MHA Aberdeen: If capital gains tax rates increase, should I be worried?

Capital Gains Tax (CGT) normally arises when an asset is sold for greater than its original cost and typically, occurs when a company is sold and the owners wish to extract value from their business.

It used to be the case that a company’s shares were sold to a buyer but it has become more popular for a buyer to purchase assets, goodwill, trading connections etc. rather than shares because of the lower risk in doing so.

Either as a result of a business owner retiring, or simply selling an interest in order to move to another business activity, the result tends to be that shareholders will have value sitting in a company which has no ongoing corporate purpose. In other words, cash is ‘caught’ in the company vehicle which requires to be released.

Of course, some will take the view that a company flush with cash can be used for another trading purpose, but the usual preference is to take the cash and dispose of the corporate shell.

The availability of Business Asset Disposal Relief (BADR) to pay tax at 10% of the first £1million of lifetime gains and 20% on the excess thereafter, offers a significant tax saving compared to withdrawing the money by way of a salary or dividend. Take the example of Mr X who has created a cash pile of £200,000 in his company and wishes to extract this before dissolving the company.

If BADR applies and the £1million lifetime allowance has not been used, the tax cost is £20,000. Alternatively, if the money is withdrawn by way of dividend, and there is no other earned income in the year, the tax cost is about £58,000. Further, and assuming no other earnings in the year, the income tax cost will be around £105,000, plus applicable national insurance if the money is taken as salary.

Some tax planning can ameliorate the position, together with the use of one’s annual income tax allowance, but the significant saving summarised above may well explain the view of the new Government deciding to align CGT rates more closely with income tax. Indeed, an accountant in Aberdeen, now retired, was fond of persuading clients to use the solvent liquidation process before a Budget in order to protect the CGT rate that would apply, because he always thought that the Treasury would focus upon CGT as a means of raising cash.

Current media comment suggests that the new Government may well be about to prove the retired accountant correct. Whilst many tax-raising options exist, it is hard to ignore the thought that CGT rates will never be lower and may well not remain unchanged for long.

It has been said that a key reason for a low CGT rate is to encourage entrepreneurs to start businesses, take risks, employ people and grow the economy. As with all matters, a sensible balance requires to be struck between the reward for risk and making money with the requirement to pay tax to the Treasury.

A recent UK Government statistic for 2023 indicates approximately 5.5 million small businesses in the UK (defined as one employing between 0 and 49 people) which accounts for 99.2% of the total business population. Accordingly, selling a small business and paying CGT on the proceeds is of keen interest for many entrepreneurs.

Given this backdrop, it is hardly surprising that there has been a noticeable increase in enquiries about using a solvent liquidation process before the next Budget, even to the extent of accepting that a company in liquidation might be slightly more expensive to administer until relevant assets are sold. If the current CGT tax rate is, say, doubled, the extra administration costs of a liquidator’s involvement may well be more than offset by a tax saving.

As one might expect, HMRC have introduced steps to stop an individual abusing the CGT system. Take the example of a one-man personal services company that generates net annual income of £100,000. The director opts to pay himself a salary of £40,000 and retain the balance in the company bank account. After three years the bank account holds £180,000 which the director seeks to obtain by liquidating the company and paying tax at 10% (better than higher rate income tax on £180,000). One of the HMRC anti-abuse rules is that if the recipient of the £180,000 becomes involved in the ownership, management or direction of a business in the same industry sector within two years of receiving the capital distribution, the CGT benefit will be withdrawn and income tax applied to the monies i.e. seeking to place such person in the same position as he would have been if the full £180,000 had been paid as salary. Taking action now may save a significant amount of tax.

Is this the time to consider the future and seek suitable advice because, if CGT rates increase, you should be worried about the negative cash impact upon you.