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Tax

Entrepreneurs suffer as CGT rules forget 'earn-outs'

Monday, 28 January 2008

Thousands of entrepreneurs have just days left to sort out a capital gains tax nightmare for which HMRC has no guidelines, accountancy firm PKF has warned.

Many entrepreneurs who sold their businesses in 2005/06 are facing the tax dilemma because the new capital gains tax (CGT) rules do not address the position of payment through loan notes.

Yet they have to tell HMRC what they are going to do before 31 January 2008. PKF tax partner Peter Harrup says that, it is common practice when business-owners sell-up to receive all or part-payment as an 'earn-out' or deferred payment.

Where this is in the form of shares or loan notes, businesspeople are able to elect whether they pay the CGT immediately or defer it until they are able to cash them in.

Owners eligible for full business asset taper relief will pay just 10 per cent on disposals made before April 6th but 18 per cent on later sales.

Many with earn-out rights will, however, not have sufficient cash to take advantage of the lower rate.

The brief notes published by HMRC on the new Entrepreneurs' relief do not say whether they will be able to claim the new relief when cashing in their earn-out rights after 5 April.

HMRC's 'Capital Gains Tax Team' says it cannot comment on the issue until the full rules are published.

Harrup says that it is “quite unbelievable” that no-one at the Treasury or HM Revenue and Customs has thought about this issue.

“It will affect thousands of people; they have less than a week to make a decision on what to do and HMRC has absolutely no answer,” he adds.

HMRC will not confirm if deferred gains attached to loan notes will qualify for the new Entrepreneurs' relief.

Harrup says his firm cannot advise loan note holders whether they should elect to crystallise their taper relief or wait and claim for the new Entrepreneur's relief instead.

The draft legislation is not expected until mid-February when the election deadline will have passed.

"As this mess was caused by the Government, the least HMRC should do is confirm that they will accept late elections by loan note holders and allow them to withdraw elections forced on them by the change in the rules,” Harrup adds.

He hopes that it will also confirm in due course that such deferred gains will qualify for the Entrepreneurs' relief.

"Quite frankly, it's another mess caused by the Government playing political football with the tax system. The tax system is incredibly complex and yet they've gone about rewriting it on the hoof," according to Harrup.

He gives an example of the impact this will have on small firms.

A qualifying business was sold in 2005/06, half for cash and half for an earn-out right in the form of loan notes redeemable in 2009.

The owner had to pay 10 per cent CGT on the cash part by 31 January 2007 but 18 per cent on the other half of the proceeds received when a loan note matures after 5 April 2008.

The owner can elect, by 31 January 2008, to treat the loan note proceeds as received in 2005/06 to get the 10 per cent tax rate but will have to pay the tax now, long before he gets the final cash (and pay interest because the tax should have already been paid).

IIf the owner does make the election it cannot (currently) be revoked at a later date – for example, when the position on the new Entrepreneurs' relief is known.

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