For decades the capital gains tax system has supported business by offering favourable tax allowances to encourage investment and entrepreneurial activity. That now appears to be under threat. In this article Managing Partner of FPC, Moira O’Shaughnessy considers the impact on FPC clients and highlights the importance of building a financial plan that does not rely on a specific event or favourable tax regime ….
The Labour Party has published their Funding Plan which sets out their proposals for increases in public spending of just under £83bn. In part, this will be funded by increases in income tax for those earning above £80,000 and higher corporation tax rates, reversing the downward trend of recent years.
A significant chunk of the £83bn comes from harmonising income tax and capital gains tax rates, reducing the annual tax free capital gains tax allowance and abolishing Entrepreneurs relief.
What is entrepreneur’s relief?
Entrepreneur’s relief reduces the amount of tax paid when an individual sells shares in all or part of a business. It results in a tax rate of just 10%. The relief was introduced in 2008 and originally had a maximum lifetime limit of £1m which then rose under the Conservatives to £2m, then £5m and then finally to £10m from 6th April 2011 – one of the most generous reliefs on the statute books.
It succeeded business asset taper relief and prior to that, Retirement Relief, continuing a long established practice of encouraging entrepreneurial activity and business investment and rewarding business owners on exit.
Are changes inevitable?
For shareholders in a business to qualify they must be an officer or employee of the business; hold at least 5% of the ordinary share capital and have at least 5% of its voting rights for at least 12 months prior to disposal. These conditions have been tweaked in recent years following evidence of growing manipulation of the rules relating to the qualification requirements.
There have also been calls for reform for some time from both the Resolution Foundation and the Institute of Fiscal Studies expressing concern the relief was not working as had been intended. We have therefore been anticipating further change regardless of who is in government.
The Labour Party has indicated that they will consult on a ‘better form of support for entrepreneurs which is not largely just a handout for a small number of people‘ and the Conservative Party has also indicated that they will look to reform the relief as they do not feel it has ‘not fully delivered on (its) objectives’.
Fears of impending change have impacted on activity in the mergers and acquisition sector in recent months and any changes are likely to have significant impact on the exit plans of many small to medium sized business owners who would see their tax rate potentially quadruple. They may well put those plans on hold.
A business sale releases wealth into the taxation arena
Overlooked in the debate about entrepreneurs relief would appear to be the fact that once a business is sold, those proceeds then form part of the individual’s taxable estate. This means that in addition to any growth on reinvested assets being subject to tax, the funds are then also potentially subject to inheritance tax at (currently) 40%.
There is very little mention of inheritance tax in either manifesto other than a pledge from Labour to reverse the decision made by George Osborne to introduce an additional main residence nil rate band for estates less than £2m overall which they view as ‘most likely to benefit high income and wealthier households‘.
Impact on our clients and their planning
Changes to either entrepreneurs relief or business relief would have a significant impact on business exit and succession planning. Many business owners may need to change their approach and focus their efforts on securing their own financial independence during their working life rather than at the end of it. That’s not necessarily a bad thing.
As financial planners, it’s our job to help ensure that your business is not your pension. This means decisions about how to structure remuneration, pensions funding ( where permitted), risk management and personal investment planning need to be integrated and focused on achieving long term financial security regardless of the economic, tax or legislative environment at the time.
Working collaboratively with your other advisers, particularly your accountant, we can help you develop a plan that reduces your reliance on the business and gives you a secure backstop.
We understand that the needs of your business will of course always come first – your customers, suppliers and staff all take precedence but we would encourage all business owners to also make sure their own financial planning is on their next Board meeting agenda!
Call us on 01704 571777 if we can help you or your business associates plan your way through the challenges ahead. As always, do let us have your comments and feedback at firstname.lastname@example.org.