There are unlikely to be many tax giveaways in the forthcoming budget, but a new capital gains tax relief could be on the cards for entrepreneurs and help drive investment into new businesses, says Chris Etherington, tax partner at RSM UK.

It has now been over five years since Entrepreneurs’ Relief (ER) was significantly restricted and rebranded, having been tagged as the “UK’s worst tax break” by the Resolution Foundation. The suggestions made by Torsten Bell, the organisation’s Chief Executive at the time, were ultimately heeded by the then Chancellor Rishi Sunak and ER was capped at a lifetime limit of £1m.

Mr Bell now has the opportunity in his new role at the Treasury to influence decision making in a much more direct way and help the Chancellor design a tax system that is effective in driving entrepreneurial activity.

Clearly much of the focus in this budget will be on tax rises and many business owners seem resigned to the fact that capital gains tax (CGT) rates may be increased again. As the Chancellor and Mr Bell will be well aware, anything more than a small increase in CGT rates could have such a distortionary impact on taxpayer behaviour that it ultimately results in reduced tax receipts. HMRC’s own modelling highlights that a 10 percentage point increase in the higher rate of CGT could reduce tax receipts by over £3.5bn by 2028/29.

The principle that taxing something more can lead to less of it is commonly seen with CGT. A case in point is that the April 2024 cut to CGT rates on residential property gains appears to have driven higher tax receipts from the sale of such properties.

Higher rates of CGT can simply result in individuals deferring the disposal of an asset, reducing tax receipts as a result. That in turn, can lead to valuable assets being retained for longer than they otherwise might have been, when they could be used more productively elsewhere by another person. It can also result in potential capital for investment being tied up for longer, contributing to the slow pace of economic growth.

One rumoured option that the government is reportedly exploring is whether to balance out an increase in CGT rates with a new relief for those reinvesting their sale proceeds into new UK business ventures. The number of businesses in the UK has been declining in recent years and there is little in the tax system to encourage individuals to invest and risk their own capital into starting up their own business.

There are some potential tax reliefs available that are not particularly well known. For example, a capital loss on shares in an unlisted trading company can sometimes be set off against income. This appears generous on the face of it, but the amount of loss that can be offset against income in any given year is often capped at £50,000, with the excess carried forward against any future capital gains.

Similarly, investing in shares that qualify for the Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS) can have tax benefits. However, these schemes are more targeted at passive investors like business angels, rather than the business owners themselves and the qualifying criteria are restrictive as a result.

There are also some aspects of the tax system which could arguably be seen as unfair to those risking their own capital. While increases in the value of assets due to inflation are typically subject to CGT, there is no such uplift in the value of any capital losses. Inflation can benefit the government with additional tax receipts, but will erode the value of an entrepreneur’s loss over time.

A new tax relief focused on reinvestment into new businesses could help to address some of these concerns. It would be very difficult to accurately predict the response of business owners to a CGT rate rise accompanied by a new tax relief, but it could help offset a slowdown in deals, an important driver of tax revenues and growth in the economy.

It is not an entirely new concept and there are comparisons that can be drawn from other countries, such as the United States, where the tax reliefs on the sale of and reinvestment into qualifying small businesses are much more generous. We also already have EIS deferral relief which can achieve a similar outcome but has historically been more limited in scope due to EU State Aid requirements.

Those in the midst of a forthcoming deal are still likely to be inclined to try and complete such transactions in advance of the budget to ensure the current CGT rates apply. In the longer term, such a tax relief could shift the behaviour of business owners in a way that ultimately benefits the economy. It would likely mean that the burden of a CGT rate rise falls more on those seeking to retire from their business interests entirely and others selling investment assets.

If a new CGT relief is announced, it might represent one of the few carrots offered up by the Chancellor on budget day to accompany a large bundle of sticks.

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