Estimates show that, since its introduction, entrepreneurs’ relief has cost the Treasury over £2 billion a year on average, a much higher figure than the £200 million it was first predicted to cost.
So, leading up to the 2020 Budget announcement, it was widely expected that entrepreneurs’ relief would be reformed, or even abolished.
Although the Chancellor, Rishi Sunak, did not abolish entrepreneurs’ relief, he did announce a significant change to the lifetime limit of gains that qualify for the relief- reducing the allowance from £10 million to £1 million for each person.
Read on to find out more about entrepreneurs’ relief and what the recent changes mean for you.
What is entrepreneurs’ relief?
Entrepreneurs’ relief is a tax break available to individuals selling their businesses, which means they don’t need to pay as much Capital Gains Tax.
Whenever you sell or dispose of an asset, such as your business or your shares in a company, you will need to pay Capital Gains Tax on any profit, or gain, you make. Entrepreneurs’ relief reduces the amount of Capital Gains Tax a business needs to pay, from 20% of qualifying profits to 10%.
So, you will be charged the lower tax rate of 10% on the gains you make up to the lifetime allowance. Once you have surpassed this limit, you will be charged the usual Capital Gains Tax rate.
When the relief was introduced, by the Labour Government, in 2008, the lifetime allowance was initially set at a limit of £1 million. However, the government subsequently raised the limit until, in 2011, it was set at £10 million where it remained until the recent Budget.
This tax relief was meant to act as an incentive to encourage more people to start and grow a business. The government thought that allowing individuals to pay less tax on their gains when they came to sell their business, would help to stimulate entrepreneurship across the country.
However, the relief has come under fire in recent years, with controversy surrounding how much it has cost the government and groups claiming that it hasn’t fulfilled its primary aim of boosting entrepreneurship. Partly because of these reasons, the government announced changes to entrepreneurs’ relief in the Budget.
What are the 2020 Budget changes to entrepreneurs’ relief?
Although many groups were campaigning to completely abolish entrepreneurs’ relief, the Chancellor of the Exchequer, Rishi Sunak, did not go this far.
Instead, he reduced the lifetime allowance from £10 million to £1 million.
This means individuals will only receive relief for the first £1 million of gains; any gains they make over this amount will be taxed at the standard Capital Gains Tax rate.
So, someone making any gains of £1 million or under will be eligible for relief and will be taxed at the lower rate of 10%. Once an individual has gains over £1 million (whether from one sale or from multiple disposals), they will need to pay the usual rate of Capital Gains Tax which, for most, would be 20%.
The lower lifetime allowance for entrepreneurs’ relief came into immediate effect for all qualifying disposals made on or after 11th March 2020.
What impact will this have?
Sunak said this limit reduction wouldn’t affect 80% of small business owners, as most beneficiaries of the relief claim under £1 million.
It is hoped that lowering the limit to £1 million will create a fairer system of tax relief, while still encouraging entrepreneurial activity in the UK. Sunak said he did not completely abolish the relief because many businesses rely on this tax break and because he still wants to promote risk-taking in business.
The reform removes the most excessive tax break that the wealthiest could exploit, while continuing to ensure that smaller entrepreneurs will still get the benefit of the relief with a lower tax bill.
Serial entrepreneurs who have already used up their £1million allowance are likely to be most affected by the change.
Lowering the upper limit of entrepreneurs’ relief will reduce the cost on government finances, with predictions that it will save over £6.3 billion over the next five years.
The Chancellor said that the government will use the money generated from this change to fund other measures to help businesses, such as cutting other business taxes and increasing research and development expenditure credit and employment allowance for example.
Who is eligible for entrepreneurs’ relief?
Entrepreneurs’ relief is available to any sole traders, business partners, and individuals with shares in a “personal company”, who would pay Capital Gains Tax when disposing of their business assets.
Individuals need to have owned their business for a minimum of two years or, if they are selling shares, they need to have been an employee or office holder of a trading company for at least two years. Shareholders need to hold at least 5% of shares in a “personal company” to qualify.
If your shares are from an Enterprise Management Initiative (EMI) Option Scheme, then you must have bought the shares after 5th April 2013 and had the Option for at least 2 years before selling them.
If you are closing your business, you can still qualify for entrepreneurs’ relief if you dispose of your assets within three years.
You will only be eligible for entrepreneurs’ relief if you have not exceeded your allowance of £1 million (previously £10 million). You can claim the relief as many times as you want, but each individual can only claim up to £1 million in their lifetime; it is not a £1 million allowance for each sale.
The easiest way to claim entrepreneurs’ relief is through your HMRC Self-Assessment tax return.
Why is entrepreneurs’ relief so controversial?
Many consider entrepreneurs’ relief to be a controversial tax break, with the Resolution Foundation branding it “expensive, ineffective, and regressive”.
Especially as the lifetime allowance rose to £10 million, there were concerns that the relief was costing the government more than they initially planned.
Even though it was brought in to encourage people to start up their own business, there has been no real evidence that the relief has resulted in more investment and growth in business activity. Indeed, many people who have benefited from the relief said they were unaware of the relief when they started their business- more than the number of people who said the relief had influenced their decision to start a business.
Because of this, critics of entrepreneurs’ relief say it’s a small number of wealthy individuals that benefit the most from it, as it significantly reduces their tax bills. The Institute for Fiscal Studies (IFS) highlighted that, in 2017-18, around three-quarters of the total £2.3 billion cost of the relief went to 5,000 individuals, with each of these making an average tax saving of £350,000.
However, for now, entrepreneurs’ relief remains in place, albeit with a lower limit. It no longer offers such a large tax break, but it continues to offer an incentive for starting and growing a business in the UK. Anyone who is self-employed or has taken out a business loan to launch their start-up will still be able to benefit from a tax break if they want to sell their company in the future, but now only on their first £1 million of gains.