For the first time in recent memory, the British business community has united around a single cause - to utterly condemn the government's plan for a flat capital gains tax rate of 18%.
Gordon Brown's dalliance with the business community now looks to be firmly on the rocks, with the Tories smiling with anticipation on the sideline.
Let's look in detail at the proposed changes. At present, business assets attract maximum taper relief of 75% after two years, representing an effective CGT rate of 10% for higher rate taxpayers, or 5% for basic rate taxpayers.
The situation is different for non-business assets. These receive no relief until year three of the holding period. Thereafter the taper relief rate is 5% pa, to a maximum of 40%. After ten years of holding, this represents an effective capital gains tax rate of 24% for higher rate taxpayers or 12% for basic rate taxpayers (after the prevailing annual exemption).
From April 6th next year, these various rates are all to be scrapped, to be replaced with a uniform 18% flat rate across business and non-business assets, with no holding period allowances.
By all accounts Alistair Darling had no notion of the flat tax initiative at the beginning of October, and business groups are understandably irritated that there was a total absence of consultation with lobby groups on this issue. It appears to many that this was a quickly drawn-up plan with unintended implications. Darling has admitted that simplifying the system was the main motivation behind the move.
Few would argue that the capital gains tax system, with its hotchpotch assortment of rules, tapers, and allowances was in dire need of reform. But much of the complexity is down to Darling's own government, and he should have understood that an abrupt announcement of this magnitude, taken without any consultation, causes much angst and confusion in itself. Many businesses have been built and nurtured on the calculated premise of an exit at the lower rate of CGT.
Despite the uproar, a U-turn on the CGT policy looks about as unlikely as a snap election before Christmas. Alistair Darling told the Treasury Select Committee on 25th October that the government had no imminent plans to impose any new regulation on the private equity industry.
Top private equity industry players, conspicuously quiet after the pre-budget announcement, are no doubt breathing a sigh of relief. Rather ironically, these original targets of the tax shake-up were not only spared a sniper attack, but may have even been handed a gift.
Chris Sanger, who leads the tax policy division at Ernst & Young, said that the flurry of business owners deciding to sell up before the 6th April might well create buying opportunities for corporate raiders and larger private equity players.
A number of top accountants, including Paula Higgleton, tax partner at Deloitte, have said publicly that many businesses contemplating an exit over the next few years may well bring forward the timing of their disposals.
But we must ask what is the realistic likelihood of these companies being able to complete their sales by the deadline, when they are only now crossing the first hurdle of putting together a memorandum of sale. Selling a business can easily take a year or more to complete from initial marketing to eventual completion.
Our view is that you should certainly get your skates on if a sale of your company is already in progress. But if you have only just (since the Pre-budget) decided to offload your company, by hurrying everything along you may well realise a lower net figure than if you took your time and prepared the ground well.
If you are in a position to sell the business prior to the 6th April you will need to exercise caution as there may be a substantial number of other business owners trying to do the same. If there is competition from other owners in your sector this will no doubt work to your disadvantage. If you are buyer, this will of course work to your advantage and a wider range of opportunities may present themselves.
Even if you do manage to sign the deal before the deadline, you could still get taxed at the new rates. This will happen if you are paid in shares or loan notes referred to as non-qualifying corporate bonds (non-QCBs). In this case the gain could be rolled over and taxed at the new rate when the replacement shares are sold or the loan note is cashed.
So what will be the effect on transactions being negotiated between now and the end of the current tax year? These will need to take into account the changes. As a seller there is obviously an incentive to get things moving along quicker. Anecdotal evidence of the effect on transactions currently in the pipeline suggest that where both parties are keen to do a deal then the 5th April deadline is helping to focus minds.
Simple business sales involving mainly property assets such as bed & breakfasts, shops and hotels will definitely see increased activity. Also where both buyers and sellers are experienced in doing deals and are able to ensure that their lawyers do not dictate the pace of the transaction, then there is a good chance that the deals can be completed prior to the deadline.
Prepare your business for sale
Before selling a business you will need to focus on an exit strategy that could take a couple of years to get right. Following on from that, the preparation of a decent memorandum of sale will take a couple of months by the time you have done the necessary information gathering.
To be more specific, the main things that need to be done prior to the sale are changes to the business that add value. These include but are not exclusively the following:
Demonstrate a clear sustainable upward trend in profits. This may even mean paying a bit more tax. Traditionally, business owners, particularly in small or family owned businesses do not manage their company's results primarily to demonstrate the highest possible levels of earnings.
A tightly controlled business, with effective monitoring of costs that will not damage the well being of the business. This may include supplier reviews every year and effective budgeting being handled by lower tier management.
Focus on winning a wider range of particularly "attractive" types of customer. This may mean formalising agreements or just diversifying your customer base.
Ensure that product or service ranges offered will be marketable going forwards, focusing on the pipeline of innovative new offerings.
Build the brand image and market profile that you should ideally be projecting.
Putting an effective management team in place and working with your existing management to ensure that they are ready to face new challenges with new owners.
Ensure that the company's statutory and tax affairs are in order. This could include checking that all potential tax has been claimed back as this can be added straight to the bottom line.
It is also the case where a business has been on the market for a long period of time, and the seller is keen to sell, then the loss of taper relief may encourage a deal to be struck by the lowering of price expectations. Potential purchasers should consider re-approaching vendors in those situations where price resistance put a halt to further negotiations.
For sellers, existing earn-out arrangements which are due to expire after April 2008 should also be reviewed. It may be possible to crystallise a gain in relation to earn-outs prior to April 2008 to take advantage of taper relief and the 10% rate of Capital Gains Tax. Again, it may be possible for the buyer to take advantage of this lower rate of Capital Gains Tax by "sharing" with the seller some part of the tax saved.
Sellers will be very unwilling to accept any element of loan notes or deferred consideration where the Capital Gains Tax is being crystallised after 5th April 2008. It may be possible to structure loan notes or deferred consideration so that the capital gain is crystallised in the current tax year (thereby taking advantage of taper relief). In this situation, of course, sellers will then have a tax bill without receiving the cash, which is still represented by the loan notes.
Extending the CGT Deadline
Tip 1 - the share sale may be structured wholly or partly as loan notes in an acquiring company. If the loan notes are QCBs (i.e. non-convertible, non-redeemable sterling securities issued on normal commercial terms, the gain computed on that element of the consideration is deferred, interest-free, until redemption or disposal of the bond. Pre-April 6th 2008 Taper Relief is calculated on the shares up to the time of disposal, and is effectively 'locked in' to the postponed gain until a subsequent disposal of the bond.
The trading status of the acquiring company, and whether it is a qualifying company of the individual, is irrelevant, since it does not affect the availability of taper relief on the shares. Any gain (or loss) on disposal of the bond itself is exempt from capital gains tax the new rate.
Tip 2 - Crystalise your CGT before April 6th. Look at selling your company to another company owned by yourself. Ideally in return for a QCB not redeemable for at least 6 months.
Tip 3 - Consider transferring the business to a trust, the consideration for which could be left outstanding as a loan.
Note: Please make sure you take expert advice before proceeding with any of these or other non-cash consideration including earn-outs.
There will be difficult commercial balances to be drawn between the commercial requirements of sellers, buyers and a desire to take advantage of lower tax rates.
In conclusion we have to be mindful that given the furore over this issue it is not inconceivable that there may be changes by the time it is actually enacted in the summer of 2008. Traditionally Finance Acts have not been enacted until July/August of the relevant year. This will produce an interesting situation as the new rules are due to come into effect on 6 April 2008, which is 3 to 4 months before the final form of the actual legislation will be known.
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