We’re not gonna lie. Capital gains tax is a pretty confusing subject. But if you’re planning to sell your online business, it’s essential that you know about it, especially in the UK right now where you could qualify for Entrepreneurs Relief, which is essentially a capital gains tax relief.
Capital gains tax will rise this year (2021) in the US and the UK. It will affect online businesses (especially eCommerce business owners), and because the changes aren’t exactly positive, it’s a really smart idea to learn more about them if you’re planning to sell your business soon.
Why? Because selling before the changes are implemented might give you an advantage in the marketplace.
In this article, we’ll be taking a look at:
If any asset you own has gone up in value, you’ve made a gain. When you sell this asset, your gain is taxable.
To be clear, the selling price isn’t taxed – it’s the gain that is taxed. This is why it’s still important that you do all you can to maximise the value of your business for maximum profits.
But let’s say that you buy a small business for £100,000 and sell it for £200,000. This means you’ll be required to pay CGT on the £100,000 gain.
Capital gains tax applies on a number of assets including, of course, business assets. But while capital gains tax can represent good and bad news, the good news at the moment is that there’s a capital gains tax relief in the UK.
More on this soon. But first …
If you’re planning to sell your business anytime soon, it’s important that you take tax into consideration. Tax shouldn’t be the sole reason you sell your business, but it needs to be taken into account because how you structure your sale will impact any after-tax proceeds you receive.
And when the tax code is changed (as is about to happen), the timing of when you sell your business becomes more critical.
Capital gains tax has always been charged at a reduced rate versus income tax in the US and UK. It’s therefore a soft target.
However, capital gains tax is also a really easy target for politicians who’d rather not go after alternative wealth taxes instead (such as mansion tax). And instead of introducing a new tax, or increasing income taxes, governments have decided to put capital gains tax on the table.
Capital gains tax has always puzzled a number of entrepreneurs who wish it could be simplified. And indeed, in the summer of 2020, Rishi Sunak, the UK’s Chancellor of the Exchequer, ordered a review of Capital Gains Tax in lieu of the COVID-19 pandemic, appealing to the Office of Tax Simplification for help with simplifying CGT.
The review was published at the tail end of that year, and in it was the proposal to “more closely align capital gains tax rates with income tax rates … for the potential to raise a substantial amount of tax for the Exchequer.”
In short, the recommendation is that any gains made on accrued value in a business will henceforth be paid at similar rates to income tax.
We can possibly blame the COVID-19 pandemic for this, of course, because the repercussions of the subsequent economic fallout will definitely spread to businesses as the Treasury seeks ways of recouping the money that was spent during the height of the pandemic.
And some of the suggestions in the report appeared to raise tax revenue.
Deloitte, an accounting firm, read the report and commented, “the UK has one of the lowest capital gains tax rates in Western Europe (in particular among nations with no Wealth Tax), so with the current cost of government COVID-19 measures, capital gains tax looks a reasonable target for some increased revenue.”
That said, Deloitte also disparaged the complete alignment of capital gains tax and income rates as being too radical, and would instead rather push for a more moderate approach. At the time of writing, nothing has been officially declared just yet, so we can assume Rishi Sunak is still considering the recommendations offered by the report.
Over in the U.S., new President Joe Biden’s government has also hinted that it will raise capital gains tax so that it aligns with income tax. However, the caveat is that only those who are making more than $1,000,000 a year will be required to pay at the new rate.
Biden and his team tried to sound as fair as possible when they said they were “asking those making more than $1,000,000 to pay the same rate on investment income than they do on their wages.”
Biden and his team actually raised this possibility during their election campaign. Now that they’re installed in the White House, we fully expect the government to go full steam ahead with their plans to increase capital gains tax on incomes over $1,000,000. Doing so means that capital gains tax aligns with income tax rates, and this will put the U.S. on par with the UK, as well as Scandinavian countries such as Norway, Denmark and Sweden. These nations typically level high rates of CGT, with top rates currently tipping 42%. Iceland is the exception to the rule at the moment.
It’s also worth mentioning that if the UK decides to completely align capital gains tax with income tax rates, the UK would become one of the most punitive European nations in terms of current tax regimes. At the time of writing, both France and Germany – two heavyweight European nations – levy their capital gains tax at 30% and 25%. Germany’s threshold is relatively low, with tax owed when capital income rises above £700. In comparison to the UK model at present, there are other European nations that have even lower capital gains tax rates, including the Czech Republic and Greece.
Only two EU countries – Switzerland and Belgium – levy zero capital gains tax on individuals.
