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Caution urged over potential changes to CGT

7 July 2015

The government must take care not to deter investment in SMEs in any changes it may be planning to make to Capital Gains Tax (CGT) in the forthcoming post-election Budget, says Connection Capital, the specialist private client investment business.

Connection Capital says that CGT could well be targeted in the July 8 Budget in order to boost tax revenue to pay for spending pledges, after increases in VAT, national insurance and income tax were ruled out before the election.

It warns that raising the existing 28% CGT rate and/or scaling back capital gains tax reliefs designed to support SMEs by creating incentives for investors or entrepreneurs risks undermining business creation and expansion.

Claire Madden, partner at Connection Capital says, “Capital Gains Tax is really the only significant tax left for the government to play with to generate the kind of revenue it will need to pay for its spending plans in the absence of the other “big three” major taxes.”

“Targeting CGT may seem like an easy win which shouldn’t generate much controversy as many people will assume that it will only really impact the rich, but the reality is not that simple.”

“It’s important to appreciate that not all capital gains are equal in terms of the risks incurred in generating them and the value the original investment has delivered to the UK economy.”

She explains, “There’s a big difference between someone who has made a gain from blue-chip FTSE100 shares or buying a buy-to-let property whose value has soared as the market has risen, and someone who has risked everything to build up their own business or investors who have put their capital to work backing small, growing companies.”

“The current regime, which offers tax breaks through Entrepreneurs’ Relief and the Enterprise Investment Scheme, is working well because it recognises and rewards this, so we are keen to see that this is not jeopardised in any way if CGT is squeezed.”

She adds, “Taxing gains on business investment more highly is likely to mean that less capital gets recycled back into UK plc – which at this critical stage in the recovery could do more harm than good.” Entrepreneurs’ Relief enables directors or employees who own at least 5% of the company’s shares to pay Capital Gains Tax at 10% instead of 28% (for higher rate tax payers) when they sell all or part of their stake, up to a lifetime maximum of £10million.

The Enterprise Investment Scheme (EIS) is designed to help small businesses raise funding by providing investors with appealing tax breaks such as 30% income tax relief on investments of up to £1million per year in qualifying companies, and zero Capital Gains Tax on assets held for three years.

Claire Madden says, “It’s vital that SMEs are supported to develop and grow to their full potential, so that they can create jobs, generate more taxable profits and add value to the economy. It’s also essential that the aspirations and ambitions of their founders and backers are encouraged, and that long-term commitment continues to be rewarded.”

Claire Madden warns, for example, that if the rate of CGT that entrepreneurs and investors have to pay is raised to closer to parity with the income tax rate, the incentive to invest in a business for the longer-term by not taking income in order, ultimately, to make a greater capital gain, would be removed.

She adds, “Although we won’t know what tax changes will be made until Budget day, it’s clear that more revenue will have to come from somewhere and CGT looks like one of the most likely candidates.”

“The government has done much to improve tax breaks for investors and entrepreneurs in recent years by expanding EIS and raising the lifetime investment threshold for Entrepreneurs’ Relief, but there’s no guarantee that either of these reliefs is safe, now that it’s time for tough decisions to be made.” Official figures show Entrepreneurs’ Relief is estimated to have “cost” the Treasury £3billion last year, while EIS was worth £440 million in total*.

Claire Madden comments, “Some professional bodies are already urging the government not to hamper aspiration by targeting these key tax incentives following amendments proposed to EIS in the last Budget – so concern is clearly growing.”

“It’s vital that policymakers look at the whole picture if they decide to review this part of the tax system. For example, if they decide to raise the headline CGT rate or change Entrepreneurs’ Relief but keep EIS as it is, there’s still a risk that significant number of SMEs and their owners and investors could be affected by the change.”

She explains that entrepreneurs cannot benefit from EIS, and the scheme can only be used for growth capital – investments in management buy-outs and equity restructurings, also key ways to enable businesses to grow - are excluded. Several sectors are disallowed, and net asset tests and employee numbers restrictions can also limit its scope for larger, more established businesses.

*2014/15. EIS total includes CGT relief and income tax relief.

 Russell O'Connor
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