Since this article has been published, Entrepreneurs’ Relief has been reduced to a £1 million lifetime limit.
It is no secret that Entrepreneurs’ Relief (ER) has become increasingly more contentious since it was first introduced back in 2008. It is one of roughly a thousand tax breaks that exist in the UK that were originally implemented to promote British business and secure further investment for our economy. However, it is seen in some quarters as a tax relief for those who are already wealthy, rather than helping young entrepreneurs setting up businesses for the first time.
A brief overview of Entrepreneurs Relief
ER was originally introduced by Gordon Brown’s Labour Government in 2008 and was sold to the public as a tax relief for entrepreneurs once they set up, grew, and sold a business. The idea being that it would encourage business owners to reinvest the tax saved from selling the enterprise into starting up a new venture or investing in others.
The tax relief comes by reducing Capital Gains Tax (CGT) from 20 per cent to 10 on the first £10m of qualifying gains from selling a company, or shares of a trading company. ER can further be applied to personal assets associated with a company and assets in use upon the closure of an enterprise.
ER becomes controversial because of the various loopholes that exist within the system, but it can be argued that this is a broader issue with the UK Tax Book in general. By having such an extensive code of conduct, it is easy for some to find ways to bend the system to make it work as tax-efficiently as possible. When it comes to ER, the policy can be utilised in some unforeseen ways to achieve the aim of reducing tax exposure.
For example; although some changes have been made to ER until fairly recently, it was entirely possible to work as a freelancer or contractor, run all of the business’ revenue through a private services company. Then take home income as dividends, and then remaining profits were built up to be taken as capital, The reason being ER offers such a good tax rate.
By doing this, an individual not only benefits from a lower rate of CGT but by taking income as dividends, they further benefit from a lower rate of tax on their income and can avoid paying National Insurance Contributions because of a perceived low income.
Further to this, there is no limit to how many times ER can be applied. So long as the £10m lifetime limit is not exceeded.
In real terms, ER is said to have cost the Government £2.3bn in uncollected tax in 2017-18 alone. Three-quarters of that sum was shared between just 5,000 individuals, which equates to an average tax break of £350,000 each. This only adds further fuel to those arguing that ER only benefits the already rich.
There are alternative tax reliefs available which present, what some might argue, is a better way to encourage British enterprise. These include policies such as the Seed Enterprise Investment Scheme (SEIS) or the Enterprise Investment Scheme (EIS), both of which offer tax incentives to angel investors, and venture capitalists to encourage them to help fund businesses. This then allows entrepreneurs to raise very valuable, and often hard to come by, start-up capital. So, rather than rewarding a business owner once they have sold their organisation, it works to help support founders at the early stages of their business life cycle. However, the question here is, does this offer enough of an incentive to a real entrepreneur to tale the risks of employment, financing and growth? For hard-working entrepreneurs who have spent years building up their business, the answer is no.
What could change?
There have been calls for changes to be made to ER for years. And, indeed, there have been some. George Osborne tried to implement significant reform while he was Chancellor; however, he didn’t have the majority support he needed to get his plans through. So, gaps still exist in the system, and where there are gaps, there will be exploitation of the rules.
As the Conservative Government announced plans to implement the largest increase in day-to-day public spending in 15 years as part of its manifesto, it also stated that income tax, national insurance and VAT will not be affected. However, the revenue to support this extra expenditure has to come from somewhere. With a Government that is adamant the additional funding will not come from raising taxes, it seems likely that tax breaks will see change, including ER.
The truth is, Sajid Javid was in favour of reforming ER, and it was rumoured to be a key part of his Budget. However, following his departure from Boris Johnson’s Cabinet, we won’t know exactly what the new Chancellor, Rishi Sunak, will have planned until Wednesday 11 March 2020. It was recently reported that he plans to scrap ER in its entirety, which would give the treasury a significant boost.
However, this has been met with criticism of its own. Some owner-managers are claiming it will “destroy retirements”.
What should you do?
If you are already thinking of selling your business and moving on, now is the time to talk to your accountant and see what possibilities are available. This will help ensure you are able to take advantage of the current tax policy. It is always better to try and be ahead of the curve than reactive to events and announcements.
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Whatever your current plans, make sure you talk to your accountant to get the best advice and ensure that you remain compliant.