If you’re thinking of selling your UK-based business anytime soon, here’s the really important bit: The Tory government has made a crucial change to the capital gains tax that could affect you. But first, let’s rewind to 2020 …
In March last year, Boris Johnson’s government decreased the lifetime limit that entrepreneurs are eligible for in the Entrepreneur’s Relief scheme. While entrepreneur’s were once entitled to £10,000,000, after March 2020, they could now only dip in for £1,000,000.
The system was renamed, too, and now goes by the name of Business Asset Disposal Relief. In better news, entrepreneurs could at least pay a small rate of 10% capital gains tax on their first £1,000,000 of CG when they flog their business.
That all said, the relief is now the centre of new attention. We don’t expect the UK government to dispose of it altogether, but more changes are apparently in the offing. For one thing, the threshold percentage ownership needed to qualify is expected to change from 5%, while the lifetime limit is again expected to shrink even more.
Over in the U.S., meanwhile, Joe Biden’s Democrats, of course, won the election. As such, we fully expect his government to press ahead with their proposed tax changes. But naturally, the situation in the UK isn’t as clear cut. We expect some changes, but no one is certain as to the extent of the changes, or even when the changes will be implemented.
According to Deloitte, if the UK does align its capital gains tax more closely with its income tax, it will be taking a different path to the rest of the G20 nations. This isn’t necessarily a good thing. In fact, it will most likely put the UK at a disadvantage. And when you throw Brexit and COVID-19 into the mix, the timing could not be worse.
The OTS report, which Deloitte have analysed, itself agreed that raising capital gains tax rates would cause behavioural changes. For example, people would be less willing to get rid of assets in case they triggered a tax charge. As a result, capital gains tax would have a greater “lock in” effect.
That all said, slashing the Entrepreneurs Relief Lifetime limit by a whopping 90% may have thrown a spanner in the works already, forcing the Chancellor of the Exchequer into a rethink. And because the intention all along was to simplify CGT, there’s every chance that the UK government will look at the likes of Canada and Australia as it seeks a model to base its revamped tax structure around.
When it comes time to sell your business, you must be the sole trader (the exclusive business owner), and you must have owned the business for at least two years.
The UK government’s rebranded and renamed Entrepreneurs’ Relief means entrepreneurs will be charged capital gains tax at 10% on the first £1,000,000 they make. For those who pay 20% on most of their assets (higher-rate taxpayers), you’ll be charged at 50% the usual rate.
The allowance applies to individuals, which means £1,000,000 is the most you can claim per individual – as opposed to each business that you plan on selling.
If you make gains over the £1,000,000 threshold, you will be taxed at the full rate, which is 20% if you’ve received capital gains or taxable income over £50,270 in 2021-22.
The clue is in the name with this one. Entrepreneurs Relief means that – if you successfully claim it – you won’t have to pay as much tax as you ordinarily would.
If you’re a sole trader, you can claim Entrepreneurs Relief. You can also claim it if you’re a partner selling a business’s assets or you control 5% or more of the businesses net assets that you’re selling.
The relief, however, doesn’t apply to any property portfolios that have been held within a business structure, and this includes portfolio landlords.
However, there are some further conditions you need to be aware of. If, for example, you’re inheriting a business and you plan to sell it instantly, you won’t be entitled to the relief. It’s the same if you purchase a business and sell it instantly. Indeed, you need to be in qualifying circumstances for the past 2 years at least.
It’s the same if you’ve got a property investment business that you now plan to sell. In that case, you wouldn’t be eligible for relief.
Okay, let’s imagine that you don’t qualify for the relief. Then what?
You’ll have to work out your capital gains bill exactly as you would if you were to sell any other type of asset. This means calculating the gains you made on the sale of your company, which is to say you arrive at a sales price and then take away what you originally paid for it, along with any additional investments you made in the company and costs related to selling and buying it.
Once you’ve got your figure, you then need to remove your personal allowance.
Anything you gain above this number will require you to pay capital gains tax, which is 10% for taxpayers and 20% for higher-rate ones.
Also, when calculating your tax bracket for the year, capital gain counts. So this means that if you are currently a basic-rate taxpayer, big capital gains might mean that you end up paying at a higher rate.
To claim entrepreneurs relief, you need to head over to your HMRC account and scroll down to the “Capital Gains Summary” section. This covers everything in more detail.
That said, we heartily recommend that you talk to your accountant before making a claim, as they will be able to a) confirm whether or not you can qualify, and b) help you avoid key mistakes.