Capital Gains Tax – preparing for change
Following a report from the Office of Tax Simplification, there is speculation that increases in Capital Gains Tax are imminent.
Following a request by the Chancellor to carry out a review of the Capital Gains Tax (“CGT”) system and, in particular, the taxation of chargeable gains in relation to individuals and smaller businesses, the Office of Tax Simplification (“OTS”) has delivered its first report and recommendations resulting in increasing speculation that increases in CGT are imminent.
Main OTS recommendations/potential changes
The main recommendations made by the OTS in their first report are to:
- more closely align income tax and CGT rates (or to subject to income tax surplus cash/trading profits that have been accumulated in the business prior to its disposal);
- reduce the Annual Exempt Amount;
- remove the CGT free uplift on death; and
- consider replacing Business Asset Disposal Relief (previously known as Entrepreneurs’ Relief) with a more targeted form of retirement relief.
The current top rates of CGT are 28% for certain disposals of residential property and carried interest, and 20% for the sale of most other assets (including shares). This compares with a top rate of income tax of 45% (on income over £150,000). Historically, many business owners have been able to sell their businesses and only pay CGT at 10% by claiming Entrepreneurs’ Relief. Aligning CGT rates with income tax rates could therefore represent up to a 35% increase in taxes for business owners looking to sell their business.
It remains to be seen if, and to what extent, any of the OTS recommendations will actually be implemented in the 2021 Budget that was postponed from November and is now scheduled to take place in March 2021.
Given the current economic uncertainty caused by the pandemic and Brexit, it may be that any significant changes are deferred and, whilst there may be some modest increase in the CGT rates, an immediate alignment in rates is more unlikely. If, however, any changes are announced they are likely to take effect from either 6 April 2021 (the start of the next tax year) or the date of the 2021 Budget.
Even if any major CGT reforms are not announced in the 2021 Budget, whilst the impact of Brexit and the Pandemic are assessed, changes could be announced in the 2022 budget scheduled to take place in autumn 2021.
Impact for sellers
For those who are currently in the process of disposing of their business there will therefore be renewed impetus to complete the transaction before the end of the 20/21 tax year.
For those who are considering retiring or selling their business but have not yet begun the process, time will be of the essence as finding a buyer and preparing for the sale is time consuming and advisers will need to be instructed sooner rather than later in order to identify any issues and ensure that the sale process can proceed in an expedited manner.
For many businesses, particularly those operating in regulated sectors where regulatory consents to any sale are often required (bearing in mind that for tax purposes if a contract is conditional on any third party consent the date of disposal, and hence date of sale for tax purposes, is not when the contract is entered into but when the conditions are met and consent is obtained), this may mean that there is less time than may first appear to drive through any sale of the business even if any changes are deferred until the 2022 Budget.
It should also be borne in mind that, even where there are potential buyers, any time pressures that may come to bear on the seller in order to secure the benefit of lower CGT rates will invariably give prospective buyers a commercial advantage in terms of any negotiations.
In circumstances where there are no identifiable trade buyers and a management buy-out is not considered viable, a sale to an Employee Ownership Trust (“EOT”) may be an alternative option. An EOT is a special form of employee benefit trust that effectively acquires the company on behalf of the employees as a collective (an all employee buy-out rather than a management buy-out where the sale is to a handful of senior employees/directors only). The EOT can raise bank funding to fund the purchase or pay for the shares on a deferred basis out of profits and could, in some circumstances, lend itself toward a more expedited process.
Impact for buyers
Potential buyers may find that deals that stalled due to the pandemic are resurrected, perhaps even on more favourable terms.
Even if there is no immediate increase in CGT rates, additional acquisition opportunities may come to market over the coming months as those who were thinking about selling in the next few years may consider accelerating their exit plans and look to cash in before any tax increases.
If buying a regulated business where third party consent is needed to complete, bear in mind the extra time pressures this will create to complete deal if your seller wants to complete before any tax changes come into effect.
It is worth remembering that any increase in CGT rates will not just effect sales but any transfers of shares or assets.
For example, the buy-out of minority shareholders is often structured by way of a share buy-back (which provided certain conditions are met can be subject to CGT) or by setting up a new holding company to acquire the shares. Potential CGT increases could therefore provide an opportunity to tidy up the shareholder structure and persuade recalcitrant minority shareholders to sell now.
Whilst there may be other ways in which to trigger a gain in order to benefit from the current CGT rates (such as gifts into trust) care is required as, earlier this year, when changes were announced to Entrepreneurs’ Relief many arrangements that were put in place to try and “bank” the relief that did not involve a sale to an unconnected third party were rendered ineffective by anti-avoidance legislation that was put in place to counter certain forestalling arrangements that sought to ‘lock-in’ the relief prior to the changes. It is therefore imperative to take proper tax advice.
Whether or not changes are announced in the 2021 Budget in March, given the record levels of borrowing it is only a matter of time before tax rises are introduced and now is therefore a good time to take stock of your plans and engage with appropriate advisers to help work towards whatever succession or exit plans you may have.
If, on the other hand you are looking to expand, now is also a good time to get back in touch with advisers to help identify opportunities and steal a march on competitors by having laid the groundwork to be able to react and move quickly as this is likely to be a key factor for sellers if tax increases are announced and there are time pressures to complete any deal to allow them to be able to benefit from lower CGT rates.