Will the OTS’s Capital Gains Tax (CGT) changes derail your deal?
The Office of Tax Simplification (“OTS”) has issued the first of two reports into their review of the Capital Gains Tax regime and, unsurprisingly, there are a number of suggested changes that could impact on business owners.
It is worth remembering that these are just suggestions at this stage. The second report, which will follow early next year, should provide further clarification on the detail.
As well as identifying opportunities to reducing the administrative burden, the indication is they would like to address areas where they believe the preferential Capital Gains Tax rates “distort behaviour and do not meet their policy intent”.
Business Asset Disposal Relief (“BADR”)
There have been a number of changes to Business Asset Disposal Relief (formerly Entrepreneurs’ Relief) over the past few years with the tightening of qualifying conditions and the consultation report indicates that they would like to go further. The OTS considers this relief is mistargeting if the objective is for its availability to stimulate business investment and risk-taking.
Their findings indicate that they would like to focus more on this relief being available for business owners retiring, similar to the ‘Retirement Relief’ which was phased out from April 1999, where the objective was for it to be in recognition of a person’s business being an alternative to a pension. Specifically, retirement relief could only be claimed by persons who were over 50 years of age.
More restrictive conditions suggested are below which would mean that it could only be available in limited circumstances:
• Increasing the minimum shareholding (suggestion of 25% compared to current holding of 5%)
• Increasing the holding period (suggesting of 10 years compared to current period 24 months)
• Reintroduction of age limits, perhaps linked to age limits in pension freedoms
If these suggestions are implemented, this would likely mean that this relief will also be unavailable to employees who have been incentivised in the business by use of share schemes, for example Enterprise Management Incentive options and “growth shares”. They may go further and seek that any value received from these schemes are taxed as income rather than capital.
There is also a suggestion that HMRC could consider taxing accumulated retained earnings, in smaller companies, at Income Tax rates. At the moment HMRC have the power to do this but only by using “counteraction” of tax avoidance. This would instead make it a standard process.
This would be bad news for small businesses which do not distribute their profits each year, rather leave them in the company to provide necessary working capital but where often the value is realised on a sale.
There are currently four main rates of Capital Gains Tax being 10%, 18%, 20% and 28%, depending on the asset sold and the individual’s income levels. This compares to the maximum Income Tax rate of 45%. The OTS has indicated that they believe this disparity can distort business and family decision making and creates incentives for taxpayers to arrange their affairs in ways that effectively re-characterises income as capital gains.
Although the suggested alignment of rates would simplify the calculation of tax due, this would result in an increase in the tax cost compared to the current regime.
What could these changes mean for you?
Assuming you hold shares in a company which you sell for £1m and you meet all of the qualifying conditions for Business Asset Disposal Relief, you would currently pay tax of £100k.
However, if the no longer met the conditions for BADR under suggested changes and the Capital Gains Tax rates were aligned with Income Tax rates, your tax liability of the disposal of shares for the same consideration could increase to £450k, based on the highest rates. An alternative way of looking at this is that, compared to the £1m disposal above, you would need to sell your shares for over £1.6m in order to receive the same net cash in hand.
Will the proposals become law?
Unsurprisingly the proposals have caused some concern in the business community as they could cause two distinct behaviours:
- Cause people to sell assets just to avoid tax rises (e.g. the press has reported that owners of second homes may rush to sell, which could cause a fall in values).
- Cause people to choose not to exit businesses where a change in ownership is actually good for the business and where “succession planning” is actually commercially helpful.
There has already been commentary issued by business groups and the ICAEW critiquing the proposals as potentially hampering the growth needed to help the economy recover. So, we would be surprised if the OTS’s recommendations were adopted in whole.
What can you do?
If you are considering selling your shares in a business, whether through a third-party sale or as part of succession planning, now may be the time to act whilst we have certainty over the current tax treatment. However, a bad deal shouldn’t be rushed through just because of tax (the tax tail shouldn’t wag the dog).
Also, if you have recently undertaken a transaction where you have received deferred consideration but elected to only pay tax on this when you actually receive it, there may be steps you can undertake to bring forward this liability. Although this would require tax to be paid sooner, it could end up costing you less.
Our Transactions Tax and Corporate Finance team can help you to understand your choices and we would be happy to have a conversation to discuss your circumstances.
The information provided is a very brief overview of what can be a complex area and therefore is something you should seek professional advice in relation to.