Entrepreneurs’ Relief – how it should be made more effective
Ahead of this year’s Budget, our Tax Partner, Alastair Wilson, looks at how he believes the Government can make Entrepreneurs’ Relief work more effectively and why it shouldn’t be scrapped…
Over the last month, various articles have appeared in The Times and The Sunday Times stating that “informed sources” say the Government are considering major changes to, or even scrapping, Entrepreneurs’ Relief.
Entrepreneurs’ Relief provides a 10% Capital Gains Tax rate on disposals of qualifying interests in businesses. It is primarily a relief that applies to persons where they are either selling all, or part, of a business or company which they own.
As a tax adviser, I get to see the impact of reliefs first hand and what drives behaviours. In my experience, people do not sell businesses because they will get Entrepreneurs’ Relief – they sell because other factors are driving that decision. Typically, this is either an offer that realises the right value for the business, or a life event such as ill health or retirement.
Entrepreneurs’ Relief makes the decision to sell a business easier. Someone who is wavering about whether the value in an offer for their business is enough will find that decision easier if they pay 10% tax compared to 20% tax. It may also mean the person has sufficient funds for retirement or to reinvest into a different business. As a “nudge” relief and when it is used properly, it works well as it makes succession planning easier for what are typically owner managed businesses.
Fixing Entrepreneurs’ Relief is simple
The perceived issue with Entrepreneurs’ Relief is that it is costing the Treasury more than expected. From an advisers point of view, the real issue with Entrepreneurs’ Relief is that you don’t actually have to be an “entrepreneur” to qualify. There, unsurprisingly, it is benefiting people it shouldn’t.
Solving that is simple – include the “working time” requirement (which exists in other reliefs) that you have to work at least 75% of your time (or 25 hours a week) in the business to qualify. Also, owners of businesses of any size can currently qualify. If you want to really focus the relief, add in the Small and Medium Sized Enterprises test used in the R&D reliefs so that only disposals of SMEs qualify.
The law of unexpected consequences
HMRC’s own statistics (which don’t include the outcomes of the tightening of the rules in October 2018) show that the cost and usage of Entrepreneurs’ Relief is in decline, not increasing. The data published in October 2019 shows costs and claimant numbers have reduced over the last few years and will be expected to fall further after the changes in October 2018.
This link to additional analysis is probably easier to follow – the key statistic being that claimant numbers for Entrepreneurs’ Relief are already reducing.
HMRC’s own statistics from October 2019 also include an interesting (and entirely accurate) statement. The statistics include the following footnote:
“The estimated cost of this exemption does not represent the yield if this exemption were to be abolished, as consequential behavioural effects would substantially reduce yield.”
In essence, HMRC rightly anticipate that if Entrepreneurs’ Relief were scrapped, different reliefs would simply be used instead.
This view is likely to be accurate, where gains qualifying for Entrepreneurs’ Relief within the “range” of CGT rates is illustrated below. If Entrepreneurs’ Relief were to be abolished or restricted, then people with gains will look at the other CGT reliefs with more frequency.
|Type of asset to be disposed of||Typical CGT rate on any gain (illustrative)|
|Residential property owned by an individual as an investment||28%|
|Shares or other chargeable assets||20%|
|Shares qualifying for Entrepreneurs’ Relief||10%|
|Shares qualifying for Investors’ Relief and owned > 3 years||10%|
|Shares qualifying for Enterprise Investment Scheme or Seed Enterprise Investment Scheme and held > 3 years||0%|
|Disposals of businesses to an Employee Ownership Trust||0%|
We are now seeing disposals to Employee Ownership Trusts being marketed at scale by boutique firms to businesses as a “tax product” rather than it being the right commercial solution for the business to be Employee Owned. If Entrepreneurs’ Relief were to be scrapped or restricted, that will accelerate.
Employee Ownership Trusts are not the right commercial answer for many businesses when succession planning is needed. If Entrepreneurs’ Relief is removed the Employee Ownership Trust will become the “tax product” of choice for the unscrupulous to sell to the unwary in a retirement scenario.
Increasing tax yield whilst better focusing reliefs
If the new Government wants to make Entrepreneurs’ Relief work more effectively, my suggestions are:
- Include a “working time requirement” in the relief to focus it properly on “entrepreneurs”
- Make the business being sold subject to a Small or Medium Sized Enterprise test
And if the Government wants to raise money, they should look at the October 2019 statistics and focus on the reliefs where the costs are trending upwards exponentially. For example, the R&D Tax Reliefs, and consider what is being done to manage those reliefs where the costs actually do appear to be lacking control.
The above commentary is only my view, but it I had the challenge of raising the tax yield, scrapping Entrepreneurs’ Relief wouldn’t be my starting point.
If you’d like to speak to Alastair regarding this topic, please contact him on 0191 285 0321 or email firstname.lastname@example.org.