Pre-budget report: Short sharp shocks for SMEs
Chancellor Alistair Darling presented his first pre-budget report to voters on Tuesday 9 October 2007. Whilst the speech itself was short, it was by no means sweet in terms of the changes proposed. Indeed there were a number of surprising measures introduced which are likely to have an impact on small business owners and entrepreneurs. Lesley Stalker and Paul Webb, tax partners at small business specialists Robert James Partnership, outline the changes and what they mean in practice.
Cuts to business asset taper relief
There has been a lot in the media recently criticising the way the private equity firms operate and the huge windfalls they have been enjoying by taking large stakes in major companies and then, when they sell after 2 years, being able to take advantage of full business asset taper relief at 10%. So it is unsurprising that one of the impending changes is billed as helping to curb this practice.
The amendments announced to Capital Gains Tax (CGT) are supposedly designed to ensure that those working in private equity pay a 'fairer share.' Basically, from 5 April 2008 there will be no more taper relief and instead anyone selling a business will be taxed at a flat rate of 18%. Whilst these changes do partly address the perceived problem they actually have a far wider impact.
Small business owners who may have been running a business for 20 years before selling up will be liable to pay the same rates as a private equity firm liquidating after just 6 months. This is an 80% increase in their tax liability and is hardly a fair deal for hardworking businessmen!
There are some business owners who have recently sold their businesses who will also be inadvertently caught by these changes. However as always, tax experts will devise ways around this for their clients. For example an acquisition deal may have been structured so that the seller received a combination of initial cash consideration (money upfront), loan notes (deferred consideration i.e. money to come in the future, this was previously usually timed to take maximum advantage of the old 10% rate of taper relief) and they may also have decided to take some shares in the acquiring company. Taking shares in the acquiring company is very tax efficient and is also an attractive proposition for the business buyer, assuming they want to ensure the owner/founder stays involved.
Under the chancellor's new regime, any shares you sell after 5 April 2008 or any loan notes due to be redeemed after 5 April 2008 will be taxable at 18%. But there are still ways to crystallize any such gains under the existing regime. For instance, one option would be to transfer the value onto trust and maybe also do some Inheritance Tax (IHT) planning, i.e. you could set up a trust for your children and transfer loan notes or shares into this trust which gets the value out of your estate. Provided you the donor survive for 7 years the value of the gift will transfer to your childrens' estate under the IHT rules and at the same time you crystallise the CGT liability now enabling you to pay the tax now at the 10% rate rather than wait for 18% rate to arise next year.
There could also be situations where although people sell their business, they are actually serial entrepreneurs and simply sell to found a new enterprise. In this situation it is also possible to sell a portion of shares acquired from the buyer of the old company to a new company set up for the purposes of your new business venture and in doing so, you again crystallize the gain now at the 10% rate . The new company can sell them in the future, and use the cash received for the increase in value to help fund the next business venture.
Although this elimination of business asset taper relief is in essence a negative for the small business owner, not all the changes in the Pre-Budget Report are as disadvantageous given the UK’s propensity to invest in second homes and buy to let property. Indeed those individuals who hold investment assets e.g. investment properties or quoted investment shares etc are set to significantly benefit. Take for example an investor who is looking to sell an investment property after two years of ownership. Under the current rules their tax liability will be 40% of any gain (assuming they are a higher rate tax payer) but under the new rules this liability will reduce to 18% of the gain. This is a 55% decrease in their tax liability!
Non-UK domiciles to pay £30,000
A significant announcement for non-UK domiciled tax payers is the introduction of a flat rate tax charge of £30,000 if they wish to continue to use the remittance basis of assessment. This can apparently only be avoided if they elect to be assessed on their world-wide income as it arises, rather than if and when it is remitted to the UK i.e. taxed in the UK only when they bring the money into the country.
Additionally, anyone using the remittance basis will also probably lose their personal allowance. For many people in this situation, they many not have enough cash available to make the £30,000 payments, so they will be forced to accept that their worldwide income and gains give rise to UK tax liability as they arise. This change to the non-UK domiciled rules will need careful consideration and if you are in this situation, you should ask your tax accountant to calculate the most beneficial way to pay taxes going forward.
Increases to inheritance tax threshold
The final change announced this week isn't really a change at all. Or at least, it isn't for anyone who had taken basic tax planning measures already and included a trust in their will designed to use the lifetime exemption.
However the move has simplified the situation and made it more transparent for the majority of people. Basically, from April 5th 2008, you have the ability to transfer the inheritance tax nil rate band between spouses and civil partners. This means that if you own a £1million house, (just for easy numbers!) and die, leaving a spouse to inherit your estate, when the entire estate ultimately passes to your children, they will only have to pay tax on £400,000 of your estate, at 40%. Ultimately, this was a bit of a headline grabbing introduction without great substance.
- The abolition of taper relief and indexation allowance for capital gains tax (CGT)
- The introduction of a flat rate of CGT of 18% for individuals
- A significant change in inheritance tax relief for married couples and civil partners allowing allowances to be transferred
- Non domiciles to pay an annual charge of £30,000 for their tax advantaged status
- An increase in the car fuel scale charge
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BusinessZONE - 12-Oct-2007
Categories: Money matters
Story read: 3252
Number of comments: 2
CGT protests
Dan Martin, 16-Oct-2007
Many people seem to agree with you Adam if recent reaction is anything to go by.
Dan Martin
Editor, BusinessZone
editor@businesszone.co.uk
Government kicks small businesses in the teeth.
Adam Daring, 12-Oct-2007
The change in taper relief from 10% to 18% is simply a kick in the teeth for owners of small businesses. I am sure that the Govt could have thought of a more intelligent approach.
