Much has been written over the last few weeks about Entrepreneur’s Relief (“ER”), many of them bemoaning the amount that the relief is “costing” (£2.7 billion last year), that it does not encourage start-ups and the fact that is only claimed by the rich. Therefore, there is lots of speculation that Entrepreneur’s Relief will be scrapped in the Budget.
So, are these criticisms justified and should the tax relief be scrapped?
It’s tempting to consider that those two questions are one, and that a yes to the first means a yes to the second. However, I would argue that that would be wrong.
Firstly, yes the Entrepreneur’s Relief does cost money, measured as the difference between the tax that would have been paid if the gain had been taxable at 20 per cent. Of course, the big word there is the “if”. This assumes that the gain would have been taxed at full without the relief. So, would it have been?
To answer that question, it’s important to remember the origins of Entrepreneur’s Relief and indeed its predecessor, Business Assets Taper, that was introduced in 1998. Taper Relief, introduced a decade earlier, sought “to get the best out of the country's entrepreneurs [by changing] the UK tax system … to recognise the investment of individuals who nurture promising start-ups into successful businesses”.
Back in 1998, entrepreneurs considering selling their businesses, and without access to retirement relief, faced the stark choice of paying CGT at the marginal income tax rate of 40 per cent, or leaving the UK before selling up and paying minimal, if any, tax given the UK’s tax treaties. Unsurprisingly, many chose the latter. Faced with the loss of lots of “rainmakers”, the Government introduced the Business Assets Taper to help retain those individuals, with a view to fostering the “Dragons Den” culture.
This intention can be recognised in the announcement in January 2008 that the abolition of Taper Relief would include the introduction of Entrepreneur’s Relief. Although the original design proposed to the Government recommended that Entrepreneur’s Relief be a limit per investment, thereby encouraging serial entrepreneurship, the final relief put forward by the Treasury involved a lifetime limit, counterintuitively removing the incentive for those who were the most successful in their first investment.
So, in evaluating the relief, the question should not be whether Entrepreneur’s Relief has a theoretical cost when compared to taxing at the full rate, nor whether it encourages people to start businesses. Indeed, the fact that the relief is only claimed by those who are successful is a sign of success of the relief (targeted on the rainmakers) rather than a sign of weakness.
So, while the criticisms may be justified, that is not a reason to remove the relief. Instead, policy makers should consider whether, without the relief, we would see entrepreneurs choose to leave the UK rather than stay and pay the tax.
The reduction in the default rate of CGT and the requirement to stay non-resident for longer will have reduced that incentive to leave, but it still remains. Rather than abolition, reforms could instead be focused on encouraging serial entrepreneurship and enhancing that focus.
Guest blog by Chris Sanger, EY’s Head of Tax Policy and a former Head of Business Tax at HM Treasury. He sits on CIOT's Technical Committee. The views expressed are his own and are not necessarily those of CIOT or EY.