With the increasing likelihood of implementation of recommended changes to Capital Gains Tax, David Crump, Corporate Finance Director at PKF Smith Cooper, explains why it could be the right time for business owners to sell.
With a heightened risk of rising tax rates and reduced reliefs, Capital Gains Tax (CGT) should be a significant area of concern for business owners considering a sale.
Governments’ focus on reforming Capital Gains Tax goes back years, and many believe the lack of action has more to do with the pandemic and the global downturn after the Russian invasion, than any lack of intent.
In November 2020, the Office of Tax Simplification (‘OTS‘), the former independent adviser to the Government on simplifying the UK tax system, produced the first of two Government-commissioned reports. The main recommendations were to:
- Consider more closely aligning income tax and CGT rates, being mindful that this would then require a new relief for inflation and/or a rebasing exercise.
- Consider reducing the number of CGT rates and making them not dependent on income.
- Reduce the annual exempt amount.
- Remove the CGT uplift in value on death where an IHT relief (e.g., Business Relief) applies, although again this may call for a rebasing.
- Scrap Business Asset Disposal relief (formerly Entrepreneurs’ Relief) and replace it with a relief focussed on retirement.
Alignment of Income and Capital Gains Tax rates
If an alignment of Capital Gains Tax (20%) to the Income Tax level (45%) was to happen, a business owner selling their business for £10m could pay £2.5m in extra tax.
The Government’s objectives were (and are still likely to be) to reduce behavioural distortions, a closer alignment of rates removing some of the incentives for people to seek to characterise certain receipts as capital gains rather than income, and to favour activities and investments that generate capital gains rather than income. It would also simplify the tax rules by reducing the need for complex anti-avoidance rules to police the boundary between income and gains.
It is worth noting that the alignment of income and CGT rates is not without precedent – it was the status quo throughout the nineties and early noughties.
Although insignificant in terms of the quantum of the tax liability of a seller, an individual’s CGT annual exemption is already under attack. From 6 April 2023 it reduces from the current £12,300 to £6,000 for the tax year 2023 to 2024, and then to £3,000 for the tax year 2024 to 2025 and subsequent tax years.
Business Asset Disposal Relief (“BADR”)
The abolition of BADR could cost a seller £100k in additional tax.
Formerly known as Entrepreneurs’ Relief, Business Asset Disposal Relief (BADR) means selling shareholders currently pay a lower 10% rate of CGT (rather than 20%) on the first £1 million of lifetime gains when selling a qualifying business.
There are stipulations to qualify for BADR, the main ones being that for at least 2 years:
- The shareholder is an employee or office holderof the company (or one in the same group), and
- The company’s main activities are in trading (rather than non-trading activities like investment) – or it is the holding company of a trading group.
This relief used to apply to the first £10m of lifetime gains but this was reduced to just £1m in the March 2020 Budget. The relief could therefore save £100,000 in tax for each shareholder – but some believe the “direction of travel” is clear and that relief could be further reduced or eliminated completely.
What is next for Capital Gains Tax?
With inflation, interest rates and the economic performance generally showing signs of improvement (and certainly better than many expected at the end of 2022), and the Government’s need to balance the books, there is an increasing risk that further changes to CGT may be implemented.
The two near-term risk points are 15 March 2023 – the date of the next Budget, and late 2024 – the likely latest date that the next general election will be held. (Albeit the technical backstop date is January 2025).
Current polling statistics predict a Labour Party majority, although of course that could change. According to a report published by the Guardian, CGT is likely to be at the forefront of Sir Keir Starmer’s ‘wealth tax’ plans, with a potential alignment of CGT rates with income tax and the abolishment of BADR also being reported.
So, is it time to sell?
If tax rates are aligned, a business worth £10m today would need to sell for £14.5m to get similar after-tax proceeds.
The threat of increased CGT means those thinking of an exit in the medium term should seriously and quickly consider getting professional advice on whether they should advance their exit timing.
This is especially relevant if future business performance is unlikely to improve significantly; the impact of the alignment of CGT and income tax rates means that a business worth £10m today would need to sell for £14.5m to get a similar amount after tax. If profit growth is less than that, shareholders could lose out by delaying.
If CGT rates stay at current levels in the March Budget, there is then a maximum 18-month window for business owners to achieve a pre-election exit and avoid the risk of changes being implemented by a new Government.
With sale processes usually taking 9 -12 months, it is crucial for owners to urgently consider the potential risks of delaying a business sale.
Need help selling your business?
Whether you choose to wait or push forward with a sale, we can ensure your business is prepared and optimally positioned to maximise its sale value.
At PKF Smith Cooper, our Corporate Finance team has broad experience of offering tailored advice to our clients and forming strategic approaches to potential disposals.
For more information on how we can help you to sell your business, get in touch with our Corporate Finance team today.