Stephen Hemmings is a tax partner and technology sector specialist at accountancy firm, Menzies.
If changes to the Capital Gains Tax (CGT) regime are announced by the Chancellor in his forthcoming Budget Statement, the entrepreneurs behind existing and future tech firms may be forced to rethink their business plans. This could have a limiting effect on the economy, just as the post-pandemic bounce back is gaining momentum. Wider corporate tax and employee tax increases could have a similar effect.
With a review of CGT currently underway, some businesses are concerned that the Chancellor, Rishi Sunak, could decide to raise the rate of tax applicable to certain gains as high as 45%. For tech businesses, such tax increases, which primarily affect business owners and those investing in growing businesses, would have a disproportionately negative impact. Some entrepreneurs could choose to accelerate plans to sell their businesses or potentially even explore ways to move overseas.
Earlier this year, concerns were raised about a potential increase in the rate of CGT, just ahead of the March Budget. The effect was quite startling, as tech sector entrepreneurs sought advice on bringing forward plans to sell their businesses. While some sales were completed at the time, in other cases, entrepreneurs were persuaded by their advisers to hold out, in the hope that the feared tax hike would fail to materialise and increases in trading activity would bring opportunities to increase the value of the business. Those that chose the latter have in most part been proved right. Economic growth in the first half of 2021 has been stronger than many experts had predicted this time last year, and growth opportunities in the tech sector have been more evident than in other sectors, largely due to the shift to doing more things online during the pandemic.
As the second Budget of the year nears, tech sector entrepreneurs are concerned that this time around, they may not be so lucky. Certainly, increases in CGT rates at some stage would seem inevitable, as the Government is seeking to recoup some of the money spent on supporting businesses through the pandemic. However, it is still worth bearing in mind that they may not come all at once and they may not be announced before next year.
The current main rate of CGT is set at 20% for higher and additional rate taxpayers, which compares favourably with the rate of income tax applicable to this group. The tax is payable on gains earned by individuals from the sale of assets, such as shares and property. For entrepreneurial business owners, the comparatively low rate of tax that applies to gains from the sale of their shares is regarded as ‘payback’ for the time and money they put in to getting their business up and running, not to mention the jobs created for others along the way. Increasing this tax to anything over and above 38%, which is the rate that currently applies to share dividends, would disincentivise entrepreneurial investment and could have a damaging effect on the economy as a whole.
Any increase in the rate could also act as a disincentive to external angel investors whose investment doesn’t already qualify for the Enterprise Investment Scheme. Such investors provide key investment to facilitate growth in early-stage tech businesses, who at this point are not attractive to larger equity investors or debt funders.
With corporation tax due to rise to 25% in 2023, it is already clear that the tax landscape in the UK is becoming less attractive to entrepreneurs that might be seeking to establish and grow tech-led businesses in areas such as London, which is known as the digital capital of Europe. Compounding this, if the Chancellor decides to abolish Business Asset Disposal Relief, at the same time as increasing CGT rates, the effect could be to drive entrepreneurial investors overseas.
Instead of taking this approach, the Chancellor should be speculating to accumulate, by incentivising entrepreneurial investment and encouraging businesses to spend more on skills development, in order to give the economy the further boost it needs. Underlining the value that such an approach could bring, the think-tank, NESTA, has predicted that, if left unaddressed, the digital skills gap could cost the UK economy upwards of £2 billion annually.
A recent report published by TechUK, entitled Fast Forward for Digital Jobs, calls for the introduction of a new digital skills tax credit, perhaps modelled on the R&D tax relief scheme, to incentivise small and medium-sized businesses to invest more in training their workforce. Now would seem the right time for the Chancellor to make this happen. In addition to this, he could also consider ways to make the apprenticeship levy work in a more flexible way, so it can provide more support for employer-backed training initiatives.
Tech sector growth in the UK has been a success story to date, and the corporate tax landscape has certainly helped by incentivising entrepreneurial investment and keeping corporate taxes lower than in many other jurisdictions. Changing this now, just as businesses are facing challenges in the form of rapid price inflation and shortages, could limit growth and damage the economy in the longer term.
