There is a growing chorus of voices urging the government to scrap Entrepreneurs' Relief.  The Institute for Fiscal Studies which suggested that business owners respond more to changes in taxes by adjusting how and when they take money out of their companies rather than by changing their investment plans.  It also claimed that many owner managers hold significant sums of cash in their companies in order to access lower CGT rates and to save tax - no sh*t Sherlock!   IFS issue with the system is that while higher income tax rates encouraged lower income take from companies, especially if it kept owner managers just below the next tax threshold, but that the cash retained wasn't invested just squirreled away.

Now the former head of HMRC has called for ER to be scrapped, as it costs the country c£2bn a year in lost tax but with "no real incentive for entrepreneurship"

An earlier HMRC research paper by IFF, found that in most cases ER was not the primary motivating factor for entrepreneurs when making decisions about investing in assets, or disposing of them.   But it did find that those most likely to be influenced by ER at the point of making their initial investment were those most likely to planning to set up a new company.  Perhaps it's motivating serial investors - and so perhaps this is a driver for enterprise?

It's difficult to predict anything in British politics, and that's also true about the future of ER.   Phillip Hammond tinkered with it in his 2018 budget but resisted calls at that time for it's abolition.  So perhaps more tinkering is the likely outcome post election?

Whether or not a transaction will qualify for ER is always an agenda item in exit planning discussions.   And it's relevant in any M&A activity, whether you're selling your business, doing a management buyout, or even if you're buying business (because it will influence the seller).  But we're now finding, in discussions with entrepreneurs around Cambridge and East Anglia, that the availability of ER is becoming a factor for some in accelerating their exit plans before possible tax regime changes.  It's certainly true to say that it's unlikely to get any more benign.  

Ultimately exit decisions are driven by personal factors such as age, and a desire to do something else in life.  Or by business factors such as the value of the company, and it's strategic plans.  So the tax tail actually doesn't often wag the dog, but it would be helpful to have some certainty on how capital gains on the sale of businesses are going to be taxed.

In the short term the best way for business owners to wrest back some control from the politicians is to have some exit planning discussions, work out a range of dates and values for you exit, and what needs to happen to deliver that.    We're always happy to have this kind of discussion, because it makes it easier for business owner and adviser to act swiftly when opportunity arises.  If you'd like to read more about exit planning and selling your business have a look at the PEM Corporate Finance website https://www.pemcf.com/services/selling-a-business/

The government is keen to encourage entrepreneurs to create wealth and employment, and it has repeatedly used the tax system to try to do so.  All the focus is now on Entrepreneurs’ Relief but before that it was on retirement relief, and business taper relief.   Entrepreneurs’ Relief began its life as a relatively minor effort – a maximum of £80,000 of tax saving for an individual over a lifetime – much much less attractive than it is now. 

The relief is now much more attractive and it would seem that every entrepreneur believes that when you sell your business you will only pay Capital Gains Tax at 10%.   Which of course means that most people are assuming they’ll qualify for Entrepreneurs’ Relief.   Alas its not quite so simple.  The tax rules are complex, and if you get it wrong you’ll pay the full rate of 28%.

There are quite a few ways in which it can go wrong.  Entrepreneurs’ Relief only applies to trading companies but alas there is no definition of what constitutes a trade and court decisions over the past 160 years are not altogether helpful.

In many businesses its pretty clear that there is a trade.   So what doesn’t qualify for the relief?  Generally speaking property investment businesses or other business relying on passive investment income, would be exempt.   Less clear cut would be businesses such as caravan parks, which the tax man generally considers to be investment businesses, even where the owners carry out related activities, such as providing utilities or other facilities.  So before you go ahead and appoint an M&A advisor to help you to sell your business give thought to the trading status of your company.

If you’re a sole trader or partnership you should qualify for Entrepreneurs’ Relief, but its more complicated if you trade through a company.  Firstly you must own at least 5% of the company’s ordinary shares and hold at least 5% of the voting power in the company.  Secondly you must be an employee or officer of the company.  And you must satisfy these conditions for a full year immediately before a sale of the company.   I've often met people who had sufficient shares to qualify but hadn't met the officer or employee criteria for a full year.  That's fine if you have time to plan, but if a strategic buyer knocks on your door with a great offer you may not have the time for that.

Where it can also start to go wrong is situations where employees get non voting shares, or where husband and wife own the company but one spouse has never been a director or employee of the company.  

There can also be problems associated with the type of deal you do with the purchaser of your business.  If you were to provide some Vendor Finance for the deal, ie you accepted a loan document rather than an immediate cash payment from the purchaser of your business, such a “share exchange” can be problematical.  If you go down this route the upfront cash you get when you sell may qualify for the Entrepreneurs’ Relief but the later loan note redemptions will not – so you might end up paying tax at 28% every time you redeem a loan note.

The key, as ever with tax, is to plan ahead.   And of course if you do have some of the issues above such as husband and wife ownership, skewed voting rights, or issues around the trading status - there are always planning options.

