One of the main measures affecting SMEs is the reduction in the entrepreneurs’ relief lifetime allowance by £9m to £1m. There are anti-forestalling measures which seem to amount to retrospective legislation but have possible gaps in what they are trying to achieve. Pleasing Budget points are that electric cars continue to be an extremely tax efficient benefit for company owners and employees and inheritance tax remains untouched. It is surprising that residential SDLT rates continue to be increased for certain purchasers without addressing fundamental aspects of the rules which often make residential SDLT rates not applicable.
This week’s Budget was hotly anticipated, with many commentators expecting the government to refocus its attention on the ‘domestic tax and spend agenda’, having put Brexit to bed. The coronavirus outbreak has put a bit of a spanner in the works here and the new chancellor Rishi Sunak has had something of a baptism of fire. With global stock markets facing unprecedented pressures and an emergency interest rate cut by the Bank of England announced only hours earlier, the chancellor took to the dispatch box to announce a £30bn package of measures to stimulate the UK economy.
The question on everyone’s minds, however, is how all the emergency measures would be paid for. Top of the agenda was, as predicted, a cut to entrepreneurs’ relief (ER). Although the government stopped short of scrapping the relief entirely the allowance has now been significantly curtailed. However, it could have been a lot worse. Rumours of an attack on inheritance tax and pensions reliefs have turned out to be unfounded … at least for now.
In this article, I seek to highlight the main points of the Budget which will be of interest to SMEs and provide preliminary comments about their implications. I do not attempt to provide a comprehensive summary of all the tax points in the Budget.
Lifetime allowance reduced for entrepreneurs’ relief
Although it had to happen sometime, many tax advisers will be shedding a tear for the near-death of a long-term friend. With the lifetime allowance being slashed from £10m to £1m, a relief that was worth £1m per shareholder or business owner has now been reduced to £100,000. Although the reduction is not a huge surprise, the attack on so-called ‘forestalling arrangements’ will leave many business owners with a sour taste in their mouths. I discuss these further below.
There had been some speculation that other ER conditions would be changed such as an increase in the 5% qualifying rate or introducing measures to address ‘money-boxing’ (where cash is built up in a company in the hope of realising it as a capital gain either through a disposal or liquidation). The fundamental mechanics of ER are unchanged which is one small mercy.
It is clear that the new £1m lifetime allowance will still take account of any ER which has previously been claimed. This means that any individual who has already used ER of £1m or more will have no future ER allowance. There will now be business owners who will want to reconsider the benefits of making inter-spouse transfers so as to access a spouse’s ER allowance. Of course, care would need to be taken here to ensure that all the normal ER conditions are met by the recipient spouse.
Investors’ relief
It is perhaps surprising that the lifetime allowance for investors’ relief (this is still £10m) has not also been cut and some serial entrepreneurs may be tempted to structure their investments to secure this relief. This is however a very different relief which does not allow an investor to have any involvement in the running of the company and it too could be reduced very easily.
Forestalling arrangements
Personally, I believe that a taxpayer should be able to take advantage of existing tax rules without fear of being caught by retrospective legislation. I also thought that this view was held by the government too. Unfortunately, some of the anti-forestalling legislation is clearly retrospective. This legislation is generally aimed at counteracting measures which were taken to lock-in what were anticipated to be more favourable pre-budget rates.
Holding companies and s 169Q elections
Some shareholders were inserting holding companies over their existing trading companies in the belief that this would provide them with an option to lock-in ER if the Budget were to go against them. The idea was that TCGA 1992 s 135 reconstruction provisions would apply by default but the shareholder would have the option of triggering a gain by making a TCGA 1992 s 169Q election. Schedule 1 para 4(6) of the draft Finance Bill removes the efficacy of the election by treating it as applying at the time that it is made rather than at the time of the share exchange. There is no motive test to this legislation but it only applies to share exchanges which took place on or after 6 April 2019. This gives us the rather arbitrary result that a share exchange that took place on 5 April 2019 could still lock in ER rates with a £10m lifetime limit by making a section 169Q election before 31 January 2021, but a 6 April 2019 exchange would be subject to the reduced £1m lifetime limit.
