Last summer I wrote this about the so-called Entrepreneur's Relief that UK capital gains tax provides:
Capital gains tax Entrepreneurs Relief does, in essence, reduce the rate of gains tax by those who sell privately owned businesses. In most situations they pay 10% on their gains rather than 20%. The tax rate is halved.
In the last year for which data is available the relief cost as much as the tax paid on these disposals, or £2.36 billion. Of this £1.73 billion went to just 4,000 people, at a tax savings of more than £430,000 each, on average.
That is wholly unjust. It is a simple boost to those already wealthy. Remember, these people had by definition just picked up gains of in excess of £4 million each. And as I have argued before, the relief makes no sense. It does not encourage entrepreneurial activity at all. It encourages short-termism and selling out rather than developing entrepreneurial activity, both of which are the opposite of what the UK needs.
Nothing about this relief makes any sense at all. It has to go.
Now there is an ongoing debate about the relief going, not least because the latest data shows it now costs £2.7 billion a year. That, to use a phrase that has now been popularised, is money spaffed against a wall.
Not all agree though. The Institute of Chartered Accountants in England and Wales is fighting a rearguard action. They implicitly acknowledge that the relief does not work:
While the exact nature of any changes is unknown at this stage, it's clear that more work could be done to improve ER and bring it in line with its intended purpose of supporting and encouraging investment.
For example, research conducted by IFF Research in May 2017 suggested that “in the majority of cases, ER was not the primary motivating factor when customers were making decisions about investing in assets, or disposing of them.”
But they also note:
Certainly the government should seek further input from stakeholders before pushing any further reforms through.
A review into ER should consider all aspects of the relief and whether it is meeting its intended aims. This would include consideration of how ER impacts investment decisions, how it influences growing businesses across the UK, and whether it could be used to encourage investment in specific geographical or business areas.
So the views of those who get a lot from this, and have the time and resource to reply should be taken into consideration, because everyone knows the rest will not take part as they have other priorities. Such is the way that consultations do not serve the democratic process.
But on this I do have to agree with the Institute of Chartered Accountants in England and Wales:
Ideally, such a review would form part of a wider, more holistic look at business reliefs generally, so that the government can understand whether each relief is achieving its intended purpose and act accordingly.
Most tax reliefs related to wealth and savings would go on that basis: few deliver any obvious benefit that could not be better achieved in other ways. The job of the tax system is not to redistribute wealth upwards, but that is what most of these reliefs do.
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Should the tax system not encourage saving so people have some capital in later life when they have less earning power?
This applies to most people. Granted those as the bottom of the pay scale can’t save and need to be served in a different way.
Isn’t that subsidy simply a way to increase wealth divides?
Is that appropriate?
Well it depends who you are referring to. I earn just over 40k so I don’t think I’m wealthy but I save a bit each month into a personal pension. The tax incentive encourages that. What is the opportunity cost? Miss out on a few meals out each month and new clothes and don’t spend what I do t have. Hopefully I’ll have something to show for it in 20yrs time..I think there are many people in my position… is this causing inequality or is it just being sensible?
Would you save without tax relief?
Richard you are of course correct that ER plays no part in encouraging people to take business risks and press on with business expansion. They do it because they want to. Some have exploited the relief – hedge funds and similar – turn business profits into capital and then extract with ER. But for the ‘real’ business people they mostly just enjoy what they do seeing a business grow.
I am a great believer in trickle up economics.
You are right: entrepreneurs are by and large born and tax has nothing whatsoever to do with their motivation
What would be better looked at is actually starting a business. Unless you already have (some) money it is very difficult if not almost impossible to start a business. It does not really matter how good your idea is, but you have to be really determined and prepared to take a very large risk. I would suspect many entrepreneurs never actually manage to get off the ground, while many that do will probably have their business stunted by lack of capital. Assuming you can’t finance it all yourself then you have to get funds from somewhere. That is often family. However if you go for external finance you will almost certainly immediately be asked for a personal guarantee. That negates any limited liability and might very well result in personal bankruptcy and thus losing your house and belongings, etc. I gather 90% of new companies fail within 5 years so that is very poor odds. It is hardly surprising that most of the population would take one look at it and decide to carry on working for somebody else. Also if you do have a business that fails then in the UK you immediately get categorised as a failure, so it puts a severe dent on your credit rating, for example. This is mostly a UK issue as in the USA they see a failure as a learning experience that helps you to avoid the pitfalls next time.
