Entrepreneurs Relief from CGT – Good(ish) News for the FewAlistair Darling has announced the concession he has been forced to make as a result of the outcry about his “reform” of capital gains tax that takes effect from 6 April 2008.
This “reform” consisted of scrapping various reliefs, notably the indexation allowance and taper relief (see the October and December 2007 Tax Insiders for details of this), and replacing them with a universal flat rate of CGT of 18% for individuals and trustees. Limited companies are not affected by these changes and will continue to be charged to corporation tax on their capital gains exactly as before, with the benefit of indexation allowance.
How does Entrepreneurs Relief Work?
From 6 April, every individual (and trust) will have a “lifetime allowance” of £1million in capital gains on “business assets” that will be charged at an effective rate of 10% - the same rate that applies to business assets under the current rules. Any gains above that, and any gains on other assets, will be charged at 18%.
That is how the Press Release describes it, but the detail is a little different. The 10% rate for Entrepreneurs Relief is achieved by reducing the first £1million of gains by 4/9, so only 5/9 of the gain is charged to CGT - 5/9 x 18% is 10%, so that’s OK, isn’t it?
Well, not quite. Consider the treatment of a gain on a business asset sold now compared to the same asset sold on or after 6 April:
Roy is the sole shareholder of his trading company and he sells his shares realising a gain of £500,000. He has owned the shares for more than two years, so under the current regime he qualifies for full business asset taper relief, and under the new regime he will qualify for Entrepreneurs Relief:
Gain on Shares
Taper Relief 75%
Entrepreneurs Relief 4/9
Gain after relief
Less Annual Exempt Amount
Tax at 40%/18%
Do you see what Alistair has done? Because the annual exempt amount is deducted from the gain after all other reliefs, Roy is about £2,000 worse off under the new regime because his annual exempt amount is only relieved at 18%, not 40% as it now is. In fact, the position will be marginally worse because the Annual Exempt Amount increases every year in line with inflation, so if it is, say, £9,800 for 2008/09 the difference between that at 40% and at 18% will be £2,156.
The winners under the new regime will be those who make gains on assets that did not qualify for Business Asset Taper Relief under the current rules – buy to let landlords of residential property (not commercial property – they will be worse off, in general), investors in the stock market and so on.
The losers will be entrepreneurs like Roy, in a big way if their total gains on business assets exceed £1million over their lifetime, and in the smaller way illustrated above even if their gains are less than £1million.
What are “business assets” for Entrepreneurs Relief?
This is the other nasty piece of news buried in the Press Release. Currently, an asset (say, a factory) qualifies for Business Taper provided it is used by an unlisted trading company or unincorporated business (such as a partnership or sole trader). The owner of the asset does not have to be involved in owning or running the business in order to get business taper relief when he sells it.
For Entrepreneurs Relief, the owner of the asset must be a proprietor of the business, or a shareholder in the company (more on this in a moment) and a director or employee of it.
This is, of course, bad news for landlords of commercial properties, but it will also affect a group you might have thought Alistair would want to encourage – employee shareholders.
Under the current rules, if you are an employee of a company (even one listed on the stock market) you get business asset taper relief on your shares. In order to qualify for Entrepreneurs Relief however, you will have to hold 5% or more of the shares in the company.
The last decade has seen a huge increase in the number of employees benefiting from various “Share Incentive Schemes”, and not just the “Fat Cats”. Many Plcs have Employee Share Schemes of one kind or another and I am sure many readers will have, or will know someone who has, shares in their employing company. I am equally sure that in the case of the big listed companies, none of those shareholdings will amount to 5% of the total share capital, so all those employees can look forward to paying 18% CGT instead of 10% when they sell their shares.
What can be done?
There are nearly two months to go before the new rules take effect and here are some things you may want to consider doing (having taken proper professional advice!) before 5 April:
If you are in the process of selling a business or a business asset, consider whether you can accelerate this so that it is charged under the old rules rather than the new – this really only applies to gains greater than £1million because the professional fees involved will be greater than the £2,000 you will lose if you make a lesser gain after 5 April.
One of my clients is currently selling their business and they have told the prospective purchaser they will walk away from the deal if it is not done before April – but in other cases, purchasers, aware of the advantage of an early sale, are offering a lower price for a deal before 5 April!
Consider transferring assets into a trust to “bank” the taper relief before it is abolished – again, not something to be done lightly and not without its problems.
If you own assets that currently qualify for the indexation allowance (broadly, assets owned since before 1998) consider how to bank this as well. This is easy for a married couple or civil partnership (see the December 2007 Tax Insider for details), but in certain circumstances can also be considered by other individuals