Rolling the dice on a Labour change to capital gains tax rates, or not!

The speculation surrounding capital gains tax (CGT) is seemingly already leading to a flurry of additional transactional activity as asset holders look to realise their assets before they risk suffering a higher CGT rate. 

Entrepreneurs holding shares in private businesses may be inclined to trigger a transaction before the date of the upcoming Budget. For some, an exit could have been on the cards in the foreseeable future and therefore the threat of an increase in CGT rates may just accelerate the timetable to bank the current 20% rate (10% for amounts within the basic income tax band and the first £1m with the benefit of the Business Asset Disposal Relief.) If all the equity in the business is owned by a few like-minded individuals, then the control exists to permit this action.

However, many entrepreneurs who potentially have a desire to bank the current CGT rates, could have co-investors such as private equity or individuals with a different strategic objective that does not involve a near future exit, which will mean they may not have the control to trigger a transaction pre-30 October. In a similar vein, there will be many management equity holders in private equity backed businesses who may be expecting an exit in the short term but post-30 October, may consider themselves at risk of suffering a hit to their post-tax exit receipts. 

It may be possible that co-investors have an appetite to permit an earlier than planned exit for an individual shareholder or member of management if they have the liquidity to make a purchase of the shares in question and have the expertise to ensure continuity of business.

If not, a shareholder/member of management could start to consider looking at routes that trigger a disposal of the existing equity, paying the tax on the gain now and then looking to reinvest all or some of the proceeds back into the business by subscribing for new equity. The intention here being to bank the gain on the shares up to now at the current CGT rates and only paying future CGT rates on the future gain. Whilst the theory sounds logical there are a few things to be wary of: 

• The CGT liability will need to be funded and therefore the shareholder/member of management will have to find the cash or perhaps reinvest less than the exit proceeds, therefore taking a lower equity stake on reinvestment.
• The bed and breakfasting rules that apply to the disposal and reacquisition of shares in the same class may render the attempt to trigger the gain at current rates and rebase the new shares as futile. The shareholder/member of management may need to reinvest in a different class of share with sufficiently different rights for there to be a disposal, which could have a material effect on reinvestment value. Alternatively, they could reinvest in loan notes rather than equity forgoing an equity return in the future for a lower debt return.
• CGT rates may not go up. Whilst there is a lot of speculation that they will, the government, in particular Rachel Reeves, has been inconclusive on whether this will be a step she will take. Some economic data does suggest that a CGT rise would decrease the CGT take. Therefore, a taxpayer could be rolling the dice and taking action to protect against something that doesn’t happen. 
• There is always the possibility that the government could introduce anti-avoidance rules that seek to prevent taxpayers from triggering a CGT liability in this way, particularly if it is uncommercial in nature. We have already seen Labour take steps to try and prevent taxpayers from avoiding the impact of the VAT changes for private school fees. They could take similar steps in relation to any CGT changes.

For those that have had a realisation event involving shares in their business in mind in the next year or so, the upcoming Budget is proving quite the conundrum, exacerbated by a lack of clarity on the tax policy direction that the government wants to take. Taxpayers could therefore be in a position whereby they just have to roll the dice and see whether the decision is the right one post 30 October. 

One thing is for sure however, if you are a shareholder in a private company that has recently ceased to trade which has value locked in it, the winding up and extraction of value, which would be a capital disposal, should be pursued quickly if you wish to ensure the value is extracted at current CGT rates.