Entrepreneurs’ Relief and the Budget

Entrepreneurs’ relief and 2020 budget changes – where are we and what can business owners do?

Entrepreneurs’ relief has been a feature of the UK system for taxing business owners since 2008 (and was a successor to earlier reliefs with some similar benefits). On the run up to the Budget the rumours that it will be amended or even abolished have been coming to a crescendo, after headline messages from 'senior government figures' that the relief is under threat and, reportedly, comments from Boris Johnson that there is pressure from the Treasury for radical reform.

What is the relief currently?

The relief is available to business owners on disposal of their business interests in a range of circumstances – partners, shareholders and sole traders can benefit and, in some cases, it can cover gains on disposals of business assets that are owned by individuals but used in the business. Trustees can sometimes share the relief available to their beneficiaries. It is a popular relief for key executives in unlisted and private equity backed businesses, and for founders of fast growth start-ups, many of them in knowledge-rich sectors such as tech and biopharma, as well as for owners of more traditional OMBs. 

Its effect is to reduce the rate of tax on chargeable gains in a qualifying disposal from 20 per cent to 10 per cent, subject to a lifetime limit of £10m of gains. In other words, the maximum value of the relief, even to a serial entrepreneur, is £1m. It’s also possible to reinvest gains into EIS or SITR investments and defer these crystallising without loss of entrepreneurs’ relief. (There is also some SEIS rollover available but this is restricted.) 

However, it should be remembered that that amount, nowadays, includes tax on inflation. Based on ONS data on RPI, for someone who invested in their business in December 1999 and sold in December 2019, growth in value of 74 per cent simply represents cumulative inflation in the interim which, since the abolition of relief for indexation, is fully subject to tax. 

There are a number of features of the design of the relief worth noting:

• It is confined to interests in trading businesses, not investment businesses.
• Where the sale is of a company, the seller has to own (broadly) shares carrying five per cent of the votes and economic entitlements during this period, and also to be either a director or employee of the company.
• The relevant ownership tests normally have to be met for two years before the date of disposal (if there is an unconditional contract, this is the date of the contract and not the date of the actual sale).
• There is greater flexibility for holders of EMI options – they don’t have to meet the five per cent test and the two year period is measured from the date of grant of the option (rather than only once the shares are acquired).
• If selling assets owned personally but let or made available to the business, there are separate tests to satisfy: there are a number of detailed conditions but these include use of the assets by the business for at least two years before the earlier of the asset disposal date and any relevant cessation of a partnership or company’s business.
• There is a potential restriction where there is an earnout. Depending on the detail of the earnout arrangements, while the market value of the earnout right is included in computing the gains subject to relief, to the extent that the actual proceeds on the earnout ultimately exceed the market value of the right to receive these, for technical reasons the relief may not be available on that excess.

Why has the relief become controversial?

Significant changes had already been made with effect from April 2019 to the scope of the relief, extending the ownership period for companies from one to two years and blocking arrangements sometimes adopted to allow executives without a full five per cent of the economic rights in the company to benefit from the relief. And the assumption had been that this would give owners some element of stability to plan for the disposal of their businesses without further radical regime changes for a period. Additionally, while one policy concern in the past has been the availability of the relief for contractor working arrangements, the proposed extension of the off payroll working rules is likely to mean the relief has little benefit any more in this context.

Entrepreneurs’ relief been estimated to cost £2.4bn a year. It does often benefit those who have generated significant gains, and repeated questions have been asked about how effective it is in encouraging entrepreneurship or investment. So it is vulnerable to pressure for further, potentially radical, reform in a context where the Chancellor will be looking for ways to fund spending commitments and an election pledge to raise the national insurance threshold. There are also lots of features of the design of the relief which would be open to policy debate – it’s far from clear what the particular magic in a five per cent ownership stake or a two year holding period was thought to be for example: an executive who gives unstinting commitment to build up a business over a 10 year period but only has a four per cent stake seems at least as deserving of a tax incentive as a late stage investor/director able to afford a five per cent stake a couple of years before sale. Is the aim to encourage a retirement pot, or give a tax incentive to serial entrepreneurs? Why may a partner with three per cent of the economic rights in an LLP qualify for relief where shareholder with a three per cent stake does not? It also covers businesses in any part of the world, which may not be consistent with encouraging investment in UK business.

What can you do?

Budget day - 11 March, and the start of the new tax year is 6 April. Because of the risk of changes in anticipation it’s unlikely that details of proposed changes will leak more than 48 hours before the Budget.

For anyone holding assets into which gains have been rolled or where the gains have been deferred due to reinvestment (including under previous versions of the legislation such as in any case of a pre 6 April 2008 acquisition of EIS and VCT shares), take advice and consider the position.

For businesses close to sale, it may be prudent, if possible without compromising value:

• to get an unconditional agreement in place to sell by 11 March as it is then extremely unlikely that the position would be affected
• if a conditional agreement is required (for example for regulatory reasons), to consider if anything can be done to accelerate satisfaction of the conditions
• if there are holding companies in place, to consider crystallising the relief by sale of the holding companies rather than dealing with winding up and extraction later
• to consider how to deal with dilution issues if there is an equity injection in prospect in the near future, in the light of the ability since April 2019 to elect to 'bank' the entrepreneurs’ relief on genuine commercial share issues and defer the benefit of this until a subsequent disposal
• for those considering inheritance tax planning as well, to address a possible opportunity to create trusts before 11 March and then decide later whether to pay the CGT charge (with the benefit of entrepreneurs’ relief), or holdover the gain. This decision would not need to be taken until 31 January 2021 (and holdover elections can be made, and tax paid reclaimed, until 6 April 2024).

In other cases, assess the risk of change in the light of the strategy for the business, and be ready to react quickly after the Budget.

While there is a worst case risk that the relief will be withdrawn or radically restricted either on 11 March or with effect from 6 April, it is more likely that there will either be a consultation or a transition period with changes later. Effective representations focused on the weaker features of the design of relief might help make sure that it is amended only in a constructive way, and/or that existing business owners who have relied on the relief being available in making their investment decisions are able to secure a reasonable transition period. 

Interestingly nothing, so far, has been said about investors’ relief – which seems to be here to stay for some time. In value, scope and design it has a number of similarities to entrepreneurs’ relief, though there is a three year minimum holding period. But it is not normally available to employees and directors other than unpaid directors. Some individuals who provide both non-executive skills and business angel investment will want to consider their position carefully – particularly as, for investors’ relief, there is no minimum shareholding threshold.

For more information or if you have any questions, please contact Ian Carnochan or your usual Burges Salmon contact.