1st December 2020

Potential Tax Changes and the Impact on Business Deals

The Covid pandemic has had a far-reaching impact across all parts of society, not least in terms of health and the strain this has put on the NHS.  Businesses and employees who have been affected by continued restrictions, or a general downturn in business, have received support from the Government.  The Job Retention Scheme alone is estimated to have cost £41 Billion up to the end of October and, with an end date of 31 March 2021, this will increase by many more billions.  In order to balance the books, the Government may look at targeting business owners or investors by increasing taxes such as Capital Gains Tax (“CGT”).  This article will consider what these changes might be, in addition to the changes that have already happened, and the impact this could have business deal trends.

Business Asset Disposal Relief

Business Asset Disposal Relief was called Entrepreneurs’ Relief until April this year, a change which may have passed some people by.  Of far more significance than the change of name was the level of relief available under it.  The relief can be claimed by owners selling all or part of their business, or shareholders selling shares, provided that certain conditions are met.

In April this year the lifetime allowance was reduced from £10 million to £1 million.  This means that those who qualify for the tax relief will pay the discounted CGT, currently 10% rather than 20% for higher and additional rate taxpayers, on the first £1 million of capital gains, rather than £10 million.  While this discounted rate is still attractive for SME owners or shareholders, it was a significant cut and will leave many paying far more CGT on the disposal of their business or assets.

Capital Gains Tax – Potential Changes

In early November the Office of Tax Simplification (“OTS”) published its report on CGT.  This report made a number of recommendations, which the Government is not obliged to follow, which would make the tax on any gains that resulted from the disposal of assets more punitive.  It was thought the Chancellor might refer to this report in his recent spending review update in the House of Commons, which would have warmed up the business community to possible changes on the horizon.  However, perhaps not wanting to detract from positive messages like NHS pay increases, the Chancellor has kept us guessing for now.

The main headline recommendation in the report is that CGT should be more closely aligned with income tax.  While stopping short of recommending these rates are mirrored, it perhaps serves as an indication of the possible increases to CGT.  At present, income tax rates in Scotland range from 19% for the ‘starter rate’ to 41% and 46% for higher rate and top rate taxpayers respectively.  Although not fully devolved, the Scottish Government has the power to set some rates of tax, so the income tax rates in England are slightly different.  If the recommendations are implemented this would mean a considerable increase in the CGT paid, particularly when read together with the change to Entrepreneurs’ Relief earlier this year.  The number of people who pay tax on capital gains is estimated to be only 265,000 whereas 31 million pay income tax, which raised £180 billion in 2017/18.  The Government might view the suggested CGT increase as an easy way of raising revenue, as much as £14 billion, while targeting relatively few people.

The other main proposal in the OTS report was lowering the annual allowance, which is currently £12,300, to between £2,000 and £4,000.  While this would not necessarily make a huge difference to someone looking to sell their business, on the basis they will likely generate a gain which is greater than the current threshold, it will mean more people will be caught by CGT than would have been previously.

Other recommendations in the report included:

  • Abolishing Business Asset Disposal Relief and replacing it with a relief geared towards retirement
  • Abolishing Investors’ Relief
  • Taxing retained earnings in companies at dividend rates rather than CGT on the sale of the shares or when the company is liquidated
  • Reviewing employee share awards and the interaction with these and Income Taxes and CGT

All of which, if implemented, could have an impact on the types of transactions that businesses might be considering and the timing of these.

Possible Impact on Transactions     

The absence in the Chancellor’s statement of any mention that CGT might be raised may not have an immediate impact on transactions.  However, some might see a CGT rise as inevitable and start to plan for an exit now.  The move from Entrepreneurs’ Relief to Business Asset Disposal Relief, and the reduction in the lifetime allowance which came with that, has already affected owners who have sold their businesses.  Prior to April 2020, while rumours were circulating that there might be changes coming, we found sellers keen to progress matters quickly so that they were not caught by the less favourable provisions.  In the short term we might see the same thing with any changes to CGT, much like we also did with property purchases before the Additional Dwelling Supplement was introduced a few of years ago.  The possible hike from paying 10% CGT to 40 or 45% is likely to focus the mind and drive deals through.

Employee Ownership Trusts

It is not known if, or when, the proposals in the OTS report will be implemented by the Government.  If they are, we may see a move away from the more traditional simple asset or share sales to alternative deal structures that are more tax efficient.

Transitioning to employee ownership, through the use of an Employee Ownership Trust (“EOT”), has become increasingly more popular in recent years. Blackadders has considerable expertise with these types of transactions, having been involved in a large number during the last few years.  This structure sees the exiting owner / shareholder selling their shares to an EOT which holds them on behalf of the continuing employees.  Provided that certain conditions are met, the disposal of shares to an EOT is exempt from CGT.  This is one of the reasons its popularity has grown in the last few years and we would expect to see more and more of these types of transactions if the proposed CGT changes are made.

The business landscape is likely to be unsettled, and the outlook uncertain, for the next few years but Blackadders’ corporate and commercial team are available to discuss any matters you have in connection with your business.

Richard Wilson, Solicitor
Corporate & Commercial
Blackadders LLP
@CorpLawyerRich

www.blackadders.co.uk

 

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