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 seek ways of taxing non-business capital gains at rates similar or close to those applied to income, with generous exemptions for entrepreneurial business activities.”
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.