While the tax break has encountered criticism from some quarters, many entrepreneurs swear by it as both a well-deserved reward for hard work, a stimulus for starting businesses and an invaluable part of an ambitious exit strategy. Even while announcing that he would cut it, Sunak admitted that Entrepreneurs’ Relief reflected something “risk-taking” in the UK’s entrepreneurial spirit.
So, what is Entrepreneurs’ Relief? What are its benefits to entrepreneurs and society more broadly? Why has it attracted criticism? And what does the recent cut mean for the UK’s entrepreneurs? In this piece, BSR examines all these questions to provide a comprehensive guide to Entrepreneurs’ Relief.
What is Entrepreneurs’ Relief?
Simply put, Entrepreneurs’ Relief is a tax break that reduces the amount of capital gains tax certain people will have to pay when selling their business, or disposing of their shares in their business. It was introduced in 2008 under Labour Chancellor Alistair Darling, before being extended under his Conservative successor George Osborne.
It is a 10 per cent tax cut on the value of the disposal, reducing the amount of CGT paid from 20 per cent to 10 per cent and allowing the seller to claim up to £10 million pounds in relief during their lifetime. From April 6th, however, this will be cut to £1 million pounds over the course of a lifetime.
Entrepreneurs’ Relief is available to anybody who has been at least a five per cent shareholder in a company for which they have served as an employee or director and meet several simple criteria. Firstly, business owners looking to sell their company must have been a sole trader or business partner for at least two years and must have owned their business for at least two years.
For someone looking to claim Entrepreneurs’ Relief on shares they are disposing of, the following criteria must be met for the two years prior to the sale: that they are an employer or office holder of the company; and that the company’s main activities relate to trading, or it is the holding company of a trading group.
Why is Entrepreneurs’ Relief controversial?
Despite saving UK business owners an estimated £2.2 billion a year, Entrepreneurs’ Relief has long proved controversial, with some arguing that it has largely benefited a relatively small number of people, rather than the wider entrepreneurial community.
Some claim that the break has been exploited by investors or contractors, who use it to wind down their interest in a business in a more tax-friendly way, rather than rewarding entrepreneurs who have built up a business.
The Institute for Fiscal Studies has questioned whether Entrepreneurs’ Relief offers people an incentive to start businesses. It has suggested that a more effective piece of legislation in this regard would be a tax cut for those looking to start businesses, rather than one for people who have already built a company up.
The Resolution Foundation, meanwhile, argues that scrapping Entrepreneurs’ Relief would free up £2.7 billion to be spent on public services. Strangely, however, this calculation is based on an assumption that the relief makes no difference in encouraging entrepreneurship and that entrepreneurs would not seek alternative means to reduce their tax bill.
Overall, criticism doesn’t tend to question that the relief helps entrepreneurs, but that it helps a small proportion far more than others. A good illustration of this is the year 2015-16, in which over 6,000 people gained over £1 million from Entrepreneurs’ Relief, out of 52,000 people who benefited.
The clear evidence that Entrepreneurs’ Relief does offer reward to a significant number of entrepreneurs has prompted some of even its harshest critics to concede that reforming the break would be more sensible than scrapping it entirely.
What are the benefits of Entrepreneurs’ Relief?
Despite the criticisms, Entrepreneurs’ Relief is credited with offering a wide array of benefits to those who look to build and sell a business and many consider it to have a hugely positive impact on the UK’s entrepreneurial community.
One of the key benefits is that it offers some form of reward for the risk-taking, hard work and success that makes up entrepreneurship and provides a crucial incentive to budding entrepreneurs to start up a business. MHA Macintyre Hudson National Head of Tax Rachel Nutt says that Entrepreneurs’ Relief represents “a valued incentive for entrepreneurs wanting to grow their business”.
Nutt goes on to say that the break is of “great benefit to small entrepreneurial business owners, many of whom have risked their houses and personal savings to build their business” and says specifically that the 10 per cent rate is “essential to those entrepreneurs that invest everything into their company.”
That brings us to one of the key benefits of Entrepreneurs’ Relief: it provides lasting benefit into retirement. As Federation of Small Business (FSB) chairman Mike Cherry says, “for many entrepreneurs [...] their business is their pension.”
Entrepreneurs’ Relief is broadly seen as a key component of many business owners’ retirement plans and exit strategies and suggestions that it could be cut are partly so controversial because many will have paid National Insurance, employee contributions and other tax for years under the belief that they will be rewarded with lower CGT when the time comes to sell their business.
The FSB’s Mike Cherry goes on to say that Entrepreneurs’ Relief encourages entrepreneurialism and incentivizes people to start and build businesses, rather than turning to other, potentially easier and more lucrative sources of income. Scrapping it, he says, “would make a mockery of the idea that it’s ever sensible to build up a business rather than invest in property, land or secure a gold-plated pension.”
What might the effects of the reduction be?
Broadly, the full implications of the Chancellor’s decision to cut the lifetime limit of Entrepreneurs’ Relief from £10 million to £1 million may not be seen for some time. However, despite Rishi Sunak’s insistence that 80 per cent of entrepreneurs will not be affected by the reduction and that the entrepreneurial sector will remain “risk-taking” in spite of, many have speculated upon the possible knock-on effects.
For Mike Cherry, Entrepreneurs’ Relief encourages employee ownership, which he links to improved levels of motivation and productivity. It’s possible that the cut could potentially point to a downturn in productivity for many small to medium size enterprises and startups, who had been operating on this model.
Cherry also argues that moves against Entrepreneurs’ Relief contradict the message that Britain is “open for business” and could lead to an exodus of entrepreneurs to more welcoming environments. This is a sentiment echoed by several other analysts and business experts.
Among them is Baron Howard Leigh, a Conservative peer who authored a letter, signed by over 150 business leaders, urging Sunak not to scrap Entrepreneurs’ Relief and arguing that such a move would backfire, by causing entrepreneurs to head elsewhere in order to start businesses.
Another suggestion has been that, while there may be an immediate rush of business owners seeking to accelerate their exit plans in order to lock-in the 10 per cent rate, this could be followed by a downturn in the business sale market, with potential sellers disincentivized by the reduced reward.
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