Capital Gains Tax – The proposed changes and what they could mean for business sales

With vaccines hopefully bringing the COVID-19 crisis to a long-awaited conclusion in 2021, thoughts are now inevitably beginning to turn to how the government will seek to foot the huge bill that has been racked up by enormous levels of spending during the pandemic.

From business interruption loan schemes and furlough to additional NHS funding, the UK government spent well in excess of £210 billion in the first six months of the pandemic. With the second wave hitting in autumn 2020, government support measures have had to be extended into 2021.

The need to pay for this has led to widespread assumptions that Chancellor Rishi Sunak will make significant tax hikes over the next year. In particular, following a Treasury-commissioned review, a major proposed increase in Capital Gains Tax (CGT) has been attracting headlines in recent weeks.

An increase in Capital Gains Tax, while seen as a logical or overdue step by some, has caused uproar among many tax observers and business owners. Among other things, the mooted increase could have a significant and lasting impact on the UK’s M&A landscape.

What is CGT?

Capital Gains Tax is charged on the disposal of an asset (such as a business) that has increased in value during the time that the seller has been in control of it. Essentially, it is a tax levied on the gain made during this time, rather than on the asset being disposed of.

There is a personal tax-free allowance of £12,300 up to which CGT is not applied. Currently, CGT is charged at 10 per cent for basic rate taxpayers (18 per cent for residential property sales) and 20 per cent for higher or additional rate taxpayers (28 per cent for residential property).

So let’s assume the seller built the business from scratch and is a higher rate taxpayer. He/she sells the business for £5 million. At current CGT rates, £900,000 would be payable. Without Entrepreneurs’ Relief, the liability would be £1 million.

What are the proposed changes?

In July, Rishi Sunak commissioned a review of Capital Gains Tax by the Office of Tax Simplification (OTS). The report was completed in November and in it the OTS stated that CGT in its current form was “counter-intuitive”.

The report argued that CGT created “odd incentives”, as well as “opportunities for tax avoidance”, such as through employee share schemes or by directors being able to re-categorise work earnings as capital gains in order to pay a lower tax rate.

To combat these perceived shortcomings, the OTS recommended a raft of changes be made. The most significant of these was that CGT should be increased to similar levels to income tax, which is currently charged at a basic rate of 20 per cent, but rises to 40 and 45 per cent for higher and additional taxpayers.

To put this in perspective, the £900,000 tax bill on a £5 million business sale under current rates would rise dramatically if CGT was aligned with income tax - to as high as £2.25 million.

The report also proposed a major cut in the “relatively high” £12,300 allowance, recommending it be brought down to between £2,000 and £4,000. The OTS also suggested scrapping Entrepreneurs’ Relief, which allows business founders to pay CGT at a rate of 10 per cent up to a lifetime limit of £1 million when selling their companies. This lifetime rate has already been cut by Sunak from £10 million in March 2020.

Finally, the OTS recommended that the capital gains uplift, which allows beneficiaries to inherit an asset at its value on the date of death, rather than its value at the time of purchase, be scrapped entirely.

The OTS argues that this encourages people to transfer business and personal assets upon their death, rather than during their life, which it says “may not be best for the business, the individuals, or families involved, or the wider economy.”

What has the response been?

The proposals have been broadly criticised as an attack on businesses and their owners, with several tax experts singling out particular elements of the report.

In an open letter to Rishi Sunak, over 2,200 business owners and founders said that it would be counterproductive to bring CGT into line with the higher income tax rate and that the proposals would stifle innovation and risk-taking.

The letter said that CGT should remain at an “appropriate level to reflect the risk we have taken and the prosperity we have brought to others in creating a new enterprise”.

Elsewhere, the proposal has been characterised as being “another blow” to business founders after the cut to Entrepreneurs’ Relief made in March 2020.

The chance that the proposals could come into force has seen accountants reporting increasing interest among entrepreneurs looking to sell their businesses prior to the likely implementation date in spring 2021 in order to lock in the current rates and relief.

The above-mentioned increase in business owners exploring potential sales has seen suggestions that there could be a rush on fast-tracked sales in order to avoid a potential 25 per cent increase in the CGT bill.

Such rushed sales, which are normally only used for businesses in distress and needing a sale in order to survive, could have a negative impact on eventual sale prices.

What should business owners do?

If you’re a business owner who already had a sale in mind, news of a possible CGT hike will be particularly concerning. As a result, there is no denying the temptation of bringing the sale forward and locking in the current rate.

Moving a sale that was already in motion forward by a few months could be a very wise decision in order to avoid what would be a hefty tax increase. As we pointed out earlier, selling a business after the proposed changes come in could see the tax bill more than double.

Even if the OTS’s proposals regarding CGT (not to mention its recommendation to scrap Entrepreneurs’ Relief entirely) aren’t implemented, it is entirely likely that some other tax increases could be introduced in 2021 that would make a sale now advisable

As Chris Love of Primas Law says: “For business owners already considering selling-up, we’re advising that it would make sense to act fast before tax rates increase. It is widely anticipated that tax changes are afoot, and the future tax environment will be harsher on business owners whether these specific proposals go ahead or not.”

However, caution should be strongly urged in this regard for several reasons. For one, the levels of business distress linked to COVID-19 could help ensure that the first half of 2021 is a buyers market and valuations may suffer as a result.

An influx of impatient business owners looking to fast-track sales in order to lock in a lower tax rate prior to a fixed deadline is only likely to exacerbate this. Simply put, businesses are likely to command lower valuations from potential buyers, perhaps even to the extent that the savings made by avoiding the higher CGT rate are erased.

Also, if the proposed changes are brought in with Sunak’s expected Spring Budget in March, this simply doesn’t leave much time to make a sale before the higher rates would come in.

This could result in risky, rushed business sales where the vendors fail to adequately vet potential purchasers and force buyers to rush through their due diligence. This increases the likelihood of wasting time and creating conflicts and deal issues down the line.

Some experts have also sought to warn business owners away from selling merely to access a more favourable CGT rate. CWC Research MD Clive Waller advises: “Simplistically, I would not sell for tax reasons unless a sale was in mind anyway. It often doesn’t work. [...] If you plan to sell in the next one to three years, now might be good. Otherwise, struggle on!”

Finally, an important point to consider is the fact that the Chancellor could very conceivably choose not to implement the OTS’s recommendations. While the OTS’s suggestions came in a government-ordered review and must therefore be taken seriously, it is by no means certain that their specific recommendations will be implemented.

Indeed, sources close to Sunak have been cited suggesting it is “unlikely” that the reforms will be introduced due to the unpopularity of previous OTS tax recommendations.

Until it is set in stone that CGT is going to be increased, then it seems somewhat risky to opt to proceed with a sale that wasn’t already decided, purely to lock in a more favourable tax rate.

However, for business owners who were already set on a sale, then getting it done ahead of the spring budget (without, of course, unduly rushing or cutting corners on due diligence) may be highly advisable.

One thing, however, seems certain. 2021 doesn’t look set to be any more stable for business sellers and acquirers, with the impact of COVID-19 likely to be felt long after the virus itself has been eliminated.

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