News and Press
Capital gains tax: Entrepreneurs' relief
01 January 2008
After months of uncertainty, Alistair Darling has confirmed that, with effect from 6 April 2008, capital gains tax taper relief will be abolished and an 18% flat rate introduced. There was some good news for "entrepreneurs": the first £1 million of their lifetime capital gains will be subject to a 10% effective rate of capital gains tax.
Who will the new entrepreneurs' relief benefit?
Broadly, employees and company directors who hold more than 5% of the shares in their employing company or its parent.
For those individuals, provided they have been employed for in excess of 1 year, the first £1 million of capital gain they make on disposal of the shares will be taxed at 10%.
It will also mean that sole traders and those in partnership selling their business continue to benefit (as under taper relief) from an effective capital gains tax rate of 10% - but subject to the same £1m cap.
What does it mean in practice?
It means employees who hold small stakes in a company and non-employee/director investors will pay an 18% rate of tax on disposal of their shares (where gains are above the annual CGT allowance). That 18% rate will apply regardless of the length of time for which the shares have been held. As an aside, property letting businesses are explicitly excluded from the scope of the relief.
For employees and company directors it will be tax beneficial to secure 5% of the shares in the company, provided those shares have voting rights.
For employees and company directors with shares worth in excess of £1 million, any further increase in the value of their shares will be taxed at 18%. If they currently benefit from the 10% rate (because they have accrued maximum taper relief), there will be a tax advantage in selling the shares prior to 6 April 2008.
How will it affect serial entrepreneurs?
The lifetime allowance of £1 million is likely to apply to gains crystallised after 6 April 2008 which will mean that serial entrepreneurs can take advantage of a 10% rate in respect of their current or future businesses. However, individuals who set up many businesses with a view to sale may burn through their lifetime allowance very quickly.
How will it affect those who have sold their business and received deferred consideration and/or an earn-out?
Sellers who have part of the purchase price for their business outstanding have been caught in an uncertain limbo since the Chancellor’s announcement last year that taper relief would be abolished from 6 April 2008.
If, as mentioned above, the lifetime allowance only applies to gains crystallised after 6 April 2008, then the first £1 million of any deferred consideration or earn-out should benefit from a 10% rate. However, where part of the sale price is likely to exceed £1 million and the entitlement is deferred until after April, tax planning can, in many cases, still bring the entire gain within the 10% capital gains tax rate.
How will this impact on employee share plans?
Employees who hold shares under a Share Incentive Plan are outside of the CGT regime.
Employees with holdings acquired under ShareSave schemes are unlikely to build up the 5% of the issued share capital necessary to obtain the new 10% rate. That means they can expect an 18% capital gains tax rate on selling their shares. That’s not all bad news - previously under ShareSave, employees were often paying tax at 20% or 40%.
If employees build up stakes of 5% or more under Enterprise Management Incentive Plans or Company Share Option Plans, it is expected that the 10% rate will apply. Note that the EMI or CSOP options will have to be over voting shares. For smaller stakes an 18% rate should be expected.
Performance Share Plans and LTIPs are unlikely to be affected too much because they are mainly taxable to income.
Conclusions
Looking forward, the owners of small businesses look reasonably protected but it may be that sales by couples or partnerships benefit disproportionately as a result of holding property jointly. As ever the devil will be in the detail. However, serial entrepreneurs who had previously been able to secure a 10% tax rate and those who have built up medium to large businesses are likely to find little consolation in this new package after the demise of taper relief.
If you would like more information please do not hesitate to contact Ben Watson, Employee Share Plans, on 0117 917 8811.
This publication is intended for general guidance and represents our understanding of the relevant law and practice as at January 2008. Specific advice should be sought for specific cases; we cannot be held responsible for any action (or decision not to take action) made in reliance upon the content of this publication.
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