Entrepreneurs' relief reform explained

07 July 2020
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If you’ve been working hard for years to build up a business, you may have your eye on a lucrative exit that will allow you to enjoy some of life’s luxuries. But if you’re among the most successful business owners and plan to sell your company for millions, Chancellor Rishi Sunak’s decision to reform entrepreneurs’ relief could leave you facing a bigger Capital Gains Tax (CGT) charge and in need of a new financial strategy.
 
While the Chancellor decided against abolishing the relief, which reduces the amount of CGT owed on the proceeds of a business sale from 20% to 10%, he did limit the lifetime allowance on gains on which this benefit can be claimed – from £10 million to just £1 million. While the vast majority of owners will be breathing a sigh of relief, the most successful, who have built very valuable businesses, will need to consider what they can do to limit their liability.
 
Entrepreneurs’ relief has come under fire from organisations ranging from the Association of Accounting Technicians and the Resolution Foundation to the Office of Tax Simplification (OTS). They said it failed in its purpose of encouraging entrepreneurialism and benefited just a small number of wealthy people. The OTS’s Business Lifecycle Report said: “Other reliefs appear to be designed to encourage investment in young and growing businesses, or to preserve existing businesses from break-up in the event of succession.Entrepreneurs’ relief does not seem to achieve either of those objectives.”

What a relief

Ignoring calls to abolish the relief, the Chancellor said it was valuable: “We need more risk taking and creativity, so we are not going to fully abolish entrepreneurs’ relief but we will reduce the lifetime limit from £10 million to £1 million. This will save £6 billion over the next five years and this money will be invested straight back into innovative businesses and technology.”
 
If you think you may now be facing a bigger tax bill, you will need to start planning in advance of your sale to take advantage of other tax breaks offered by the government. For example, a financial adviser might suggest that a company begins to pay into a pension for you. This can both provide a tax-efficient way of withdrawing money and reduce the amount of corporation tax the company has to pay.
 
There are other legitimate tax breaks that an adviser might suggest, depending on your circumstances. For example, if you plan ahead, you could give half of your shares to your spouse or civil partner, who will also then be entitled to entrepreneurs’ relief as long as they have owned the shares for at least two years.
 
Alternatively, you could pay yourself a dividend and, although you will have to pay an income tax charge, you could then invest the money into an Enterprise Investment Scheme (EIS) or a venture capital trust. Because the government wants to encourage people to support small businesses, you would then receive 30% income tax relief.
 

Make a plan

Senior Wealth Planner, Carl Drummond says: “The change to entrepreneurs’ relief is only going to affect about 5,000 individuals so there’s going to be a limited number of people affected by the change. Most entrepreneurs that sell up are selling for under a million pounds and will still get the allowance. For those over the million pounds they will need to think about how they structure the sale in a little bit more detail. They will need more advice.
 
“The Chancellor and HMRC need to get tax from somewhere. It’s good that the Chancellor is getting some money back but if you are a small business owner and you are building up the business, will the change disincentive you from keeping going after its value rises to a million pounds? My personal view is probably not. But maybe you’ll restructure how you actually sell it. So, you might take out further pension contributions for example before you actually get to the point of sale. Rather than just focus on the business you might need to do more financial planning around how you actually structure the deal in the lead up to the sale.
 
“If you put it into perspective, if the company was sold for £10 million that means on £9 million you are going to pay 20% and on £1 million you are going to pay 10%. The reality is not actually too bad because there are other tax incentives you can take advantage of outside of entrepreneurs’ relief. You are going to have to pay a bit more tax but it’s about planning the sale properly and taking financial advice to work out what the tax position is, and then mitigating its impact.”
 
It is also worth remembering that the Chancellor was under pressure to abolish the relief and this might happen at some time in the future, so all entrepreneurs should be alert to the possibility that their financial plans will need to change before they sell.

Carl Drummond
Senior Wealth Planner

The information and opinion contained above should not be taken as instruction to buy or sell any particular investment or to adopt any investment strategy. It is based on our current understanding of current tax legislation. You should seek personal advice regarding your tax situation and the consequences of  any investment decisions before acting.

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