Allister Heath

Darling must scrap his tax attack on entrepreneurs

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Gordon Brown can’t stop himself from meddling, even with his own good ideas. Soon after he moved into No 11 Downing Street, he introduced one of the best pro-growth capital gains tax regimes in the world. Last week his Chancellor Alistair Darling, with Brown grinning approval beside him, undid much of that good work in one fell swoop.

Their primary target was the City’s private equity industry; but their destructive 80 per cent tax hike will also ensnare farmers, entrepreneurs, small companies quoted on the Aim market, life assurance companies, 1.7 million employees who participate in company share schemes, business angels and venture capital funds, to name but a few. Combined with a previously announced corporation tax rise from 19 per cent to 22 per cent for small firms, this makes Britain a dramatically less friendly place for entrepreneurs from next April, when the changes are due to kick in.

For once, the main business groups have done the right thing: they have put aside their rivalries and are mounting a concerted campaign to convince Darling to change his mind. The joint letter they have written to the Chancellor is laudably robust.

Under the old system, introduced in 1998 and subsequently improved, ‘taper relief’ ensured that the tax payable on capital gains fell to 10 per cent for certain assets held for as little as two years, rather than the maximum 40 per cent rate. Private equity firms almost invariably paid only the 10 per cent rate, as did entrepreneurs selling shares in their businesses that they had held for at least two years.

Taper relief will now be abolished, as will the sliding-scale rates of capital gains tax, to be replaced instead by a single, flat 18 per cent rate applicable to all types of assets regardless of the period of time for which they are held, meaning that many will be hit by an 80 per cent tax increase. The Chancellor also wants to abolish ‘indexation allowance’, which reduces taxable gains on assets held over the long term to take account of inflation. These moves will bring in an extra £900 million a year of tax revenues by 2010/11.

The increase will certainly hit private equity firms: some may well decide to up sticks and move abroad. Even after the changes, however, most private equity partners at the top London firms will continue not to pay capital gains tax at all — because they are non-domiciled.

By contrast, employees who own shares in the companies they work for will no longer enjoy an advantageous tax status, a development that could discourage some firms from offering stock options. A farmer with 500 acres of land could be landed with extra tax of £200,000 were he to sell up. Entrepreneurs who spent a lifetime building their businesses will now see their tax bill surge when they decide to sell; many may choose to do so in a rush over the next few months and take early retirement. From 6 April next year, many Aim stocks will incur an 18 per cent tax charge, up from 10 per cent today; one of the main advantages of holding shares in the junior market will have been swept away.

There will be one class of winners from the changes, however, and that is buy-to-let property investors and those with second homes. Previously, most of these paid between 24 and 40 per cent on their capital gains; now they’ll only have to pay 18 per cent. All tax cuts are gratefully accepted; but it is absurd to cut capital gains tax on buy-to-let investors and property traders — encouraging yet more people to put all their eggs in that particular basket — while making it less attractive to start a new business.

But then Darling’s entire attempt to overhaul capital gains tax is sorely misguided. Brown’s tax-regulate-and-spend regime was deeply flawed but at least it was remarkably supportive of entrepreneurs and long-term investors. If Darling is to protect what is left of this government’s crumbling reputation for economic competence, he should swallow his pride, admit he’s wrong and scrap this misguided reform.