Changes to Capital Gains Tax (Continued)

In our January newsletter article on capital gains tax, we indicated that the Chancellor was coming under strong pressure to amend the proposed legislation. Sure enough, on 24 January Alastair Darling announced the introduction of entrepreneurs' relief to mitigate the impact of the proposed changes.

To summarise, for many years capital gains have been taxed at 40% but for business assets held for more than two years, taper relief of 75% was available which reduced the effective rate to 10%. In a ‘sledgehammer to crack a nut' move aimed at the huge perceived profits of the private equity sector, the Chancellor announced in the pre-budget report last year that from 5 April 2008, all capital gains would be charged at a flat rate of 18%.

Not surprisingly, this elicited howls of pain from owner managers and entrepreneurs whose plans had been built around CGT at 10%. Recognising the crucial role played by high growth technology companies in the UK economy, the Chancellor announced the introduction of ‘entrepreneurs' relief’ which will operate as follows:

The relief applies to capital gains on the sale of business assets (usually shares) up to £1m. This will be calculated by calculating the capital gain and then reducing it by 4/9ths – not pretty, but it works, as shown in the following example:

Dorking Technology Ltd

Frank acquired his holding of 100% of Dorking Technology in September 1994 for £1,00,000. Dorking Technology is a trading company (making and selling widgets) and is expected to be eligible for entrepreneurs' relief.

Pre 5 April 2008

£

Post 5 April 2008

£

Net sale proceeds

As you would expect there are various restrictions:

• The shares must be in a trading company or the holding company of a trading group
• The shareholder must be a director or employee(at least part time)
• The shares must represent at least 5% of the ordinary share capital and also at least 5% of the voting rights.
• The shares must have been held for at least a year to get full relief.
• The £1m relief is a ‘lifetime allowance

This will apply to a large number of start-up companies where the founders and management team have a significant stake, although there will also be many cases where dilution has reduced the holding beneath the 5% threshold, making the shares liable for CGT at 18%.