Effect of TCGA 1992 s 137?
Schedule 1 para 4(7) of the draft Finance Bill states that if TCGA 1992 s 138(1) clearance has been obtained for a share for share transaction then there will be no scope to argue under TCGA 1992 s 137 that a disposal occurred. This could be the case if a disposal was not carried out for bona fide commercial reasons or if one of the main purposes was the avoidance of capital gains tax. This begs the question of what the position is if a clearance was not obtained. I think that we are left here with the rather bizarre conclusion that if the holding company was inserted for the avoidance of tax (which would seem consistent with the introduction of all these anti-forestalling measures) then a gain is triggered and therefore the so-called tax avoidance arrangement has been successful! This is an interesting paradox which I note is already the subject of some discussion involving various prominent tax barristers.
Uncompleted contracts
Perhaps surprisingly the anti-forestalling legislation is not just restricted to ‘internal’ transactions between connected parties. There is also legislation which in certain circumstances can disapply TCGA 1992 s 28 so as to make the point at which capital gains tax is triggered completion rather than exchange. This means that gains on transactions to third parties which had exchanged but had not completed before 11 March will be subject to the reduced £1m lifetime allowance. The only exclusion from this provision is if ‘no purpose of entering into the contract was obtaining an advantage by reason of the application of section 28(1) of TCGA 1992’ and the person who completes on the contract makes a statement in his or her return to state that that is the case. As many transactions were being rushed through in anticipation of budget changes it will be difficult for many sellers to say truthfully that there was no motivation to lock in a gain. Some further guidance from HMRC on this point would be welcome. The impact of this legislation will seem particularly unfair to sellers where completion has been delayed due to external factors such as coronavirus (had they have completed before 11 March 2020 then the £10m lifetime limit would have been retained).
There are also (less surprisingly) rules which seek to override section 28 for transactions between connected persons. These try to counter arrangements involving a transfer to a company or other vehicle that ‘stands on contract’ until such time as a purchaser is found. These have similar exclusions to those for unconnected parties as well as a ‘wholly for commercial reasons’ test. In practice the exclusions will rarely apply.
2018/19 s 169Q election
As the anti-forestalling legislation only relates to transactions which took place from 6 April 2019, s 169Q elections should still be effective to lock-in gains for 2018/2019 share exchange transactions (both under TCGA 1992 s 135 and s 136). Any such election would need to be made by 31 January 2021. Although this can potentially save £900,000 of tax it does mean that the tax payment date is accelerated and that there will be a ‘dry’ tax charge. Furthermore, if the value of shares declines after an election is made then the ‘dry’ charge will remain and the shareholder may be left with a capital loss and no gains against which to relieve it.
Other interesting measures
Electric cars
We already knew that electric company cars are a very tax efficient way to remunerate employees from 2020/2021 to 2022/2023. The benefit in kind rates are respectively 0%, 1% and 2% for these three tax years. For example, an employee would only pay tax on a £1,000 benefit in respect of the provision of a £50,000 company Tesla in 2022/23. The budget announced that this rate will be frozen until 2024/2025 which is welcome news. Electric cars must now be one of the most tax-efficient employee benefits in history. This will be attractive for both company shareholders and employees who will be keen to consider salary sacrifice arrangements.
As an added benefit, first year allowances for electric vehicles have been extended by a further four years up to April 2025. This means that certain contract purchase deals can be cash positive in the early years. This is because a business can claim full tax relief for the cost of a car before it has actually been paid for.
Pension contributions relaxation
Higher earners apparently have doctors to thank for a relaxation in the amounts that can be contributed to a pension without restriction. Currently, anyone earning over £110,000 (who has a total income of over £150,000, including their pension contributions) would not be able to get tax relief in respect of their normal £40,000 allowance. Instead it would be tapered by £1 for every £2 that their ‘adjusted’ income exceeds £150,000, down to a £10,000 minimum contribution.
