Entrepreneurs' and business investment relief
Starting and growing a new business is a daunting prospect. Despite the UK being ranked
8th in the world for ease of doing business by the World Bank [link 143], about 1 in 10 UK
businesses cease trading every year. The five-year survival rate for new businesses was
42.4% as of 2018 [link 144], i.e. a majority of new start-ups go out of business within five years.
Starting a new business requires founders and investors to risk a significant amount of
capital, as well as time and effort, on a venture that has a high risk of coming to naught.
It is certainly a safer bet to invest in an established company. However, if everyone did that
we would be deprived of the important role new firms play in creating dynamism and
innovation, which can help to boost economic productivity [link 145]. A great deal of concern and
action has been dedicated to incentivising the creation of and investment in new
businesses via tax reliefs.
Less attention has been paid to the sacrifices required of start-up employees. Building up
any new company is necessarily a cooperative process in which founders, investors, and
employees all play a key role. Working for a new business is often at least as demanding
and risky as investing in it. As this specific topic seems to have generated little interest
data is hard to come by, but a study of the Danish labour market suggests that start-up
employees earn less than workers hired by large, established firms, both up front and over
the long-run. The high risk of start-up failure, leading to a spell of unemployment, can
damage a worker's earning potential for many years [link 146]. By contrast, a survey of the UK
start-up job market suggests that start-up employees are paid about £10,000 more than
the national average, though this might be partially explained by UK start-ups being
concentrated in London, where salaries are high in general, as well as the fact that they
work especially long hours – nearly 50 hours per week on average. The UK start-up job
market may be particularly unappealing for women, who are found to frequently experience
discrimination, who are paid 25% less than men, and who are less likely to be promoted to
leadership roles [link 147].
In this context, a tax system which prioritises those who risk their capital over those who
contribute their labour is another example of policy benefiting the wealthy.
Entrepreneurs’ Relief.
Entrepreneurs’ Relief – now known as Business Asset Disposal Relief (BADR) following
reforms introduced in April 2020 – is a Capital Gains Tax (CGT) relief that business owners
can claim when they sell up. BADR allows owners to pay just 10% CGT on gains made on
qualifying assets, just half the usual rate [link 148]. The lifetime limit on gains that the relief can be
applied to is now set at £1 million, a reduction from the previous limit of £10 million, but
this still means that owners can save up to £100,000 on lifetime profits of up to £1 million –
a lot of money for one person by any standard [link 149].
According to the Office of Tax Simplification (OTS), Entrepreneurs’ Relief was the most
expensive tax relief available to business owners and investors, despite a lack of evidence
that it actually encouraged investment in new and growing businesses [link 150]. HMRC estimates
that it cost £2.7 billion in 2019-20 [link 151]. Estimates of the impact of reducing the lifetime limit
suggest that this cost could be halved over the next few years, but that would still leave a
significant expense going towards something which may not actually achieve its intended
goal of encouraging entrepreneurship.
A survey conducted by HMRC found that the vast majority (84%) of the beneficiaries of
Entrepreneurs’ Relief were unaware of the tax break when they made their qualifying
investments [link 152]. This should immediately cast doubt on the efficacy of the policy as it can
hardly be shaping the behaviour of those who don’t even know it exists. Beneficiaries tend
to be relatively old with an average age of 57 and 82% are men. Just 12% made claims on
gains of over £1 million, suggesting most would be largely unaffected by recent reforms,
though that 12% accounted for 69% of the total value of gains, which does demonstrate the
cost-saving potential of the lower limit.
Analysing these statistics, a report by the Resolution Foundation suggested that the main
impact of Entrepreneurs’ Relief may have been to give retiring businessmen, who were
going to sell up anyway, an unexpected windfall. It may also have contributed to the
doubling of the number of incorporated self-employed over the past decade, as individuals
seek a tax advantage, but this boom has not been associated with a rise in the number of
self-employed employers which has remained stagnant [link 153]. Research by the Institute for
Fiscal Studies (IFS) suggests that Entrepreneurs’ Relief and the other tax advantages
afforded to capital gains primarily change how and when owners take money out of their
company. They prefer to retain profits and build up the value of their shares, instead of
taking a higher salary or paying out dividends, but this does not actually encourage more
investment, with retained profits held in the form of cash and other liquid assets, rather than
productive capital [link 154].
