The chancellor tweaked entrepreneurs' relief in the Budget but there are still serious structural problems, says Richard Mannion
Between 1998/99 and 2007/08, taper relief was available to mitigate the impact of capital gains on assets held for lengthy periods of time. As a result, most business owners or employees who sold their shares or their business would have been taxed at an effective 10% rate on their chargeable gains.
However, in the 2007 pre-Budget Report, the then chancellor Alistair Darling decided (without notice or consultation) to scrap taper relief. He inferred that it was too generous to partners in private equity firms who were able to pay tax at a lower rate than their cleaners. Yet his proposals meant that other business proprietors would be caught in the crossfire.
This announcement was followed by some fierce lobbying by business which resulted in the introduction of entrepreneurs' relief on the first £1m of gains, which at that time was worth a maximum of just £80,000 in terms of tax. Unfortunately the relevant legislation was written in a hurry, which shows. In short, it was based on the old retirement relief which had been scrapped some years previously due to its complexity.
The conditions for entrepreneurs' relief are more tightly drawn than those for the business asset taper relief so there is substantial opportunity for misunderstandings by taxpayers and advisers.
OTS review
The Office of Tax Simplification scrutinised entrepreneurs' relief in its Review of Tax Reliefs report published in March 2011 and identified some shortcomings:
- if the relief was really to encourage entrepreneurship there should be no limit on the relief;
- the rules are complex;
- if the business is incorporated it is possible to sell part of a shareholding and obtain entrepreneurs' relief. However, if the business is not incorporated, the entire business or a distinct part must be sold;
- having one set of rules for companies and one for unincorporated businesses creates complexity for businesses and advisers, and leads to mistakes.
There are also concerns around the sale of a company, specifically the rule requiring an individual to own at least 5% of the ordinary share capital and voting rights for at least a year prior to disposal which can lead to inequity and create complexity. For a year prior to selling, an individual needs to monitor the other shareholdings, to confirm whether he will be eligible for the relief, which may become unavailable at any time due to circumstances beyond his control (for example, a new investor coming in and diluting the other holdings).
Where part of the consideration is deferred and contingent on future events, an estimate is made of the most likely consideration and this is taxed at the point of sale (and may be eligible for entrepreneurs' relief). When the consideration is finally determined, a further profit or loss will accrue at that time. If there is an extra profit, this will not be eligible for entrepreneurs' relief as it is a different asset from the business that was sold.
The OTS identified that this entrepreneurs' relief performed a valuable function in sending a 'powerful and positive message' to entrepreneurs. However, it suggested some improvements, since when the business community has been holding its breath.
George Osborne did respond to the first criticism by increasing the lifetime allowance from £5m to £10m in the 2011 Budget, but there was just one further crumb of comfort in the 2012 Budget. Relief is to be extended to shares acquired from 6 April 2012 under the Enterprise Management Incentive (EMI) scheme irrespective of the 5% test. However, it appears they will still need to hold their shares for 12 months prior to sale to qualify for relief.
The government says it recognises the importance of the enterprise economy as one of the keys to future growth, but arguably it needs to do more to demonstrate its support.
Structural problems
Firstly, the government needs to deal with the major structural problems with entrepreneurs' relief. For example, in order to qualify for entrepreneurs' relief on the sale of business assets, an individual who invests in a company must own 5% of the total shares and also must have been an employee or office holder (director, company secretary or similar) for the whole year prior to sale.
Therefore, an individual who has been a director for many years but who retires a short time (or is sacked) before they dispose of their shares, will not qualify for relief. Changing this to a requirement to have served for 12 months in the last 24 months of ownership would be a move in the right direction.
The new rule for holders of EMI shares only applies to the size of shareholding requirement and the 12-month rule remains an issue. Similarly option holders in qualifying share schemes will frequently exercise their options immediately prior to sale, and therefore do not satisfy the 5% test for the one-year period prior to disposal. Under the taper relief system the length of ownership was counted from the date the options were granted, which was much more practical.
The 5% shareholding requirement has been relaxed for EMI shareholders, but why not relax the rule for all shareholders who work in the business?
Case law
The old retirement relief rules requiring the sale of the whole or distinguishable part of a business led to several contentious tax cases being heard in the courts with various rules of thumb developing as a result. This was a particular issue for farmers disposing of farmland and buildings. Those difficulties are now coming to the fore with entrepreneurs' relief as evidenced by the recent case of M Gilbert v HMRC [2011](UK FTT 705 (TC)) where the Tribunal had to decide whether the taxpayer had sold a viable section of his business.
Secondly, the guidance needs to be improved. HMRC has recently responded to 25 practical questions put forward several months ago by the professional bodies, but many queries remain outstanding. HMRC needs to beef up its technical resource so as to provide adequate guidance on a more timely basis in future.
So what do we want? Better legislation and guidance. When do we want it? Now!
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