Today we had the Chancellor’s first Spring Statement since the decision to move the Budget to the Autumn. The Chancellor took pains to manage expectations downwards but, while there were no major tax announcements for the new financial year, there were some interesting consultations launched and updates on earlier consultations.
Entrepreneurs’ Relief (ER)
ER provides a reduced 10% capital gains tax (CGT) rate for gains on qualifying business assets including shares held by directors or employees. This means that entrepreneurs can keep more of the rewards when their business is successful. Generally an individual such as a founder must own at least 5% of the company’s shares in order to qualify for ER but there is a risk that founders may become victims of their own success. They may be diluted below this 5% level and lose their ER eligibility if the company’s expansion and their fundraising efforts result in the founders’ own shareholding percentages becoming reduced. It has been suggested that this may act as a barrier to growth for some firms. Such an outcome conflicts with the intended purpose of ER, so the Government is now consulting on a proposal to remove this barrier.
It is proposed that, where an individual’s shareholding is about to be diluted below 5% on a company share issue which is part of a commercial scheme or arrangement to raise funding :
- individuals may elect to be treated as having disposed of and re-acquired their shares at the market value immediately before the new share issue, and
- individuals may defer the taxation of this gain until an actual disposal of the shares to avoid a charge on “dry gains”. On the eventual disposal, the deferred gain would become chargeable at the ER 10% rate together with the subsequent gain (the increase in value since the deemed disposal and re-acquisition) which would be taxed at normal CGT rates.
For example, assume 1000 shares were acquired at £1 each and were worth £5 each at the time of the fund raising and disposal election and were eventually sold several years later for £10 each. The ER qualifying gain would be £4000 (£5000 – £1000) and tax on that gain would be deferred. On the eventual sale of the shares for £10,000 several years later, the deferred gain of £4000 would be taxed at 10% and the subsequent gain of £5000 would be taxed at the usual CGT rate, currently 20%. This assumes that the shares increase in value after the fund raising. If they fall in value, the consultation proposes that the loss should reduce the gain charged at the 10% rate if the individual had elected to defer the taxation on the ER gain.
The Consultation Document can be found here
Corporate Tax and the digital economy
It is now widely acknowledged that international taxation systems are not fit for purpose to cope with multinational businesses operating in the digital world. Most countries are only able to tax companies which are resident or trade through a permanent establishment there or have income from sources within that country. A company may have no physical trading presence in the UK but derive substantial revenues from monetising its UK user base, typically by selling online advertising targeting those users. The Government published a paper with initial thoughts at the time of the Autumn Statement, see Richard Taylor’s earlier blog post here. The EU and OECD are also actively considering possible ways to tackle this problem, see my colleagues’ article on leaked EU proposals here .
The Treasury published a further position paper today, available here . This provides more detail as to its current thinking on the complex issues arising and contributes to discussions at EU and OECD level. The Government believes that the focus should be on businesses which collect user data to monetise it to create value for their businesses, not merely soliciting customer feedback for product improvement. The ultimate goal should be an international system which identifies how much value companies derive from user participation and then allocates the rights to tax that value between the jurisdictions in which those users are based. There are obvious practical issues here: how does one locate users with certainty and identify differential amounts of value provided by users? which company in the group should bear the tax? how can it be enforced? Take AirBnB for example, both the person providing accommodation and the person seeking it are users of the platform and both generate value through their participation.
This could only work effectively with international buy-in and substantial amendment to double taxation agreements. The Government’s stated preference is an international solution but it states that it is prepared to work towards an interim solution alongside like-minded countries or unilaterally in the absence of sufficient progress. This would be difficult without amendment of double tax treaties but the Government was prepared to pre-empt the BEPS process when it introduced the Diverted Profits Tax in 2015, arguing that this was a new tax not covered by its double tax agreements.
Enterprise Investment Scheme (EIS) Funds
Following the Patient Capital Review, the government would like to explore possibilities for a new EIS fund model focused on knowledge-intensive companies. Currently there is no model for a formal EIS fund, as opposed to a looser arrangement in which EIS investors agree to co-invest in qualifying companies. In particular the Government may consider giving income tax and CGT deferral relief for investment in the fund itself, on the condition that the capital is invested within a specified time window, for example two years. This might enable fund managers to raise larger amounts for investment over a longer period. This would be accompanied by a longer holding period requirement to ensure that funds are invested in companies for a minimum of three years. The paper is available here .