Growing call to scrap entrepreneurs relief

The introduction of incentives such as entrepreneurs relief have resulted in business owners shifting their income around to minimise tax payments, rather than encouraging investment, according to research by the Institute for Fiscal Studies (IFS)

The IFS says its analysis of UK tax records shows that, in general, company owner-managers respond to changes in income taxes by adjusting how and when they take money out of their company and not by changing the amount of income they create or how much investment they do.

It claims the findings indicate many company owner-managers hold significant sums of cash in their companies in order to access lower capital gains tax (CGT) rates and thereby substantial tax savings. It also says business incomes, and therefore the benefits of lower taxes on such income, accrue disproportionately to those at the very top of the income distribution. According to the IFS, systematic retention of income within owner-managed companies is large, particularly for higher income individuals; this income is held as cash and equivalent assets, and is not associated with increased investment in business capital.

The think tank’s research indicates that company owner-managers are very responsive to taxes, citing the large number who report earning an income exactly equal to the higher rate threshold in income tax, along with the large reductions in taxable income following the introduction of the 50% additional rate and the withdrawal of the personal allowance above £100,000.

The IFS says that, in principle, these responses could reflect a higher rate of tax deterring real business activity, but states it could find no evidence of this. Instead, the responses to thresholds and policy changes are due to owner-managers changing the timing of when dividends are taken out of the company.

Owner-managers whose income fluctuates around the higher rate threshold choose when to withdraw income in order to smooth their taxable income across tax years and thereby avoid paying the higher rate when their incomes are temporarily high.

Company owner managers also enjoy significant tax savings by retaining income in their companies, often for long periods and until liquidation, in order to access entrepreneurs’ relief, which enables business owners to pay a reduced 10% rate of CGT on all gains on qualifying assets, rather than the standard 20% rate.  

The IFS said it did not find any evidence that tax-motivated retention of profits translates into more investment in business capital; profits retained with companies are held as cash or other liquid assets.

The think tank points out that entrepreneurs' relief costs the government £2.4bn a year relative to taxing gains at the full CGT rate. This revenue cost would be even higher if calculated relative to taxing the income as dividends or labour income. The policy is also arguably unfair in that it favours those who are able to save their income within a company.

There is support for the IFS analysis from the Association of Accounting Technicians (AAT) which is calling on the government to scrap entrepreneurs relief and replace it with initiatives or reliefs that encourage business start-ups or scale-up activity.

Phil Hall, AAT head of public affairs & public policy, said that Entrepreneur’s Relief is ‘extremely expensive, misguided and ultimately ineffective [and] if the government is serious about wanting to encourage entrepreneurialism, committing this £3bn of relief to helping small British businesses to grow and prosper would be a far better investment for UK plc than encouraging business owners to do nothing more than sell-up.’

IFS report, Intertemporal income shifting and the taxation of owner-managed businesses

By Pat Sweet

Pat Sweet |Reporter, Accountancy Daily [2010-2021]

Pat Sweet was the former online reporter at Accountancy Daily and contributor to the monthly Accountancy magazine, pub...

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