Why the axe keeps hovering over Entrepreneurs' Relief
“The thing that's wrong with the French is that they don't have a word for entrepreneur.” Well, whether or not it’s true that George W Bush actually said it, it’s too good a line not to quote.
But the more important point for our purposes is that UK tax legislation doesn’t have a word for it either, in the sense that it isn’t a defined term, writes David Whiscombe, partner at tax specialists BKL.
Yes, you get Entrepreneurs’ Relief -- not because you pass some objective test of being “an entrepreneur,” but because you meet a set of pretty arbitrary conditions laid out in the statute.
And that might be why government has, over the years, seemed to have been uncertain at quite what it was aiming to achieve with Entrepreneurs’ Relief and why, despite regular tinkering over the years, it might be in line for further changes.
If it applied only on the sale of a business (or a company) as a going concern to a third party, it probably wouldn’t be of great relevance to most contractors. Sure, you do occasionally see the sale of a contractor business which has developed specially valuable intellectual property or a saleable niche business, but most contractor businesses are never sold.
Yet ER also potentially applies to a capital gain on shares on a winding-up of a company following “retirement,” including packing up as a contractor and going to regular, 9-to-5 employment. In that circumstance, the main (often the only) asset coming out in the winding-up is cash. And given a choice between taking surplus cash out as a dividend during the company’s active trading lifetime and paying Income Tax at up to 38.1% or leaving the cash in until winding-up and paying CGT at 10%, guess which most people choose?
HMRC are on record as saying that they have two related problems with that. The first is “phoenixism” -- periodically winding-up a company, taking the cash out at a 10% tax rate and then starting over again. “Phoenixism” is what is intended to be countered by the new(ish) Targeted Anti-Avoidance Rule (though the scope of the rule is a whole lot wider than that; another article for another time).
Less well-known is HMRC’s second issue -- “money-boxing,” the deliberate leaving of cash in a company until the business is finally closed down on “retirement”. So far, there’s no specific legislation countering that. If the amounts are large, and especially if the retained profits are invested rather than simply being held on short-term deposit, HMRC might try to deny ER on the basis that the company is no longer a “trading company” -- though, depending on the facts, HMRC may struggle to get that over the line.
Back in the day, there was targeted legislation which effectively discouraged money-boxing by deeming you to have divided out any cash which was surplus to business requirements, and requiring you to pay Income Tax on the deemed dividend accordingly. But the legislation was horribly subjective and hugely labour-intensive for HMRC to police: we can’t really see that being dusted off and brought back.
However what is worth noting is that the tax law of many countries doesn’t differentiate at all between dividends during the lifetime of a company and dividends in a winding-up: all distributions are charged to Income Tax. Could it happen here?
No reason to suppose not. It would certainly penalise money-boxing -- especially if you were unlucky enough to be winding-up your company just as a left-wing government had introduced new higher rates of tax on dividend income! Less drastically, though, it would be relatively simple to amend the ER legislation so that it applied only to sales of shares and not to proceeds in a winding-up, thereby doubling at a stroke to 20% the rate of tax payable on a winding-up. Will it happen in this Autumn Budget 2017? Nothing’s been leaked. But in the longer-term, who knows?