Restriction of Holdover Relief on Gifts to Companies Improvement of Business Asset Taper Relief
In his Pre-Budget Report on 9 November 1999, the Chancellor announced certain changes to the operation of Capital Gains Tax (CGT) gifts relief and the taper relief for business assets which will have important tax planning implications for entrepreneurs and others holding shares in private companies.
Gifts of business assets to companies
Background
Subject to some restrictions, gifts relief (also known as holdover relief) is available on gifts of assets used for the purposes of a trade and on gifts of shares or securities of a trading company or holding company of a trading group. If the shares are listed the donor must hold at least 5% of the company.
Where gifts relief applies the donor is not charged to tax on any gain resulting from his gift of the asset. The recipient is treated as acquiring the asset for the current market value less the amount of any chargeable gain on the gift, effectively inheriting the donor's base cost in the asset. The gain will be brought back into charge when the recipient eventually disposes of the asset.
The main purpose of the relief is to allow a business to be handed down from generation to generation within a family and to prevent the breakup of small businesses which otherwise might occur if a significant CGT charge arose on the gift of assets or shares to the next generation.
The change
With effect from 9 November 1999 gifts of shares or securities to a company (as opposed to an individual or a trust) will no longer be eligible for business assets gifts relief. Legislation to effect this change will be introduced in next year's Finance Bill.
Why the change?
The Treasury believes that the relief is being widely abused and exploited in schemes designed to avoid a CGT liability on an anticipated sale of the shares rather than simply to defer the liability on a genuine gift. It is true that there are a number of such schemes which do make use of the relief on gifts to a company. Whether the use of a relief in the context of wider tax planning amounts to abuse or exploitation is another matter. It is however difficult to envisage a situation in which a gift of shares to a company would be made solely in the context of handing on the family business rather than as part of a more sophisticated tax planning arrangement.
The effect of the change
A wide number of tax planning strategies have evolved in recent years making use of this relief to mitigate the potential CGT charge arising on a sale of shares in a private company. These include:
- Offshore insurance bonds
- Sale of an interest in a UK trust
- Making use of companies eligible for Business Expansion Scheme (BES) relief
- Gifts to authorised unit trusts
- Use of companies incorporated in jurisdictions with which the UK has an appropriate double tax treaty
The withdrawal of the relief reduces the number of options available on a sale of private company shares. There are however still a number of tax planning opportunities which remain and which can be utilised at a reasonable cost. Most of the strategies noted above simply operated as deferral mechanisms. However, those who have implemented any such scheme which utilised the gifts relief on an eventual disposal to a third party (principally the UK trust route) will need to reconsider their exit strategies.
Taper Relief Changes
At the same time as withdrawing the relief for gifts of business assets to companies, the Chancellor announced plans to make taper relief for business assets more generous. Business assets are assets used for the purposes of a trade and shareholdings in a trading company (or a holding company of a trading group) when the shareholder can exercise at least 5% of the voting rights (if the shareholder works full time in the company's business), or 25% in other cases.
Detailed consultation is to follow but broadly the Government is contemplating allowing maximum taper relief for business assets after five years ownership instead of ten years. This would reduce the equivalent CGT rate for a higher rate tax payer by 6% a year from 40% for assets held for less than one year to 10% for assets held for more than five years.
The timing of the change and the transitional provisions which will apply to assets which are already owned have not yet been announced.
Whilst pre-sale dividends and stock dividends (which reduce the effective rate of tax from 40% to around 25%) will undoubtedly remain attractive as ways to reduce the overall rate of tax on a disposal, the proposed change to the business taper relief may prove to be a sufficient tax planning strategy by itself. After holding a business asset for just three years an individual (or trustee) would pay CGT at 22%. This would be less than the rate of tax payable on a stock dividend. Even after holding assets for only two years a 28% tax charge would arise. Given the costs of putting in place any tax planning scheme and the possibility of Revenue challenge, many entrepreneurs may see this as an acceptable tax rate. In management buy out and venture capital transactions the shareholders will generally hold shares for at least two to three years before a further sale or a listing and this change to taper relief may prove to be extremely attractive.
If you would like further information or specific advice please contact Robin Vos or Jonathan Conder.
This note is intended to provide general information about some recent and anticipated developments which may be of interest. It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so. Professional advice appropriate to the specific situation should always be obtained.
