 could easily be a false dawn.
“I personally agree that CGT does need to be overhauled. 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 to have a good look at CGT but in doing so, not only to spare any tax increases on the entrepreneur but also to reverse the changes made to Entrepreneurs Relief in March. One might even consider the abolition of CGT entirely and instead 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 businesses run by entrepreneurs sat on Caribbean islands.”
So as an entrepreneur, what do you do?
Shaw concludes: “If there is a sensible deal on the table that you would have taken anyway, then it would seem logical to proceed. But if 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 versus the probability of a tax rate change in the relatively near future. Ultimately however, this is a decision only the individual can take.”