UK Tax Authority Throws Lifeline to Entrepreneurs

Stephen Harris 25 January 2008

UK Tax Authority Throws Lifeline to Entrepreneurs

HM Revenue & Customs, the UK’s tax authority, has published new draft legislation, effective from 6 April 2008, that sets out how the proposed simplification of capital gains tax for all individuals, trustees and personal representatives will work. The new rules will not apply to companies. For disposals on or after 6 April 2008, there will be one single rate of CGT set at 18 per cent, but with a new relief for some entrepreneurs. Taper relief (which could reduce CGT to as low as 10 per cent for a higher rate taxpayer) will be removed. Indexation relief (broadly inflation relief in the period before April 1998 for assets owned at that time) will be abolished. This legislation may be amended as a result of consultation and we will not see the final rules until July 2008. Entrepreneurs’ Relief will apply to people who sell a business and also to directors/employees who own more than 5 per cent of the shares in a trading company or group of companies. In broad terms, it is proposed that the first £1million for an “entrepreneur” will suffer CGT at 10 per cent on assets held for at least a year. It will only be possible to claim up to the maximum lifetime Entrepreneurs’ Relief. Trustees can benefit from this relief, as long as a life interest beneficiary qualifies as the “entrepreneur”. According to Smith & Williamson, with a current 40 per cent top rate of CGT in the UK, the winners from the new regime will include investors anticipating a 40 per cent CGT charge on a share portfolio or a second home and people who have deferred gains from the 40 per cent regime to the 18 per cent regime after 5 April 2008. Some people are likely to have a large tax increase, though, including highly successful entrepreneurs, some employee shareholders in quoted companies and other investors in small businesses who sell after 5 April 2008. People who had a gain arising in the 10 per cent regime, but deferred it into the 18 per cent regime will be losers along with some people who have owned assets from before 1998 as indexation relief will no longer be available. Smith & Williamson says that where a 10 per cent rate of CGT had been anticipated, clients should consider “banking” the lower CGT rate on an unrealised gain before 6 April 2008. If a third party purchaser is not available, a disposal to a family structure, such as a trust or possibly a pension plan, could trigger the gain. The resulting CGT would become payable on 31 January 2009. If a 2007/08 gain would be subject to a higher rate of CGT, consider deferring any such disposal to benefit from the proposed 18 per cent rate. This is subject to investment decisions. And where a gain has crystallised in the last three years with a rate over 18 per cent, the firm advises considering the use of EIS deferral relief to defer the gain to the 18 per cent CGT regime. If loan notes were taken on the disposal of a company, or a gain has otherwise been deferred, consider whether the gain can now be crystallised to benefit from a 10 per cent rate of CGT. The UK tax authority has also confirmed that if an individual owned an asset on 31 March 1998 and it is transferred to their spouse or civil partner, the indexation relief is, in effect, “banked”. This transfer must happen before 6 April 2008. But if the asset was held at 31 March 1982, it is still unclear whether the indexation could be banked in this way. A cash earn-out may now be preferable to a loan note alternative during a sale transition period. A cash earn-out in 2007/08 will crystallise a capital gain under the current regime rather than under the 18 per cent regime. In some transactions earn-outs are structured as a right to receive shares and securities. In deals pre 5 April 2008 you could consider electing out of the automatic rollover position on such transactions. Anti-avoidance rules have meant that CGT can be as high as 64 per cent on gains in offshore trusts. HM Revenue & Customs has confirmed that this will be lowered to 28.8 per cent.

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