Wednesday 11 March 2020 6:00 am

Entrepreneurs' relief: A tax break unravels?

Chancellor Rishi Sunak’s first Budget beckons, and business founders will be looking out for one announcement in particular: will he scrap entrepreneurs’ relief?

The controversial tax break enables people who start their own successful businesses to pay less capital gains tax when they eventually sell it on. It was originally intended to encourage people to set up companies.

Read more: DEBATE: Should the chancellor rethink plans to get rid of entrepreneurs’ relief in the Budget?

However, speculation has mounted in recent months that the government could be about to ditch it today, after Boris Johnson criticised the relief earlier this year. “I have to tell you, the Treasury is fulminating against it because there are some people who are staggeringly rich who are using that relief to make themselves even more staggeringly rich,” the Prime Minister told a group of female entrepreneurs in his Uxbridge constituency in January.

He is not alone. On the other side of the aisle, Labour leader Jeremy Corbyn has also described entrepreneurs’ relief as “largely just a handout for a small number of people,” and promised to get rid of it if he was elected in his election manifesto last year.

Yet many business owners in the City and beyond are up in arms, leaving the chancellor, still less than two months into the job, with a conundrum. With entrepreneurs on the verge of finding out what he has decided, here is everything you need to know about the divisive scheme.

An olive branch

Entrepreneurs’ relief was brought in under the last Labour government, in early 2008, as something of an apology to business lobby groups. Months before, the then chancellor Alistair Darling had clamped down on so-called taper relief, which private equity barons were using to pay a lower rate in tax than the cleaners who mopped their office floors.

But lobbyists protested, saying that cutting taper relief would hurt companies far beyond the private equity firms of Mayfair. Darling was forced to compromise.

His solution was to offer an olive branch to small businesses by allowing owners selling their firms to pay just half the usual 20 per cent capital gains tax on any profits they made, up to a lifetime allowance of £1m. The measure was estimated to cost little more than small change for a national government — about £200m. In the tax year 2008–9, it ended up costing £500m.

As shadow chancellor, George Osborne decried Darling’s attempted compromise as a “humiliation”. But not long after he succeeded him at Number 11 Downing Street, the chancellor went on a fact-finding trip to Silicon Valley, to see what he could learn from California’s entrepreneurs. When he returned, he decided to radically expand the scheme.

Osborne increased the lifetime allowance for the capital gains tax relief to £10m and, a few years later, extended it to long-term investors in unlisted companies.
Both he and Darling argued that the relief would encourage entrepreneurship, reward risk-takers and job creators, and bring wider benefits to society as a result.

‘Expensive, regressive and ineffective’

Entrepreneurs’ relief has not gone entirely to plan, however. The measure now costs the Treasury between £2bn and £3bn a year, and the benefit to the wider economy is debatable.

According to the Institute for Fiscal Studies (IFS), 43,000 people claimed £2.3bn in entrepreneurs’ relief last year, which works out as roughly £50,000 each. This is just an average, however, with the vast majority of the proceeds ending up in the pockets of relatively few people.

Of the total paid out last year, about three quarters went to just 5,000 people who were making gains of more than £1m a year. These beneficiaries got an average of £350,000 a year each from the measure.

There are concerns that wealthy professionals are choosing to form companies and partnerships especially so as to be eligible for the tax break, rather than collect salaries that would be subject to the top rate of income tax.

Similarly, the Resolution Foundation last year excoriated the scheme as “expensive, regressive and ineffective,” pointing out that the amount the government spends on the relief alone is more than the entire budget for the intelligence services and enough to give £100 a year to every household in the country annually.

“There is no evidence that it has led to any substantial increase in genuine entrepreneurship, with the number of self-employed people that have employees falling during the financial crisis and remaining at or below 600,000 since 2010,” it said.

Both think tanks have made their feelings clear on the measure: ditch it. At a pre-Budget briefing, IFS economist Stuart Adam told economists: “I’d be delighted to see it removed altogether if possible.”

‘Of great benefit’

Despite the figures, the reaction to the PM’s comments in the City has been largely negative, with tax firms and business owners arguing that, rather than being regressive, entrepreneurs’ relief rewards success.

“After a difficult period with limited growth in many sectors, positive news to boost business is much needed,” says Rachel Nutt, head of tax at MacIntyre Hudson. “The current allowance of £10m of lifetime gains is a valued incentive for entrepreneurs wanting to grow their business.”

“Despite commentary that entrepreneurs’ relief only benefits the rich, it is of great benefit to small entrepreneurial business owners, many of whom have risked their houses and personal savings to build their business,” she adds.

Baron Howard Leigh, a member of the House of Lords, also wrote to Sunak late last month, urging him to keep the tax relief in place so as to attract investment into the UK.

In a letter signed by more than 150 business owners, including founder of failed bakery chain Patisserie Valerie Luke Johnson, Leigh suggests that entrepreneurs looking to start new companies would relocate to countries like Singapore should the tax relief get the chop.

“Equally, other entrepreneurs have sold their business and are now currently considering whether to start a new business or not and the rate of tax is a very important factor,” he writes.

A happy medium?

Among small business owners, there is a feeling that scrapping entrepreneur’s relief entirely would be throwing the baby out with the bathwater.

Small business confidence is at an 18-month low, and many among the entrepreneurial community think such a measure would make the situation even worse.

Part of the problem with axing the scheme is that some businesses were set up on the basis that their owners could sell them and use the proceeds to fund their retirement — a process which would inevitably be affected by entrepreneurs’ relief.

“A lot of entrepreneurs see their business as their retirement plan. They don’t have the gold-plated pensions enjoyed by Treasury civil servants,” says Mike Cherry, chairman of the Federation of Small Businesses.

He points out that the Conservative General Election manifesto last year committed to reforming the scheme — which he describes as an “incentive” — rather than getting rid of it.

If the lifetime allowance of £10m is too high, Cherry suggests that the solution is to bring it back down to £1m, meaning the benefits are felt most strongly by small business owners.

“Doing so would save the Treasury more than £1bn and maintain a vital incentive which encourages entrepreneurs to start-up, hire and invest,” he says.

Read more: Businesses and government in entrepreneurs’ relief row

With the recent outbreak of coronavirus overshadowing Sunak’s first Budget, economists will likely be focusing on the bigger picture. But for those who have started their own companies, the tax relief will have formed a vital part of their future planning. They will be watching with eagle eyes.

“Today’s Budget is the chancellor’s first big test,” Cherry says, “and an opportunity to show he is unequivocally on the side of the small business community at an uncertain time.”