So what we need if we want more start-up companies is a source of patient capital that is prepared to share the risks. Obviously the entrepreneur needs to be committed (have skin in the game (which incidentally most FTSE directors don’t have)), but not face a total personal wipeout if things go wrong.
My business when we founded it back in 1998 to do digital mapping could have ended up in the position later occupied by billion dollar start-ups like Teleatlas, MapQuest and Here if we had had the £1 million or so that would have allowed us to capture the UK at large scale within 2 years. But we had little money and I was not prepared to sign a guarantee for more than £100k that my wife and I could just about survive without losing the house. So we stayed small and others from elsewhere in the World got the mega-bucks.
Hopefully this is the sort of area that the Scottish National Investment Bank will look at. Anyway if the government want to spend £3 billion a year (UK level) then helping at the start of a business is where it should go. And in general more equity finance and less debt finance would be good. In fact in mature companies too the tax system currently encourages debt (interest is tax deductible) and penalises equity.
Schemes the government does have such as the Enterprise Investment Scheme actually specifically exclude the entrepreneur and his / her family from claiming any tax benefit on their investment.
I agree with you Tim
The government’s logic is entirely wrong on almost all issues to do with real entrepreneurship
Will you be commenting on this? Is this another tax relief that should be scrapped?
https://www.telegraph.co.uk/business/2020/02/10/hi-fi-entrepreneur-hits-back-claims-tax-hypocrisy/
I do not have a Telegraph account and so have no way of knowing what that is about
We need to remember how we got here. Capital gains tax was introduced in 1965, with a 30% rate. Before then, some gains were taxable as income, but many gains were free of tax. Even so, the rate of the new CGT was much less than the top rate of income tax, and a cottage industry developed of turning income into capital, with a host of anti-avoidance rules and court cases brought by the Inland Revenue trying to stop blatant avoidance.
Through the 1970s and into the 1980s, much of the taxable gains arose from inflation. From 1988, the rate of capital gains tax was aligned with marginal income tax rates (i.e. increased at the top end by a Conservative government to 40%, as the top income tax rate came down from 60%), but indexation allowance was introduced with effect for inflationary gains since 1982.
There was then a period of relative calm when there was little point in converting income into capital because the rates were the same. Which you might consider to be a sensible state of affairs for a tax that is effectively an anti-avoidance measure.
Then in 1998, the Labour government replaced indexation with a 10 year taper relief, gradually reducing the taxable gain year by year so the effective rate of capital gains tax on business assets held for 10 years would be just 10% (and 24% for non-business assets). I can see some merit in encouraging longer term holdings, but the taper period was cut to 4 years in 2000, and just 2 years in 2002. This I think was the big mistake.
And then the rather complicated machinery of taper relief was replaced by a flat 18% CGT rate in 2008, with entrepreneurs’ relief giving a 10% rate on the first £1 million of lifetime qualifying gains. That already sounds quite generous (how many people ever make a gain of a million pounds?), but that £1m became £2m in March 2010, £5m in June 2010, and then £10m in 2011, for no good reason that I can see. A top rate of 28% was added in 2010, but cut to 20% for most gains in 2016. You might even say that 28% or 20% is generous enough, compared to the headline rate of income tax, so why bother with ER.
Thanks Andrew
And all gains are still income at the end of the day
Which all of this ignores….
Try this link. Is this tax avoidance? Should the law be changed?
https://www.continentaltelegraph.com/uncategorized/isnt-this-tax-abuse-julian-richer-sells-richer-sounds-without-paying-capital-gains-tax/
If you think Worstall is right then the answer is you need to get a life