Entrepreneurs' relief: the end of an era or an error?

The title of this blog is deliberately ambiguous because it addresses a conundrum as old as capital gains tax itself:

  • Should an investor in a business be entitled to relief from CGT on disposal?
  • If so, what relief should they get?
  • Who should get that relief?

Actually that’s a set of conundrums to consider against the background of government statements that imply that entrepreneurs’ relief (or ‘ER’) is doomed.

Throw in hints at alignment of CGT rates with income tax and business participators face a wall of questions worthy of Only Connect without the assurance that there can ever be any ‘right’ answers.

‘Those who fail to learn from past mistakes are doomed to repeat them’

So how did we get here?

I will try to spare you a lengthy discourse. CGT was born in 1965 as a ‘simple tax’ but, like all taxes, it soon lost its innocent simplicity, branched out in unexpected ways and developed a few unsightly growths.

One of these was retirement relief which provided employees and office holders with a reduction in their CGT bills. It seemed pretty sensible, allowing business owners (who met ownership and business involvement criteria) to save CGT if they genuinely retired at or over the age of 55. The criteria were a bit hit-or-miss but it worked quite well.

It was replaced in 1998, since when we’ve had indexation relief for inflation and taper relief for long-term (and then short-term) ownership. Taper relief took ten years of constant tinkering to make it more or less fit for purpose, but then it was replaced by entrepreneurs’ relief. This unfortunately reinstated many of the weaknesses of its former self and added a few more.

Does entrepreneurs’ relief encourage enterprise?

It’s difficult to see how it fulfils any of its supposed purposes of rewarding investment of time in growing businesses, encouraging serial entrepreneurship and enabling retirees from business to reap the benefits of their efforts with a little sweetener from the taxman.

The time element is the first dubious area as, even following Chancellor Hammond’s reforms, the qualifying period for ER is still just two years. This favours businesses that make a quick start and are then quickly disposed of. Admittedly the £10 million lifetime limit does allow serial entrepreneurs to start, grow, sell and repeat but there is no inducement to reinvest. However, the big weakness is that ER does not really contain an incentive to be involved in running the business. The employment requirement carries no minimum working time at all; only the holding of an office or employment.

In fact, an entrepreneur who has used their £10 million lifetime allowance might be dissuaded from serial entrepreneurship in favour of investors’ relief which offers another £10 million lifetime allowance, but only on condition of the investor not being employed in the business. It seems odd that external investment should be valued above genuine investment of time and effort in making a success of a business.

And what of the nature of the business?

One of the features of ER that makes it popular is its application to furnished holiday lettings, a sector often viewed as low risk in the sense that it is property-based and, as such, is relatively low risk. It is hard to see a justification - certainly there is no social benefit - in singling out FHLs but not other forms of letting to benefit from a relief that is supposed to encourage enterprise and risk-taking.

Reform, remove or replace?

ER has been around for over ten years but has never really worked properly because it was not properly conceived or designed when it was introduced. Instead, the Treasury simply hauled out the old retirement relief, blew off the dust and made a few tweaks before embarking on a lengthy process of tweaking and tinkering.

If entrepreneurs’ relief can be likened to a ship, it was unseaworthy at launch and all that has happened since is a series of patches and bodges which keep the old rickety hulk drifting and barely afloat.

One suspects that none of this would much concern the government but for the fact that the leaks don’t let water in; they are now perceived as letting tax revenue out. However, the fact remains that the ship now consists more of patches than structure. In addition, government pronouncements focus on perceived ‘abuse’, the great majority of which has been encouraged by the government’s own changes, the most fundamental of which was the shortening of the qualifying period.

Abolishing any form of relief for those who have genuinely invested time and hard work in building businesses smacks of desperation and a lack of ideas about what the policy behind ER is or should be and the government should take the trouble to decide what distinguishes the baby from the bathwater.

Therefore now is the time to consider an appropriate replacement, start again with a clean sheet of paper, decide on a coherent policy objective and develop a new model for a relief that meets the objectives of rewarding enterprise, managing compliance and recognising that any business that has developed to the point where it can be sold for a healthy sum (such as the £10 million lifetime ER limit) is likely to have contributed far more in employment and business taxation during its lifetime than the public purse may lose to any CGT relief on disposal.

Chris Williams

Written by Chris Williams

Chris Williams is co-author of Capital Gains Tax Reliefs for SMEs and Entrepreneurs (Bloomsbury Professional) and a senior manager at Mazars LLP. The views expressed here are his own.

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