Chris Etherington

Written by: Chris Etherington

Chris Etherington

Partner

HMRC’s nudge letters could prove costly for business owners

HMRC has confirmed to the Chartered Institute of Taxation that they intend to send ‘nudge letters’ to some taxpayers who sold shares in the year to 5 April 2020. It is likely to focus on those who have made substantial gains during their lifetime and may have inadvertently exceeded their ‘lifetime allowance’ for Entrepreneurs’ Relief.  

Specifically, the letters will be sent to individuals whose tax returns for the year to 5 April 2020 show proceeds from a disposal of shares and this amount differs from that declared by the acquiring company. It’s a fair assumption that the purpose of the nudge letters is to establish whether more sale proceeds in the year to 5 April 2020 should have been taxed at the higher 20 per cent Capital Gains Tax (CGT) rate.

Entrepreneurs’ Relief was subject to substantial changes in March 2020 when the Chancellor reduced the lifetime allowance (i.e. the amount of gains that qualify for the relief during a taxpayer’s lifetime) from £10 million to £1 million. At the time, many business owners were concerned about changes to Entrepreneurs’ Relief and the effective increase in CGT rates on a proportion of their sale proceeds from 10 per cent to 20 per cent.

One particular area of focus is likely to be on transactions involving deferred consideration, commonly known as earnout consideration. A significant proportion of transactions involve earnout consideration, which is often determined by the future performance of the business. It can therefore be challenging to accurately value such consideration at the time a deal is done because the future performance of the business is unknown.

There is therefore a risk that business owners may have overvalued their earnout consideration at the time of a deal so that more of the consideration qualified for the Entrepreneurs’ Relief tax rate of 10 per cent, rather than the standard CGT rate of 20 per cent.

This will be unwelcome news to business owners who sold out in the year to 5 April 2020 and those receiving a nudge letter will be encouraged to make a disclosure using the Digital Disclosure Facility. Quite rightly, many business owners may have assumed HMRC was satisfied with their tax returns as the normal enquiry window for that tax year is now closed. 

Any HMRC investigations could be challenging if they involve questions around value but there is a lot of potential tax at stake. In the year to 5 April 2020, £21 billion of Entrepreneurs’ Relief was claimed by those with capital gains over £1 million. Those receiving a letter will need to be well-prepared to evidence and potentially fight their case with HMRC that they have paid the correct amounts of tax.

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