3rd October 2024
In less than a month, the UK’s new chancellor, Rachel Reeves, will unveil her first budget and Green Square director Tony Walford says agency owners should brace themselves for tax changes that could hit them where it hurts.
It’s hard to overlook that Rachel Reeves, the UK’s new chancellor of the exchequer, is preparing the country for significant tax changes in the upcoming budget on October 30. And while Labour has committed to maintaining income tax, national insurance, VAT and corporation tax at current rates, capital gains tax (CGT) and inheritance tax remain in the spotlight.
As M&A advisers, at Green Square we are frequently asked about potential CGT changes and how they might affect business owners. While we can’t predict the future, here’s a simple guide to the current CGT situation and possible change – though remember, this is a general overview and specific tax advice is always recommended.
Historic CGT position
Back in 1997, CGT rates in the UK were based on the individual’s marginal income tax rate, with a top rate of 40% for higher-rate taxpayers.
Ironically, it was the Labour government that introduced taper relief in the 1998 budget, which significantly reduced CGT on business assets. Under taper relief, the longer an asset was held, the lower the CGT rate and, after two years, the effective rate could be as low as 10%.
In 2008, Labour replaced taper relief with entrepreneurs’ relief (now called business asset disposal relief, or BADR), which further reduced CGT on qualifying business sales to 10%, up to a lifetime limit of £1m (later increased to £10m under the Conservatives, but then reduced to £1m in 2020).
Current CGT position
Under the current rules, shareholders who are employees, including directors and founders holding at least 5% of shares for two years (and EMI option holders for more than two years), qualify for BADR.
This allows the first £1m of lifetime capital gains to be taxed at 10%, with the remainder taxed at 20%.
As an example, if a business founded by three shareholders is sold for £15m, with each owning a third (and assuming they hadn’t tapped into their lifetime gain limit), their £5m gain per person would incur £100,000 in tax on the first £1m (at 10%) and £800,000 on the remaining £4m (at 20%), leading to a total CGT bill of £900,000 per person.
Potential changes
Rachel Reeves has not provided any details on CGT changes, but there’s speculation it could be aligned with income tax or a flat 30% rate or tapered based on the length of ownership (as it was in the old days). Here are a couple of possibilities:
1. Worst case: removal of BADR and CGT aligned with income tax
This would be a case of Labour reversing the business growth incentives it had created from 1997 onwards and the shareholders in the above example would each pay £2m at a 40% rate (or £2.25m at a 45% rate) compared with £900,000 currently.
If the first £1m remains under BADR, their CGT bill would be £1.7m at 40% or £1.9m at 45% – still a significant increase from today’s rates.
2. Median case: removal of BADR with a flat 30% CGT rate
Our shareholders would each pay £1.5m. If BADR is unaffected, the bill drops to £1.3m, still £400,000 more than the current rate.
What would we like to see?
As M&A advisers, ideally the current CGT regime would stay as it is, rewarding entrepreneurs for taking risks and creating employment. But that’s very unlikely to happen.
Given changes are inevitable, we’d suggest increasing the 10% BADR lifetime allowance to £3m, with anything beyond £3m taxed at 30%. In the example above, a gain of £5m would result in the same CGT bill of £900,000, but gains over £5m would see higher taxes. A £10m gain would be taxed at £2.8m instead of the current £1.9m. Painful, but not draconian.
When are changes likely to take effect?
Given the £22bn hole in public finances we keep being reminded of, it’s likely that changes will take effect from budget day, October 30. However, there’s a chance they could be deferred until the next tax year, April 6, 2025, allowing time for preparation.
For those close to completing a sale, it’s advisable to aim for closure before October 30. But be cautious of accepting a discounted deal just to expedite the process – it would be quite annoying to find the discount given was more than the ultimate tax increase. Additionally, if completing before October 30, pre-paying CGT on future earnouts to lock in the current rate is worth considering.
For those planning to enter the market soon, we suggest waiting for the budget outcome. While if changes are immediate, you may reconsider selling depending on the new rates, if the changes are deferred, there’s a tight window to close a deal, with six to nine months typically required to find the right acquirer and complete the sale, so you’d have to move fast.