Capital Gains Tax: A guide for entrepreneurs
The chancellor has had us all guessing for months - so where are we now?
The government has created a lot of confusion over Capital Gains Tax (CGT) and is causing a headache for entrepreneurs and investors. Following the chancellor’s statement on January 24 we spoke to Richard Garrod, a tax expert at the international accountancy firm Mazars for an update
Starting with the basics when do you pay CGT?
It is on disposal of an asset such as a business or a property that someone has bought as an investment or for business reasons. You pay on the gain; the difference between what you bought it for and how much you sold it at. For a business this would be for the vast majority of the sale price as usually company shares in a start-up are at a nominal value only, typically £1 per share. In the case of a property you can claim various costs of acquisition and disposal against this but in the case of a business its more resticted.
Where exactly are we now with CGT?
At the moment CGT is set at 40% but when it first came to power the government introduced taper relief. This meant that if you sold a qualifying business after 12 months then you paid 20% CGT or after 24 months then you paid 10%. However, in the pre-Budget report made in October 2007 the chancellor Alistair Darling did away with taper relief and introduced a flat rate of CGT of 18%. There has, of course, been a strong reaction from the business community and the chancellor looked to make amendments. He has now altered his altered his position by adding ‘entrepreneur’s relief’ which means that business owners still only pay 10% on the first £1m. However, this is a once in a lifetime opportunity so if you sell for £1m after April 5 then all subsequent CGT payments will be at 18%.
So if a multi-millionaire or serial entrepreneur like Sir Richard Branson sells a business for less than a £1m can he claim ‘entrepreneur’s relief’?
Yes any business owner can claim entrepreneur’s relief for the first £1m of a capital gain, even someone like Sir Richard Branson.
Who can’t get entrepreneurs relief?
It only applied to people who sell equity and are working in the business. So a passive shareholder cannot claim. But if you had five people who worked in a business and sold their equity each would be able to claim entrepreneur’s relief provided that they hold more than 5% equity and voting rights.
How is Her Majesty’s Revenue and Customs (HMRC) going to keep track of all of this? Is the government planning some sort of mass database to keep track of all of this?
That’s a good question. HMRCs records aren’t always the best and I think in reality they are going to rely on the people involved to be honest.I think most people will assume that HMRC does know things and as it is self-assessment then they are going to tell the truth. I would certainly advise someone to fully disclose everything but it might be quite easy to make mistakes. If someone sells this year for less than £1mand then in ten years’ time sells another asset are they going to remember the precise amount of the first deal? I think it will lead to a lot more red tape and that isn’t good for entrepreneurs or the government. I think that HMRC is going to have to put together some sort of database to keep track of all of this.
If I sell my business now but get paid after April 5, can I still get taper relief?
It depends on how they take the consideration. If you sell for instance on March 31 and receive some cash upfront and there is a deferred payment of cash after the April 5 deadline then you can get taper relief on both parts. However, you will be taxed at 10% straightaway and this means that typically you will have to pay HMRC in full by January 31, 2009. You might want to do this as if you receive a separate payment after April 5 you will be taxed at a higher rate. But part of the difficulty for the business owner is that they might have to pay tax before they have received the full payment for their business. Also, a lot of deals are a mixture of cash, loan stock and shares. But it is only deferred payments of cash that can attract taper relief, so if you were given shares, which you sell later, then you will have to pay 18%.
What about earn-outs?
This is even more complicated! HMRC will look at the value of the earn-out at the time the deal is made and if the agreement is signed before April 5 then taper relief will apply. Once again you will have to pay the taxman upfront which could be a strain. However, if the earn-out turns out to be less than expected then you can claim tax back. But if it is more than it was valued at the time of the deal you will have to pay additional tax and this will be at a rate of 18% not 10% as it will occur after the April 5 deadline (providing you have gone over your lifetime limit of £1m). This makes valuation of an earn-out a risky business as if you undervalue your earn-out then you will have to pay a higher rate of tax later. But if you over-value it then you are liable for a greater amount of tax upfront before you have received your money. In the past there was a tendency to undervalue the earn-outs so entrepreneurs didn’t have to pay too much tax upfront. But with the recent changes this may have been reversed. This is an area where I would recommend professional advice as if you get your sums wrong you could end up out of pocket.