Changes to Capital Allowances

If you are at all likely to be investing in assets over the short to medium term there are some changes to the regime that might make it worth accelerating your plans.  Two important changes to the Capital Allowances legislation were announced in the 2012 Autumn Statement.  

Annual Investment Allowance (AIA)

The AIA was introduced with effect from 1 April 2008 and is a 100% deduction for business expenditure incurred on qualifying plant or machinery (other than cars). The announcement in the 2012 Autumn Statement that the AIA would increase from £25,000pa to £250,000pa, whilst to be welcomed, isn't as straightforward as it first appears.

As a reminder, there have been several changes to the AIA in recent years:

From 1 April 2008 £50,000
From 1 April 2010 £100,000
From 1 April 2012 £25,000
From 1 January 2013 £250,000
From 1 January 2015 £25,000 (proposed)

To complicate things further there are transition rules not only when the allowance increases but also when it decreases, which affect the magnitude of the AIA available to a company in a particular accounting period. Finally, you need to bear in mind that the increased AIA may only be with us for 2 years so some businesses may wish to accelerate capital expenditure in case this more generous AIA is not extended.

Short Life Assets (SLA)
Another change which may be beneficial to your business is the extension of the period over which assets can be treated as short life assets from 4 to 8 years. The advantage of this treatment is that a balancing allowance i.e. full tax relief for capital expenditure can be obtained without a cessation of the trade if the elected asset is disposed of for less than its tax value within this 8 year period. This is beneficial for assets which are likely to be scrapped or sold for a negligible value within 8 years of acquisition. The company must make an election for an asset to be classified as a SLA. 

What to think about?

If you're planning to incur significant capex in the near future it would be worth speaking with your tax adviser - my tax colleagues at PEM are working with a number of clients already to maximise their capital allowances claims.

R&D Tax Relief

The R&D Tax Credit Scheme has been around for a number of years but if you think it’s all about test tubes and lab coats – and so doesn’t apply to your business – read on.

 The scheme exists to encourage innovation in the UK through research and development in the fields of science and technology.   It does require there to be a scientific or technological uncertainty to be resolved, but this can be applied to advances in a wide variety of fields. Successful claims have been submitted for, amongst others, tomato plants, wire bending machines, trees, software and goldfish bowls!

The Schemes

There are two schemes: the Small and Medium sized Enterprise (SME) scheme and the Large Company scheme. The relief only applies to companies, not partnerships or sole traders.  

The SME scheme generally applies to companies that do not breach the limits of fewer than 500
employees and either an annual turnover not exceeding €100 million or a balance sheet not exceeding €86 million.   Circumstances in which a company will fail to qualify include where the R&D project receives any State Aid grant funding (although it is only the funded project which is affected, other R&D projects carried on by the company can still qualify).

The SME scheme is the more lucrative of the two schemes and provides most tax relief. The Large
Company scheme applies to companies who do breach those limits or fail the conditions for the SME scheme for some other reason.

The SME scheme providees an additional tax deduction to the company over and above what they've spent. The rates have steadily increased over the last few years and from 1 April 2012 the rate has increased to 225% - that is to say for every £1 spent on R&D, the company will receive a £2.25 tax deduction.

The company will either benefit from a reduced tax charge or, if the company is loss making, there is the option to surrender the loss created by the R&D claim for a tax credit. Surrendering for a tax credit is less tax efficient as cash is received at only 11% of the amount surrendered compared with a potential tax
saving in future years of between 20% and 24%.  However if short term cash is more important companies will presumably go for that ahead of perfect tax efficiency.

The Large Company scheme is less beneficial as it only confers an additional deduction of 30% and
no repayable tax credit is available. However, it can still provide useful relief for companies which fail the conditions for the SME scheme.   

Qualifying R&D Activities

To qualify for relief the company must be carrying out an R&D project which is seeking to achieve an advance in science or technology.   To qualify as an “advance” the company must carry out its R&D with a view to creating a new, or appreciably improved, product, process or service. The question of whether
something represents an “appreciable improvement” is very subjective but essentially, it is an improvement that a fellow competent professional in the field would consider a genuine and non-trivial improvement.  There is also a further requirement that in seeking the “advance”, the company must be seeking to resolve some form of scientific or technological uncertainty.

 Whilst it is a requirement that the R&D must involve the resolution of a scientific or technological uncertainty and result in a related advance, the end product, process or service can be virtually anything.

 R&D projects which fail or are aborted will also qualify if they meet the other conditions as the project needs only to “seek” an advance, it does not need to achieve it.   

Qualifying Costs

 Qualifying costs must fall into one of the following categories:  

• Staff costs (including pension, employer’s NIC and expenses reimbursed via the
       payroll)
• Consumable  items (these must be consumed or transformed in the R&D process)
• Utilities  (water, power)
• Software
• Subcontracted expenditure

 Only the costs incurred directly in carrying out the research and development can be claimed so where costs are incurred on both qualifying and non-qualifying activities, a reasonable apportionment will need to be made. In addition, where costs are incurred on subcontractors, as a general rule only 65% of the payment is allowable.