Analysis: will the reduction in Entrepreneurs’ Tax Relief motivate or deter deals?

25 March 2020

The reduction of Entrepreneurs’ Tax Relief announced in the 2020 budget was not a surprise. 

However, for many of Evolution Capital’s clients who we advise throughout the complete business disposal process, there has been a very real effect as a result of reducing  the incentive. 

An owner disposing of their qualifying business today at a gain of £10 million will now pay an additional £900,000 in capital gains tax.  The ‘overnight’ loss of such a generous relief emotes strong sentiment among the business community, particularly those serial entrepreneurs with a record for creating and disposing of TMT businesses in the mid-market.

Anne Stokes, CEO and founder of award winning technology consulting services business ST2 said: “My view is very simple, they should not have reduced it for existing owners. There are plenty of entrepreneurs that have ploughed everything into their businesses, taken all the risk and have received next to nothing by way of help from those who could have provided it most. We have worked 7-day weeks to make the business what it is and have worried ourselves senseless at times to make sure that our staff get paid – often before us. This is the thanks we get.”

And yet, whilst the Government’s reduction in the terms of the incentive is not particularly welcome, many believe the move is not sufficiently pejorative to dampen the entrepreneurial spirit. 

Although the lifetime allowance has been drastically reduced, many experts believe that £10m was always too high a threshold to serve its original purpose and encourage new ventures to come to market.

Glen Thomas, Evolution Capital’s Tax Advisor, said: “The previous limit of £10m was probably too high to encourage the entrepreneurial behaviour for which the incentive was designed. A figure of between £2m to 3m might have achieved the goals of the scheme a little more successfully.   An alternative could have been to extend the qualifying period of ownership to five years or even more to encourage the sustainable growth of a business over an extended period of time. The government is gambling that such a move will not adversely affect entrepreneurial behaviour on the basis that a standard rate of Capital Gains Tax of 20% is still relatively low compared to historical rates.” 

The relief allows business owners to pay a reduced 10% rate of capital gains tax on the sale of their businesses instead of the normal 20% rate. With immediate effect, the lifetime limit of qualifying gains, which can qualify for the relief, is reduced to £1m from the previous lifetime limit of £10m.  This results in a potential loss of tax relief equivalent to £900,000.

The original purpose for introducing Entrepreneurs’ Tax Relief was to create an incentive for new business owners to set up and grow trading businesses. 

However, evidence suggested the incentive did not, in fact, encourage those mid-tier business owners but was broadly viewed as a tax break for the wealthy.   

During his maiden budget speech earlier this month, new chancellor Rishi Sunak told the House of Commons the incentive was “expensive” and “unfair” in its existing format and that 75% of the benefit, worth about £2.4bn a year, was shared by only 5,000 individuals.

A 10% rate of capital gains tax is nothing new and was originally introduced by the Labour government of Tony Blair and Gordon Brown in 1998.  The 1998 version was expanded by the Conservative government later in 2010. 

There has been a considerable amount of reaction to the Chancellor’s changes to Entrepreneurs Relief, much of it vociferous, but it remains to be seen as to whether it will be enough to stall owners’ plans for business disposals. 

Thomas continues: “I don’t think the changes will materially affect many disposal points that were set before this year’s budget.  Entrepreneurs might be a little disappointed with the cut in relief but I don’t think it will be a show-stopper.”

Tom Carroll, founder of Our IT and an entrepreneur who sold his business under the previous tax relief system, said: “I sold my MSP business in 2018 and I can honestly say that the reduction in relief would not have adversely affected my decision to sell the business. An exit happens when there is a confluence of events that create favourable conditions for a sale and the right ‘tax’ environment is just one of them. Obviously, every owner would prefer the higher threshold of £10 million but most successful entrepreneurs do not start their business by deciding on the date when they will dispose of them. I am sure there were businesses in a hurry to conclude their sale ahead of the budget but the right deal does not always arrive when you want it to and you just have to be pragmatic about things. Changing market conditions are just the nature of the beast and you need to deal with them.”

At a macro level, the Chancellor maintains that he listened to both sides of the argument before making his deliberations. However, he felt that there are overriding factors for keeping it, although he had listened to representations for the tax break to be scrapped completely.

Sunak also committed £130m in new funding to extend loan facilities to 10,000 start-ups in the next two years. Perhaps this will not be sufficient to assuage the depth of feeling from those entrepreneurs who have lost out directly by the cut in relief but it might be enough to engender some positivity from the small-business lobby.

Is your glass half-empty or half-full regarding the cut in Entrepreneurs’ Relief? For those of us working with entrepreneurial business owners in the mid-market, only time will tell.

 

Photo: Photo by Hello I’m Nik

Evolution Capital prides itself on offering bespoke M&A advice to clients in the TMT sector. Our carefully chosen tax experts are on hand throughout the transaction process to ensure all outcomes are as tax-efficient as possible. If you’re a business owner looking to buy, sell or accelerate, please get in touch with our transaction team. 

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