In summary, the available evidence suggests that Entrepreneurs’ Relief has been a boon for business
owners and it may have shaped their behaviour to the extent that they may be
more likely to incorporate and to save up capital gains for the sake of maximising their tax
advantage. However, there is a worrying dearth of evidence to suggest that it actually
encourages entrepreneurship. It may be nothing more than a public subsidy of the
personal wealth of owners. Its reform and rechristening as BADR may mean less money is
wasted on an ineffective and inequitable tax break, but there is no reason to expect that it
will suddenly start doing what it is supposedly meant to do.
Investors’ Relief.
Perhaps it should not be surprising that Entrepreneurs’ Relief failed to actually encourage
entrepreneurship. The difficulties faced by new firms are typically most acute in the first
few years of the business life-cycle, as shown by the low survival rate of new firms.
Entrepreneurs’ Relief/BADR is arguably, therefore, timed wrongly as it rewards those
owners who have made it to the end – the sale of their ownership stake – rather than
actually supporting founders and new investors at the critical moment. This gap is, to some
extent, filled by Investors’ Relief, but unfortunately this has many of the same problems.
Investors’ Relief is a tax relief which strongly resembles Entrepreneurs’ Relief/BADR in its
design. Whereas Entrepreneurs’ Relief is only accessible to business owners (sole traders
and partners) or company officers and employees who hold shares in said company,
Investors’ Relief is available to external investors in a company, which is not publicly listed
on a stock exchange. (Employees and anyone ‘connected’ with them are specifically
excluded from eligibility).
Investors’ Relief offers the same benefit as Entrepreneurs’ Relief – capital gains from qualifying
assets, which must be held for at least three years, are taxed at half the usual rate – and
still has a lifetime limit of £10 million, which has not been reduced [link 155]. In other words, investors
can save up to £1 million in tax relief on profits they make from buying and selling shares in
unlisted companies. Investors’ Relief was only introduced in 2016 so its long-term impact
remains to be seen. Given that it works like Entrepreneurs’ Relief it could well run into the same
issues: rewarding people at their exit from the business rather than directly supporting their entry,
incentivising the accumulation of capital for tax advantage rather than productive investment, and
ultimately just being a publicly-funded boon for wealthy shareholders.
Employee Shareholders.
What tax relief is available for employees? In short, a limited amount if they are fortunate
enough to be offered equity stakes through a few approved schemes; nothing at all
otherwise.
Enterprise Management Incentives (EMIs): this is an employee share scheme available to
relatively small companies with assets of £30 million or less. Employees who purchase
shares in their company through an EMI scheme pay no Income Tax or National Insurance
on the shares, provided they pay at least the market value - shares bought without making
use of the scheme are treated as taxable earnings [link 156], but that’s all. Notably, any profits
made on those shares are subject to CGT with no relief [link 157]. While offering substantial
savings – employees can buy up to £250,000 of shares via EMIs over a three-year period
which, if subject to Income Tax and National Insurance, could result in nearly half being
taxed [link 158] - this still does not seem as generous as the reliefs available to investors.
Share Incentive Plans (SIPs): employees buying shares in their employer via SIPs are
exempt from paying any Income Tax or National Insurance on the purchase or any CGT on
their sale, as long as they keep them for at least five years. However, SIPs are limited to
just £3,600 in free shares every year [link 159].
Employee Ownership Trusts (EOTs): if shareholders sell their ownership stakes to an
employee-owned trust they can benefit from several tax advantages: the previous owners
benefit that is! Shareholders who sell to an EOT are exempt from paying any Income Tax,
CGT, or Inheritance Tax on those shares. Companies owned by an EOT can pay each of
their employees a tax-free bonus of up to £3,600 per year, but that pales in comparison to
the potential savings shareholders could make by facilitating a tax-free sale of their
stakes [link 160].
The system of tax breaks described above, therefore, treats founders, external investors,
and employees differently even if they all own shares in the same company. External
investors are clearly able to access the most generous array of benefits, while employees
seem to get a comparatively poor deal.
Should Entrepreneurs’ and Investors’ Reliefs be scrapped?
