Keeping entrepreneurs on the right side of potential incoming UK tax rates

As the pandemic continues to stretch the public purse, raising concerns about how to reduce the country’s increasing deficit, it is expected that the Spring Budget (set for 3 March) will be a turning point. 

Whilst the government may choose to push any changes to tax policy back again to the autumn when life returns more to “normal”, it is vital that entrepreneurs consider how these potentially changing tax rates will impact their businesses.

Potential changes

Last month, the Wealth Tax Commission published a report considering the introduction of a one-off wealth tax in the UK, which could raise £260bn, assuming a tax at 5% on assets over £500,000. The report concluded that a one-off wealth tax would be preferable to increasing taxes on spending or work, and that “major structural reforms” to capital gains tax (CGT) and inheritance tax (IHT) would be more beneficial. However, given that Chancellor Rishi Sunak has said that “there is not now and never will be a time for a wealth tax”, it seems unlikely that we will see one introduced in the Budget. 

In January 2020, we saw the publication by an All-Party Parliamentary Group, which proposed replacing the current IHT regime with a flat-rate gift tax at 10% payable on lifetime and death transfers (rising to 20% for death transfers for estates worth over £2m). Significantly, it also recommended scrapping all reliefs and exemptions other than the charity and spouse exemptions. This would mean saying goodbye to business property relief (BPR) that, subject to certain conditions being met, currently allows business owners to pass their businesses down the generations without incurring a 40% IHT charge. It would also significantly restrict the ability for entrepreneurs to put BPR assets into trust; currently, there is effectively no limit on the value of this, whereas generally there is a 20% tax charge for assets over £325,000. Furthermore, BPR trusts can be a particularly useful planning tool for entrepreneurs looking to sell their business in sheltering value from future IHT whilst benefiting from the asset protection trusts afford.

CGT rates are also expected to rise off the back of the report by the Office of Tax Simplification (OTS) in November 2020. The OTS recommended more closely aligning the CGT rates with income tax rates, reducing the annual exempt amount, and considering whether reliefs (such as Business Asset Disposal Relief, formerly Entrepreneurs’ Relief) should be replaced or abolished. For employees, it was questioned whether more employee share-based rewards should be taxed at income tax rates.

Effect on entrepreneurs

If these changes come to pass, it will be significant for entrepreneurs selling their businesses, effectively doubling the tax rate. For individuals who would end up paying income tax at the highest rate, this could mean a 45% tax rate as opposed to the current 20% for CGT. Both entrepreneurs, and Private Equity funds invested in scale-up companies, may seek to accelerate exit plans to ensure they obtain the benefit of the current CGT rates.  

Given the limited timeframe before the Budget, completing a sale is unlikely to be possible for many business owners. As is common, it is likely that anti-forestalling measures will be announced alongside any changes, preventing pre-Budget tax planning arrangements and retrospectively applying any changes in certain circumstances. This could be the case, for example, where unconditional agreements for sale are entered into before the Budget but not completed by that time, unless the seller can demonstrate that the arrangement was not entered into in order to take advantage of the current CGT rates. Other general anti-avoidance legislation will also need to be considered if you are thinking of going down that route.

Key considerations

At times like these, other tax considerations around structuring of both the deal and the purchase price come in to play.  Key issues include the alignment between the seller and buyer on pricing, particularly given the last 12 months have been difficult for most companies, and whether the deal is a share sale or an asset sale, with more risk averse buyers preferring an asset sale to allow them to cherry pick what to buy. If we see lower valuations for a while, this may lead to a tougher climate for sellers, with buyers able to dictate the return of more asset purchases. Additionally, sellers have typically sought to trigger CGT up front on as much of their sale proceeds as possible. Going forward, sellers may seek to defer higher rates of CGT on deferred or earn-out parts of the purchase price. Indeed, in the short-term, more deferred and earn-out deals are likely for commercial reasons, both de-risking the price for the buyer and, at times of greater pricing caution, potentially allowing sellers access to a fuller price. The increasing use of warranty and indemnity insurance is also likely to continue. 

While this is all speculation at this point, the potential CGT and IHT changes align with the direction of travel that the government has shown itself taking in recent years and, with the growing need to bolster the Treasury’s balance sheet, seem increasingly likely to be implemented to some extent. If a sale is on your horizon, now is a good time to take professional advice.