Does tax relief really help encourage business investment? As the political parties gear up for their election manifestos and tax and spending plans, recent research highlights not just the cost of entrepreneurs’ relief to the government, but also questions its effectiveness in promoting business growth.
The report from the Institute for Fiscal Studies (IFS), published in October, claims not only that the cost of the relief has spiraled but is not fulfilling its original remit.
Brought in under Gordon Brown’s Labour government ten years ago, the relief was supposed to boost small business start-ups. Its expansion since then, and higher rates of take up, have increased the cost from a projected £200m a year to £2.4 bn. The relief gives businesses a reduced 10% capital gains tax rate on the sale of qualifying assets up to a lifetime limit of £10 million, a reduction from the standard 20% or 28% for residential property. The qualifying period was increased by Philip Hammond in the 2018 Budget from one to two years with some additional adjustments on distribution of profits.
The IFS report says that their evidence shows business owners use the relief to minimise tax payments, retain profits and pay themselves through their companies in the form of dividends. The relief does not appear to be going into increasing investment in existing businesses or starting new ones, leading instead to owners “adjusting how and when they take money out of the company” by timing their dividend withdrawals and managing their incomes within key tax bands.
The overall effect, the IFS says, is to increase personal wealth by retaining income within a company rather than promoting business growth through investment in their own or other companies. The IFS could not find evidence of higher tax rates deterring business activity, but rather stimulating changes on the timing of dividend payments, favouring those who are able to save income within a company.
In the run up to the now postponed November Budget, the Association of Accounting Technicians (AAT) called on the Chancellor Sajid David to scrap entrepreneurs’ relief entirely and redistribute the savings to start-up and growing businesses. Whether it is on the cards for a new Conservative government after the election we will have to wait to see. The focus on the cost of tax reliefs in general is only likely to get more intense.