From 6 April 2020, those earning up to £200,000 (or £240,000 with the pension contribution) are no longer caught by these tapering rules; allowing a full £40,000 annual contribution to be made. A sting in the tail is that the minimum tapered allowance will be reduced from £10,000 to £4,000. Therefore, anyone earning more than £300,000 will be worse off as a result.
Unfortunately, there is no increase in the lifetime allowance for pensions, beyond the consumer prices index inflationary increase which will take the limit to £1,073,100 from 6 April 2020. Although high earners are still restricted by a relatively low limit the new rules will allow many entrepreneurs to make maximum £40,000 pension contributions in the short to medium term.
Things that haven’t changed: IHT
I anticipated that a reform of IHT would form a major part of the new government’s first Budget. There is a well-accepted view that the tax is too complicated and gives too many reliefs. A recent review was carried out by the Office of Tax Simplification which advocated a number of changes and in particular a simplification of the lifetime gift rules. The valuable business property relief is also a ripe target for ‘simplification’, and in particular current strategies which involve investment in AIM portfolios which can be exempt from IHT after two years of ownership.
Inheritance tax, however, was not mentioned at all in the chancellor's address, and is also absent from HMRC's post-Budget announcements. This is probably something that will be visited again in the future.
Things that haven’t changed much: SDLT
Although SDLT rates have been increased by another 2% for non-resident buyers of residential property from April 2021 there have still been no changes to the ‘elephant in the room’. I am referring here to the longstanding SDLT rule which means that residential SDLT rates do not apply at all if there is any part of a land transaction which is not residential. As residential and non-residential rates have diverged over the years this means that significantly less SDLT is payable when non-residential rates apply. For example, a £2m property bought by a company would trigger £124,250 more SDLT at residential rates than non-residential rates. As even a small value of non-residential land (such as a field leased to a farmer) can lead to this rate reduction it seems strange that no rules have been introduced to address this. By its own admission, HMRC is dealing with a backlog of refund claims and it is generally resistant to suggestions that non-residential rates should apply (see Hyman & Another [2019] UKFTT 469). If the rules were changed then these kinds of arguments could be knocked on the head.
One of the main measures affecting SMEs is the reduction in the entrepreneurs’ relief lifetime allowance by £9m to £1m. There are anti-forestalling measures which seem to amount to retrospective legislation but have possible gaps in what they are trying to achieve. Pleasing Budget points are that electric cars continue to be an extremely tax efficient benefit for company owners and employees and inheritance tax remains untouched. It is surprising that residential SDLT rates continue to be increased for certain purchasers without addressing fundamental aspects of the rules which often make residential SDLT rates not applicable.
This week’s Budget was hotly anticipated, with many commentators expecting the government to refocus its attention on the ‘domestic tax and spend agenda’, having put Brexit to bed. The coronavirus outbreak has put a bit of a spanner in the works here and the new chancellor Rishi Sunak has had something of a baptism of fire. With global stock markets facing unprecedented pressures and an emergency interest rate cut by the Bank of England announced only hours earlier, the chancellor took to the dispatch box to announce a £30bn package of measures to stimulate the UK economy.
The question on everyone’s minds, however, is how all the emergency measures would be paid for. Top of the agenda was, as predicted, a cut to entrepreneurs’ relief (ER). Although the government stopped short of scrapping the relief entirely the allowance has now been significantly curtailed. However, it could have been a lot worse. Rumours of an attack on inheritance tax and pensions reliefs have turned out to be unfounded … at least for now.
In this article, I seek to highlight the main points of the Budget which will be of interest to SMEs and provide preliminary comments about their implications. I do not attempt to provide a comprehensive summary of all the tax points in the Budget.
Lifetime allowance reduced for entrepreneurs’ relief
Although it had to happen sometime, many tax advisers will be shedding a tear for the near-death of a long-term friend. With the lifetime allowance being slashed from £10m to £1m, a relief that was worth £1m per shareholder or business owner has now been reduced to £100,000. Although the reduction is not a huge surprise, the attack on so-called ‘forestalling arrangements’ will leave many business owners with a sour taste in their mouths. I discuss these further below.
