Danvers Baillieu

Guest post: Will the new UK government be good to entrepreneurs?

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This is a guest post by Danvers Baillieu, an associate solicitor at Winston & Strawn and co-founder of Bootlaw.

The day before the UK General Election, Techcrunch EU ran this post highlighting the taxation policies of the Liberal Democrat party and suggested that plans to raise capital gains taxes could be damaging for UK based start-ups. Whether or not the disappointing results for the Lib Dems were directly connected to this withering attack is yet to be proven but nevertheless, having the balance of power and entered into coalition with the Conservatives, it would appear that the Lib Dems are to get their way on capital gains tax.

At this point, I should declare an interest as a card carrying member of the Conservative Party and I have been enthusiastically supporting the new coalition through my personal blog. But before you hurl your laptop through the nearest window, it’s worth pointing out that I also happened to comment on the earlier Techcrunch EU post along the lines that the cut in capital gains tax by Labour was not all it was cracked up to be, but on balance was pretty good for the tech sector.

A quick refresher for those of you who have not been paying close attention. Sometime in the mid-1980s, the Thatcher government equalised the top tax rates on income and capital gains at 40%, whereas previously income had been taxed up to 60% and capital gains at 30%. Although both types of gain had separate allowances, this was seen as a sensible move to prevent tax payers from arranging their affairs so that they took their profits as capital gains rather than as income.

The crucial part of the capital gains regime was that there were various reliefs available which meant the tax was often not levied at the full rate on the whole gain over the lifetime of the investment. First, investors were entitled to “indexation allowance” so that the base value of the investment was supposed to rise with inflation (in other words, so that tax was not payable on the increase in value which was as a result of inflation). Secondly, taper relief on “business assets” meant that the tax rate was reduced the longer an investment was held and in many cases the effective rate was as low as 10%. This meant there was a recognised distinction between those who made investments for the long term and those who had made an overnight profit. In other words, the real investors were rewarded whereas speculators were not.

In the 2008 budget, the Labour government ended this regime, dropped capital gains tax to 18% and abolished taper relief. This was one of the few times the Labour government actually made the tax system simpler to navigate but was much criticised for effectively raising the rate for many investors from 10% to 18%, even though second home owners were delighted by the cut from 40%. To counter this criticism, the government quickly invented Entrepreneurs Relief to provide an effective 10% rate for the first £1 million in capital gain over a person’s lifetime on a sale of a business which they had themselves been running. In the last Labour budget earlier this year, this allowance was increased to £2 million.

Fast-forward to the present day and investors are nervously awaiting George Osborne’s first budget which has been scheduled for 22 June. The coalition agreement, recently published by Her Majesty’s Government, gives a strong hint of what is to come. It says:

We will not know the detail of any of this until 22 June, but my hope is that the pre-2008 position will be broadly restored so that:

  • Entrepreneurs’ Relief will be abolished and Taper Relief restored;
  • Enterprise Incentive Scheme (EIS) and Venture Capital Trusts (VCTs) will all be kept intact;
  • Non-business capital gains (e.g. second homes, stock market investments) to be taxed at a top rate of 40% to be applied going forward – not retrospectively. The discrepancy with the top rate of income tax will fall away when the 50% rate is inevitably removed.
  • The separate annual tax free personal allowance for capital gains (currently £10,100) will be retained.

As a pessimist, my guess is that the “new” Taper Relief will be less generous than the old one, although some form of Entrepreneurs Relief for those directly involved in running a business may survive.

For many small tech companies seeking investment, this should improve their investment position, albeit marginally. UK based angel investors will have an added incentive to invest in EIS-qualified companies rather than in other investments which attract the full 40% rate. VCTs will also have the same added attraction for investors.

Although it is hard to make the case that an entrepreneur with a multi-million pound exit in the bag should receive a more favourable tax regime than typical “hard working” families who are taxed on their income, the new coalition government is already showing promise when it comes to rolling back the state both in terms of its spending and its activity. After 13 years of the state becoming more and more bloated, the government appears to understand that key to the recovery is a vibrant private sector. More than anything, including lower tax rates, all businesses including tech start-ups need a return of business and investor confidence – and my fingers are tightly crossed that it is now on its way.

  • http://blog.david.bailey.net davidjwbailey

    Fingers crossed. the real problem is that the cack-handed ‘partial announcement’ has meant that most Angels just clammed up and won’t even discuss investing until this is sorted out properly.

    The second issue is that – contrary to the belief of many Entrepreneurs – Angels don’t have piles of cash from which they graciously invest; they have to sell other assets (holiday homes, shares, bonds, paintings, cars, wine collections) in order to fund the investment they are making. This means that any ‘upstream’ tax on those disposals makes the investment in out little ventures less likely, more complex and more expensive. Even where there are ‘roll-over’ style reliefs, these can be really complex to comply with.

    As ever, these changes may be longer term good news, but for the rest of 2010, I personally predict a very thin Angel market until it all settles down.

  • http://twitter.com/mugathur moo

    Great post, Danvers! It’s really useful to have someone break it all down for new entrepreneurs. Can you comment on the details of the old taper relief and your expectations for the details of the “new” taper relief?

    • http://www.bootlaw.com Danvers

      Hi moo – we’ll just have to wait and see what happens!

