Who gains with the tax changes?

31-Oct-2007

Gina Lovett

Alistair Darling's decision to scrap taper relief for capital gains tax has generally outraged business organisations and thrown small business owners into possibly taking short-term decisions which they might have postponed taking before the changes. Gin

The new simplified capital gains tax system announced last week by Chancellor Alistair Darling has been widely perceived as a short straw for the business community across the UK.

The abolition of taper relief means that with a flat rate of 18%, business disposal costs will rise, and anyone considering selling their business will look to do so before 5 April next year to avoid paying the 8% increase.

Although the move is broadly seen as the government's response to criticism of private equity groups for paying too little tax on excessive profits, it has provoked outcry among organisations representing business interests, including the CBI, Chambers of Commerce, the Institute of Directors and the Federation of Small Businesses, who say it is, in fact, hitting the private business owner and could stifle investment in the long term.

Martin Kay, head of the London corporate team at Blake Lapthorn Tarlo Lyons, says that the recruitment sector, with over 20,000 privately-owned, small to medium-sized businesses, could be among the casualties of this political measure.

"While trying to hit private equity groups with a jump in taxation, the government has also hit the private business owner," Kay says.

David Silver, managing director at investment bank Robert W Baird, agrees: "The taxation issue is a bit of blunt instrument that's hitting out at the wrong people."

Despite concerns from business organisations raised last week during meetings with Darling and business secretary John Hutton, neither Silver, nor Kay feel that investment in growing businesses or start-ups, especially in the recruitment sector, will be affected.

Kay comments: "A tax rate doesn't inhibit good investment. If there is money to be made, private equity will follow, whatever the tax rate."

Silver points out: "I can't imagine it will hamper entrepreneurship or investment at all. No one wanting to start up or invest in a business will say that they have changed their mind because of changes to capital gains tax."

Within corporate finance, a swathe of groups, including BDO Stoy Hayward, Grant Thornton and FMCB Corporate, have all reported an increase in the number of enquiries about completing business sales by next April.

Christopher Clark at BDO Stoy Hayward says: "The announcement came as a complete surprise. Normally we have about three to four conversations a week with prospective clients, but now this has increased to about 20 a week. There is a significant increase in the number of people who are talking about it."

Clark says that although the changes in capital gains tax could create a flurry of merger and acquisition activity between now and April, it could also result in a subsequent pause, while those who are unable to streamline and maximise their business value within the given timeframe, will be unable to complete deals by the 5 April deadline.

"We could well see a situation where people are focused on the net proceeds and what they want to extract in the long term. It could end up that they hold on to the business for longer than they intended. If people are settling on a definite figure, then they may have to rethink how they are going to get there," Clark points out.

The dynamics of the market could also be affected, he explains, with the supply of businesses for sale within the next six months increasing, resulting in buyers having more choice, which could result in a decrease in price.

Kay disagrees with this forecast. "A good company is a good company. And especially in recruitment, if you have a niche, you can demand a higher price. It's not likely that there are going to be lots of other good quality, niche competitors selling at the same time."

Corporate finance advisors are also warning that with pressure on vendors to complete deals by April increasing, sales that turn out to be more lengthy than anticipated could actually result in buyers having more bargaining power.

"There is an implication that buyers are also going to want to share the benefits [of taper relief], so we could see buyers using the limited timeframe as an opportunity to negotiate on price," says Mat Bhaghrath, partner at Grant Thornton's corporate finance team.

Bhagrath also predicts an acceleration of merger and acquisition activity over the next six months, but, like Silver and Kay, feels that the urgency to complete by April could turn out to be a red herring if aspects of timing, tax and share options are not fully considered.

"The worst thing that a business can do is sell if it is not ready to be sold. People would be badly advised to sell just because of the changes to the capital gains tax," says Silver. "All the changes have done is simply created a deadline for those who are ready to sell," he adds.

Other factors, according to Bhagrath, such as the recent credit crunch could over a period of time, lead to a correction in pricing, or a general decrease in business valuations, as some buyers find it increasingly difficult to raise the finance needed.

• See related Feature Article: Planning your exit strategy