There had been some speculation that other ER conditions would be changed such as an increase in the 5% qualifying rate or introducing measures to address ‘money-boxing’ (where cash is built up in a company in the hope of realising it as a capital gain either through a disposal or liquidation). The fundamental mechanics of ER are unchanged which is one small mercy.
It is clear that the new £1m lifetime allowance will still take account of any ER which has previously been claimed. This means that any individual who has already used ER of £1m or more will have no future ER allowance. There will now be business owners who will want to reconsider the benefits of making inter-spouse transfers so as to access a spouse’s ER allowance. Of course, care would need to be taken here to ensure that all the normal ER conditions are met by the recipient spouse.
Investors’ relief
It is perhaps surprising that the lifetime allowance for investors’ relief (this is still £10m) has not also been cut and some serial entrepreneurs may be tempted to structure their investments to secure this relief. This is however a very different relief which does not allow an investor to have any involvement in the running of the company and it too could be reduced very easily.
Forestalling arrangements
Personally, I believe that a taxpayer should be able to take advantage of existing tax rules without fear of being caught by retrospective legislation. I also thought that this view was held by the government too. Unfortunately, some of the anti-forestalling legislation is clearly retrospective. This legislation is generally aimed at counteracting measures which were taken to lock-in what were anticipated to be more favourable pre-budget rates.
Holding companies and s 169Q elections
Some shareholders were inserting holding companies over their existing trading companies in the belief that this would provide them with an option to lock-in ER if the Budget were to go against them. The idea was that TCGA 1992 s 135 reconstruction provisions would apply by default but the shareholder would have the option of triggering a gain by making a TCGA 1992 s 169Q election. Schedule 1 para 4(6) of the draft Finance Bill removes the efficacy of the election by treating it as applying at the time that it is made rather than at the time of the share exchange. There is no motive test to this legislation but it only applies to share exchanges which took place on or after 6 April 2019. This gives us the rather arbitrary result that a share exchange that took place on 5 April 2019 could still lock in ER rates with a £10m lifetime limit by making a section 169Q election before 31 January 2021, but a 6 April 2019 exchange would be subject to the reduced £1m lifetime limit.
Effect of TCGA 1992 s 137?
Schedule 1 para 4(7) of the draft Finance Bill states that if TCGA 1992 s 138(1) clearance has been obtained for a share for share transaction then there will be no scope to argue under TCGA 1992 s 137 that a disposal occurred. This could be the case if a disposal was not carried out for bona fide commercial reasons or if one of the main purposes was the avoidance of capital gains tax. This begs the question of what the position is if a clearance was not obtained. I think that we are left here with the rather bizarre conclusion that if the holding company was inserted for the avoidance of tax (which would seem consistent with the introduction of all these anti-forestalling measures) then a gain is triggered and therefore the so-called tax avoidance arrangement has been successful! This is an interesting paradox which I note is already the subject of some discussion involving various prominent tax barristers.
Uncompleted contracts
Perhaps surprisingly the anti-forestalling legislation is not just restricted to ‘internal’ transactions between connected parties. There is also legislation which in certain circumstances can disapply TCGA 1992 s 28 so as to make the point at which capital gains tax is triggered completion rather than exchange. This means that gains on transactions to third parties which had exchanged but had not completed before 11 March will be subject to the reduced £1m lifetime allowance. The only exclusion from this provision is if ‘no purpose of entering into the contract was obtaining an advantage by reason of the application of section 28(1) of TCGA 1992’ and the person who completes on the contract makes a statement in his or her return to state that that is the case. As many transactions were being rushed through in anticipation of budget changes it will be difficult for many sellers to say truthfully that there was no motivation to lock in a gain. Some further guidance from HMRC on this point would be welcome. The impact of this legislation will seem particularly unfair to sellers where completion has been delayed due to external factors such as coronavirus (had they have completed before 11 March 2020 then the £10m lifetime limit would have been retained).
There are also (less surprisingly) rules which seek to override section 28 for transactions between connected persons. These try to counter arrangements involving a transfer to a company or other vehicle that ‘stands on contract’ until such time as a purchaser is found. These have similar exclusions to those for unconnected parties as well as a ‘wholly for commercial reasons’ test. In practice the exclusions will rarely apply.