  • Angel

    Can we first kill one myth: VCTs do not invest in early stage businesses and is largely irrelevant for ambitious entrepreneurs . They invest in the most riskless assets the rules allow. Of the typical £700M raised in VCTs in a typical year, £3 is raised by early stage funds.

    What seems to be forgotten is that with Government spending decreasing, something will have to pick up the slack in terms of value generation. The burden will be spread across private enterprise with increased reliance on entrepreneurs to create value.

    Ambitious entrepreneurs need funding to succeed. There is therefore no point to only give entrepreneurs relief from CGT. An increase in CGT to 40-50% would decimate the important angel’s market; the first port of call for a fledgling business. It will particularly hit the crucial sector of ‘super angels’ who invest more than the Enterprise Investment Scheme allowance every year. It would severely impact ‘true’ Venture Capital funds’ ability to raise money. UK has been a European leader in Venture Capital for many decades, but this would cut off an important funding stream – individual investors. Individuals will be driven in to Venture Capital Trusts, which are not a funding source.

    Most people are happy to pay CGT in the 10-20% range; risking your money (a total loss is a real outcome) and then have half taken away if you are involved in something that creates jobs, export earnings, pays rent to landlords, VAT etc is plain bad economics and bad politics.

  • http://www.diletttantemusic.com Juliana Farha

    Other than as an attempt to slag off the Labour government, this post in which Baillieu ‘guesses’ what he thinks ‘might’ happen is completely meaningless. In fact, Baillieu simply flies the ideological flag when he says, ‘after 13 years of the state becoming more and more bloated, the government appears to understand that key to the recovery is a vibrant private sector.’ What’s the evidence that the coalition government understands this? All we’ve seen so far is a ham-fisted approach to setting CGT policy.

    • http://www.bootlaw.com Danvers

      Juliana – thank you for your comment. I thought my criticisms of the Labour government were pretty muted. But in terms of guess work, yes, I have said it is just that but have also directly quoted the only meaningful (or official) statement we are likely to get prior to the budget, from the coalition agreement. We’ll soon find out what is happening to CGT, but this was simply an effort to give it more context.

      In terms of the government encouraging the private sector, taking measures to cut the deficit this year and thus restoring investor confidence is a pretty good start.

  • Bill Haslowe

    I have to agree with Juliana here old chap. There’s more than a whiff of politicking about this post that comes off as thinly veiled rant or political point scoring exercise. There’s certainly not a lot of substance in it. You couldn’t even resist in your comment “I thought my criticisms of the Labour government were pretty muted” – who asked for your criticisms of the Labour government, muted or otherwise?

    How about you come back when there’s actually something to announce and analyse… and maybe leave the politics out of it.

  • http://www.primemaths.co.uk Wilfred

    The germans have a saying “Man soll den Tag nicht vor dem Abend loben”. Rough translation – Don’t praise the day before the evening.

    Might be wise to keep this in mind.

  • Gideon

    A long time ago in the then Inland Revenue I was working, and attempting to calculate the impact on revenue of the first change to CGT in 1997, which changed from the simplicity of the rate being the same as your marginal income tax rate, of which there was then 2, to having 2 different tapers, that ran for 10 years. I think the FT calculated that there were 240 different possible tax rates. This was of course announced as a simplification…

    Simplification is a non argument here, the overwhelming number of those who pay CGT can afford a computer to run a spreadsheet, or if they are old school, an accountant.

    Intellectually, putting aside the real problems with abusive avoidance by the wealthiest, it is difficult to see why income from working should face higher tax rates than income from in investment taken as capital gains, and in a progressive tax system, you would probably favour returns on work over investment. Seems fair to aim at making them roughly the same for most people.

    However, taxing inflation is unfair, and when equity comes for a business owner many years of work, there should be relief or exemptions to reflect they may not have earnt as much income, and have some relief, or lower rate, rather than have most of it at the higher rate as was under Thatcher.

    For those who want to argue for lower rates on the grounds that angel investment create jobs I agree, spending money always generates some activity and usually some employment – but if they instead saved in some other way, say put the same money into their pension or bought some other assets, this would also create jobs, and even if they decided to instead spend the money instead, that would create jobs as well. There is no reason to seek to systematically distort investment across the whole economy – the tax you pay on returns should be the same. However we know that equity investment is hard to come by below VCTs, so there is justification for schemes such as EIS.

    In 1997 the Taper was introduced with the idea that “long term” investment was somehow better for the economy than “short term” investment. I’ve never seen any evidence of this – and given markets tend to price new information in as soon as they know, – seems inefficient to design a tax system to reward people to hang onto assets they would otherwise sell, just to lower their rate of tax. Indeed, we take this to the extreme at the moment if you hang onto assets until you die, you pay 0% CGT.

  • http://eu.techcrunch.com/2010/06/23/guest-post-the-budget-is-a-win-for-startups/ Guest post: The budget is a win for startups

    […] few weeks ago on these pages, I reviewed the history of capital gains tax (CGT) in the UK and made my predictions for the first budget from Britain’s new coalition government. Luckily for me, I’m neither a betting man or an […]

  • http://bootlaw.com/2010/05/28/guest-blogging-on-techcrunch/ Bootlaw – Essential law for startups and emerging tech businesses – Guest blogging on Techcrunch

    […] You can read the rest on Techcrunch here […]

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