Entrepreneurs’ relief, which allows founders and investors in small businesses to pay a reduced 10% rate of Capital Gains Tax when they sell up, could soon be restricted or scrapped altogether, with rumours that Chancellor Sajid Javid will make an announcement in the Budget this March.
At the moment if you sell a business you will pay tax of just 10% on the proceeds of the sale.
This applies to limited companies, partnerships and sole traders. If you sell most other types of asset you will pay capital gains tax at the rate of 20%. If you sell a property asset such a buy-to-let property you will pay CGT on the gain at 18% if you are a standard rate taxpayer and 28% if you are a higher rate taxpayer.
And if you draw profit from your business as salary or dividends you will pay tax on your earnings at a rate of up to 45% plus National Insurance contributions.
Entrepreneurs’ relief is therefore an extremely valuable concession for business owners which is of course why it is under review.
It is believed that the tax break costs HMRC around £2.4bn per annum in lost tax and our new Conservative government might come to the conclusion that ending a tax break that goes mostly to the rich would generate positive headlines in the tabloid press and win extra votes from their new-found supporters.
There have been many articles in the press over the last few months about how much this tax break costs but I have not seen a single article that defends the entrepreneurs’ relief, so let me make the case for it now.
Imagine what would happen if the Government were to impose a new tax on people when they sell their cars.
Most people hate paying taxes, particularly new ones, so the result would be that people would hang on to their cars for much longer, and before we knew it, the roads would be full of old bangers polluting the atmosphere and clogging up the roads when they broke down.
Huge amounts of PAYE and corporation tax would be lost because of all the redundancies that would happen in motor manufacturers and car dealers. This would more than outweigh the revenue earned from the new tax.
Before long the Government would have to admit that the new tax was unsuccessful and perform an embarrassing U-turn.
Exactly the same thing would happen if the Government were to switch the burden of Stamp Duty from buyers to sellers.
People would decide not to sell and many thousands of spacious family homes would be occupied by just one or two elderly people for many years longer than necessary. Again, the revenue raised would be negated by lost taxes on builders, removal companies, furniture shops and of course estate agents.
I predict exactly the same thing would happen if the government were to end entrepreneurs’ relief. If advance note were to be given, there would be a rush by business owners to sell before the deadline, but those that missed the boat would be furious.
If they were to be asked to pay two, three or four times as much tax as they pay now, they would simply refuse to sell up and the consequences of this on our economy would be catastrophic.
So why do I say this? Well, most businesses go through a cycle. An ambitious entrepreneur starts a business and in the early days they do whatever it takes to make it work. If they are successful, the business matures and enjoys a period of good profitability. But after ten, 20 or 30 years of doing much the same thing, many business owners get tired.
Their business then starts to go into decline and new and hungrier competitors start to take market share away from them. Almost every town in England has a business like this. Businesses that were once the market leaders but are now past their best.
This is when smart business owners recognise what is happening and sell their business to someone who has the skills and the energy to revitalise it. If they do not do so, the pace of decline often quickens.
Some business owners respond by putting a manager in, but a salaried manager very seldom runs the business as well as the owner would themselves. Some sell the business to their staff, but most good estate agents do not know how to run a business. The skills required are very different.
Some people give their business to their sons or daughters, but many of their offspring turn out to be less capable in business than their parents were. Once again, the result is that the business declines.
All too often the end result is that turnover declines, staff are made redundant and profits drop. Eventually a once viable business is closed and the Government gets no PAYE, no corporation tax and no Capital Gains Tax on the sale because what is left is worthless.
So, I would urge our new government to leave entrepreneurs’ relief alone because by encouraging business owners to sell their business at the right point in their lives, the whole country will benefit.
* Adam Walker is a business transfer agent and consultant who has specialised in the property sector for more than 25 years.