IMPORTANT: This briefing note is only intended as a general statement of the law and no action should be taken in reliance on it without specific legal advice. Release Date: 27 May 2010

Briefings

Planning for a CGT increase

Capital Gains Tax is going up. Whether you’re the owner of a business, a senior executive with a minority shareholding or a passive investor, these are worrying times. The government will reveal full details in the emergency budget on 22 June but everything suggests a new CGT rate for top earners of up to 40% or even 50%. That’s more than double the current rate of 18%. This note explores what planning can be done now to beat the increase.

When will the new rules apply?

Any changes are likely to take effect either on budget day or on 6th April 2011. Even a retrospective change is possible with effect from 6th April 2010 or from a number of dates in May 2010 when various announcements were made about increasing CGT. Whilst the lack of certainty makes planning difficult, we still believe it is sensible to assume a budget day increase on 22 June and plan for that. The potential tax savings could be very significant while the cost of doing nothing could be equally high.

Will there be special rules for entrepreneurs and investors in small businesses?

The government has announced that there will be “generous exemptions for entrepreneurial business activities…”. The problem is no-one knows what that means or indeed how generous any new exemptions or reliefs will be. The old Business Assets Taper Relief gave a CGT rate of just 10% and was widely available, not just to business owners and working directors with large shareholdings but also to small-scale investors in private companies. When Taper Relief was abolished in 2008 and replaced with a new fixed 18% CGT rate, Entrepreneurs’ Relief was introduced to preserve the 10% rate for gains up to £1m (later £2m). However, Entrepreneurs’ Relief is far more restrictive than Business Assets Taper Relief, since it requires a shareholder to own at least 5% of the business and be an employee or director. Our view is that any new reliefs are more likely to mirror the tighter rules for Entrepreneurs’ Relief and be restricted to larger shareholders working in private trading companies.

What planning can be done now?

The key to any planning is to dispose of your shares or other business assets now before potentially higher CGT rates apply. The aim is to lock in the current rate, which will be either 18% or possibly 10% if Entrepreneurs’ Relief applies. Of course a sale to a 3rd party before 22 June is likely to be impractical unless a deal is already in progress. That means any disposal would have to be to a connected party such as a family trust. In that case there is nothing to stop you benefiting from the trust or even being a trustee so that you still retain control.

What are the advantages?

A disposal to a family trust is taxed like an actual sale at today’s market value. That means the shareholder pays tax at just 18% (or 10%) on all gains to date. If those historic gains are large, the tax saving could be very significant compared to paying tax at up to 40% or even 50%. Locking in today’s tax rates is particularly attractive if a sale of the business is expected in the next few years. In that case only future gains would be taxed at the new higher rates.

What are the disadvantages?

A disposal to a family trust means the tax will ordinarily be payable on 31st January 2012 even though the business might not have been sold by then. That means finding cash from other resources although in some cases you can pay the tax in 10 annual instalments (with interest). It may even be possible to defer the entire tax charge for several years (without interest) by structuring the disposal in a particular way.

The other potential downside is the risk of having to pay tax on theoretical gains which may never actually be realised. Unfortunately the tax liability does not disappear even if the business subsequently falls in value or becomes worthless (but see below).

What if the business falls in value or there is no sale in prospect?

If the value of the business falls, you could be worse off paying tax now on current gains even at today’s lower rates. Of course it depends how much the value falls and how much CGT rates rise. Similarly if a sale to a 3rd party is unexpectedly delayed for many years (or forever), paying tax now on current gains, even at low rates, will have been a poor decision in cash-flow terms. Fortunately there may be a solution to this problem. It still involves a disposal to a family trust so as to lock in today’s lower CGT rates. However, the disposal is structured in such a way that if circumstances change, there is a mechanism to unwind the disposal.

Who should consider pre-budget planning?

Planning for an imminent increase in CGT is relevant for the following:-

• Those currently selling a business where the deal won’t be completed before 22 June
• Those expecting to sell their business in the short to medium term
• Shareholders who are unlikely to qualify for any new CGT business reliefs
• Shareholders who currently qualify for Entrepreneurs’ Relief but whose gains exceed £2m
• Those who received loan notes on an earlier sale of their business

For further information on possible CGT planning before the emergency budget on 22 June, please contact Andrew Goldstone on 020 7440 7205 or Jonathan Legg on 020 7440 7092.