Deal Point is a regular briefing on issues relevant to corporate transactions, notably M & A and reconstructions. Each edition of Deal Point will focus in detail on one area of law and practice which may be of interest to principals and practitioners in the corporate transactions area.

This edition of Dealpoint looks at the impact upon corporate transactions of the proposed changes to Capital Gains Tax announced by the Chancellor on 24 January 2008.

Capital Gains Tax Reforms "Entrepreneur Relief"

Introduction

In October 2007 the Chancellor announced that taper relief will be abolished with effect from 6 April 2008 and that in its place a single flat rate of 18% will apply to all capital gains made by individuals, whether resulting from business disposals or other capital gains. This impact of this will prima facie be to increase the effective rate of tax payable on most share and business disposals by 8%.

In the face of aggressive lobbying, the government has today attempted to placate business groups by introducing a relief it says 'will benefit the owners of small businesses'. Whilst draft legislation is still awaited, HMRC have today issued guidance summarising the proposed scope of the relief.

Overview

The effect of qualifying for the relief will be that the first £1 million of qualifying gains made during an individual's lifetime will be charged to CGT at an effective rate of 10%. Any gains in excess of £1 million will be charged at the new 18% rate.

The relief will apply to gains arising on disposals of the whole or part of a trading business and gains on disposals of shares in a trading company (in much the same way as the existing taper relief regime). However, to ensure the relief only benefits those whom the government deem to be 'entrepreneurs' it will only be available if the individual making the disposal:

• has been an officer or employee of the company, or of a company in the same group of companies, and
• owns at least 5 per cent of the ordinary share capital of the company and that holding enables the individual to exercise at least 5 per cent of the voting rights in that company.

Relief will also be available in respect of any 'associated disposal' of an asset which was used in the company's business but held in the personal names of the selling shareholders. This is most likely to be relevant where a selling shareholder owns a freehold property used by the Company and disposes of it at the same time as his shares.

In the context of the new 18% rate the relief offers a potential lifetime saving of £80,000. Whilst this will not doubt be a relief to owners of small businesses planning their exits, contrary to statements made by the Chancellor in the House of Commons the value of the relief to business angels and individual venture capital investors appears to be limited. In particular, the officer/employee condition will be likely to be problematic.

The £1 million of gains which qualify for the relief is not to be assessed on a disposal by disposal basis but across an individual's lifetime. Whilst this means that a series of very low value disposals could qualify for the relief up to a lifetime total gain of £1 million, serial entrepreneurs and venture capital investors will not be able to take advantage of the relief on each individual disposal. In addition, the requirement for the individual to be a company officer or employee and have had a 5% stake in the business will create additional obstacles to obtaining the relief which investors (who may not wish to occupy such roles) will need to examine carefully. We will be able to assess how these requirements might be satisfied in practice once draft legislation has been released.

Impact on Corporate Transactions

Whilst the introduction of 'Entrepreneurs Relief' might offer some hope to small business owners, in the context of a significant increase in the effective rate of tax payable on large disposals and by established investors, many will consider the value of the relief insignificant.

We have already seen a desire amongst sellers to accelerate sales processes in order to take advantage of taper relief. Where the sales process is ongoing there is still a reasonable prospect of sellers taking advantage of the existing taper relief regime. Tax planning arrangements can also be exploited to take advantage of taper relief without disposing of the business during the current tax year.

However, sellers should avoid rushing into a 'bad deal' simply to try and sell their business before 6 April. In addition, with the precise legislation governing the relief still awaited, there is still an element of uncertainty for those considering a sale of their business in this tax year.