According to a 2016 paper published in the journal Small Business Economics, most
public policies intended to promote entrepreneurship fail to do so. Instead, these largely
reward those already intent on founding or investing in a business, generating artificial
one-person corporations intent on exploiting tax advantages, and ultimately just redirecting
a great deal of public money into the pockets of owners and investors for little apparent
return. The renaming of Entrepreneurs’ Relief as Business Asset Disposal Relief at least
gives it a more honest name: it is a tax relief for people selling stakes in a business rather
than entrepreneurs per se.
Those policies that successfully promote genuine entrepreneurship tend not to be explicitly
associated with entrepreneurship, but rather improve the general ease of doing business
and reduce market failures. For example, publicly-funded healthcare and other benefits
reduce the extent to which employees have to choose employers based on the non-salary
benefits they provide. Higher levels of education can produce more people with the
knowledge and means to start innovative business, and immigration reform could give
companies access to a broader pool of workers with relevant skills [link 161].
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The apparent ineffectiveness of entrepreneurship policies should also highlight their inequality.
As demonstrated above, these policies confer substantial tax breaks to business owners and especially
to external investors, i.e. groups who already tend to be significantly richer and wealthier than the
average person. This makes them essentially regressive, redistributive measures.
If they did what they were intended to do and boosted overall employment and economic growth to the
benefit of all, then such measures might be defensible, but there is little to no evidence that they do so.
These measures also shape the behaviours of market participants in ways that are not
necessarily efficient. For example, they typically require would-be beneficiaries to retain
shares for a certain number of years, when they might not otherwise want to, and have
limits which may discourage investment after a certain point. If removing market failures is
a vital to genuinely promote entrepreneurship, the wisdom of creating distortions via tax
policy is questionable.
Finally, there is also the fundamental question of whether these tax breaks really make any
sense in a capitalist system. Successful entrepreneurship is its own reward, the value of
shares grows so owners and investors profit. Taxation may dis-incentivise such behaviour
to some extent, but surely not any more than the comparatively heavy taxation of
employment income discourages work. While, as discussed earlier, the risks that new
ventures may fail discourages some investors, the other side of that bargain is that the
potential rewards tend to be greater than those found in safer investments. Investors
seeking high returns who have an appetite for risk will always find new enterprises to put
their money into, whether or not governments give them tax breaks for doing so.
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143 https://www.doingbusiness.org/en/data/exploreeconomies/united-kingdom#
145 http://www.oecd.org/sti/inno/3_3_thurik.pdf
146 http://www.olavsorenson.net/wp-content/uploads/2020/02/Final_preprint.pdf
148 https://www.gov.uk/business-asset-disposal-relief
149 https://www.gov.uk/government/publications/reduction-in-the-lifetime-limit-for-entrepreneurs-relief-technical-note/reduction-in-the-lifetime-limit-for-entrepreneurs-relief-technical-note
150 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/699972/OTS_Business_Lifecycle_report_final.pdf
151 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/930728/Oct20_tax_reliefs_bulletin_v7_-_Accessible_Final.pdf
152 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/663877/HMRC_Report_456_CGT_ER.pdf (p. 6)
153 https://www.resolutionfoundation.org/comment/entrepreneurs-relief-has-cost-22-billion-over-the-past-10-years-was-it-worth-it/
154 https://www.ifs.org.uk/publications/14511
155 https://www.gov.uk/government/publications/investors-relief-2020-hs308/hs308-investors-relief-2020
157 https://www.gov.uk/tax-employee-share-schemes/enterprise-management-incentives-emis
158 If all the purchases were concentrated in the Additional Rate bracket they would owe 47% of the total amount
purchased in tax (45% Income Tax rate + 2% National Insurance Contributions) or £117,500. If spread out and
subject to lower tax brackets less would be owed, but the absolute minimum liability would be £79,071.
159 https://www.gov.uk/tax-employee-share-schemes/share-incentive-plans-sips
160 https://www.bdo.co.uk/en-gb/insights/tax/global-employer-services/employee-ownership-trusts
161 http://eprints.lse.ac.uk/67382/1/Acs_Public_policy_to_promote_entrepreneurship.pdf
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