2018/19 s 169Q election
As the anti-forestalling legislation only relates to transactions which took place from 6 April 2019, s 169Q elections should still be effective to lock-in gains for 2018/2019 share exchange transactions (both under TCGA 1992 s 135 and s 136). Any such election would need to be made by 31 January 2021. Although this can potentially save £900,000 of tax it does mean that the tax payment date is accelerated and that there will be a ‘dry’ tax charge. Furthermore, if the value of shares declines after an election is made then the ‘dry’ charge will remain and the shareholder may be left with a capital loss and no gains against which to relieve it.
Other interesting measures
Electric cars
We already knew that electric company cars are a very tax efficient way to remunerate employees from 2020/2021 to 2022/2023. The benefit in kind rates are respectively 0%, 1% and 2% for these three tax years. For example, an employee would only pay tax on a £1,000 benefit in respect of the provision of a £50,000 company Tesla in 2022/23. The budget announced that this rate will be frozen until 2024/2025 which is welcome news. Electric cars must now be one of the most tax-efficient employee benefits in history. This will be attractive for both company shareholders and employees who will be keen to consider salary sacrifice arrangements.
As an added benefit, first year allowances for electric vehicles have been extended by a further four years up to April 2025. This means that certain contract purchase deals can be cash positive in the early years. This is because a business can claim full tax relief for the cost of a car before it has actually been paid for.
Pension contributions relaxation
Higher earners apparently have doctors to thank for a relaxation in the amounts that can be contributed to a pension without restriction. Currently, anyone earning over £110,000 (who has a total income of over £150,000, including their pension contributions) would not be able to get tax relief in respect of their normal £40,000 allowance. Instead it would be tapered by £1 for every £2 that their ‘adjusted’ income exceeds £150,000, down to a £10,000 minimum contribution.
From 6 April 2020, those earning up to £200,000 (or £240,000 with the pension contribution) are no longer caught by these tapering rules; allowing a full £40,000 annual contribution to be made. A sting in the tail is that the minimum tapered allowance will be reduced from £10,000 to £4,000. Therefore, anyone earning more than £300,000 will be worse off as a result.
Unfortunately, there is no increase in the lifetime allowance for pensions, beyond the consumer prices index inflationary increase which will take the limit to £1,073,100 from 6 April 2020. Although high earners are still restricted by a relatively low limit the new rules will allow many entrepreneurs to make maximum £40,000 pension contributions in the short to medium term.
Things that haven’t changed: IHT
I anticipated that a reform of IHT would form a major part of the new government’s first Budget. There is a well-accepted view that the tax is too complicated and gives too many reliefs. A recent review was carried out by the Office of Tax Simplification which advocated a number of changes and in particular a simplification of the lifetime gift rules. The valuable business property relief is also a ripe target for ‘simplification’, and in particular current strategies which involve investment in AIM portfolios which can be exempt from IHT after two years of ownership.
Inheritance tax, however, was not mentioned at all in the chancellor's address, and is also absent from HMRC's post-Budget announcements. This is probably something that will be visited again in the future.
Things that haven’t changed much: SDLT
Although SDLT rates have been increased by another 2% for non-resident buyers of residential property from April 2021 there have still been no changes to the ‘elephant in the room’. I am referring here to the longstanding SDLT rule which means that residential SDLT rates do not apply at all if there is any part of a land transaction which is not residential. As residential and non-residential rates have diverged over the years this means that significantly less SDLT is payable when non-residential rates apply. For example, a £2m property bought by a company would trigger £124,250 more SDLT at residential rates than non-residential rates. As even a small value of non-residential land (such as a field leased to a farmer) can lead to this rate reduction it seems strange that no rules have been introduced to address this. By its own admission, HMRC is dealing with a backlog of refund claims and it is generally resistant to suggestions that non-residential rates should apply (see Hyman & Another [2019] UKFTT 469). If the rules were changed then these kinds of arguments could be knocked on the head.
