SMEs would suffer from a CGT hike – not just investors

News: Insight & Opinion | 15 February 2021

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Despite the cancellation of the Autumn Budget, capital gains tax increases are reported to remain in the Chancellor’s sights. This could discourage small business investment just when it is needed most, says Claire Madden, Managing Partner at Connection Capital.

Has there ever been a more challenging time to be the Chancellor of the Exchequer? Having been forced to take unprecedented measures to safeguard jobs and businesses as economic activity went into Covid-induced freefall, now Rishi Sunak faces tough choices around how to repay eye-watering levels of public debt while stimulating recovery.

Of all the potential tax rises that have been trailed in the press, it’s important to make the case for caution on increasing capital gains tax (CGT) – specifically as it relates to gains made from investments into small and medium-sized businesses (SMEs). If the priority is to re-boot the British economy – and I think most people would agree that it is - then any move that disincentivises investment in UK SMEs will threaten that goal.

Maintaining perspective on risk and reward
An important source of this kind of investment is typically private capital: i.e. funding that individuals commit out of their own pocket, rather than from institutional investors such as pension funds (which tend to focus on large cap companies), for example. They may be business owners putting cash into in their own companies or private investors keen to back unquoted or small cap/AIM-listed SMEs that they believe have sound business models and strong growth potential.

Either way, the reality is that by doing so, they are taking real risks with their money. Far more so, you could argue, than investing in major corporates with well-known brand names whose shares can be easily traded on mainstream stock markets, or a second home.

Investing in this way can create real value, not just for the businesses and the investors themselves but for workers, through enhanced job protection and creation and for the Treasury by bolstering tax receipts. Indeed, the entire economy stands to benefit. Government figures show that SMEs account for three-fifths of UK private sector employment and around half of its turnover .

Do we really want to deter investors who are minded to support SMEs by, in some cases, effectively doubling the rate of tax they will pay on any gains they realise if CGT is equalised with income tax rates, as has been suggested?

Lifeblood for SMEs
This matters now more than ever because SMEs’ need for finance is greater than ever. It won’t be long before the government’s short-term support measures come to an end and state-backed loans start having to be repaid with interest, deferred tax bills fall due and the furlough scheme tapers out. When that happens, businesses will need access to finance, offered on a more permanent basis, if they are to trade successfully out of recession and into recovery.

There’s no telling if banks will be in a position to lend more or offer favourable terms at that point, but it’s by no means a given. Private capital could provide that vital lifeblood – indeed, our research indicates that investors are standing by to do so – but hiking CGT would doubtless pour cold water on their enthusiasm.

On the face of it, raising CGT is an obvious target, but while such a move may play well to the court of public opinion, not all capital gains are equal, nor are they the same as income. I’m no advocate for complexity in the tax system, but it’s important to acknowledge that the risk involved in backing SMEs is greater than more conventional kinds of investment and should, therefore, be treated differently.

“This is not the time to be stuffing cash under the mattress: SMEs need help and there are some good opportunities out there for private investors to provide it.”

Currently, Business Asset Disposal Relief (formerly known as Entrepreneurs’ Relief) does recognise this issue, reducing CGT for entrepreneurs who have put “sweat equity” into their businesses, but for how much longer, having already been significantly curtailed in this year’s Spring Budget? And although the Enterprise Investment Scheme (EIS) also offers CGT breaks for external investors, it only covers start-ups and early stage businesses, not well-established ones. The bulk of UK SMEs are excluded. Therefore, headline CGT matters.

If we are to beat the economic crisis triggered by Covid-19, we need private capital circulating through the system, investing in businesses that will aid the recovery and enabling value to be created and shared. To do that, we need a tax regime that is structured in a way that is fair, and that offers suitable incentives to individuals which will ultimately result in broader benefits for everyone.

This is not the time to be stuffing cash under the mattress: SMEs need help and there are some good opportunities out there for private investors to provide it. Encouraging and supporting that should have positive outcomes all round: for businesses and those with capital to invest, the UK workforce and the Treasury too. After all, aren’t we all in this together?