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Accounting Firm Warns Of Capital Gains Tax Change Consequences

by Philip Morton, Investors

30 November 2007

According to accounting firm CLB Littlejohn Frazer, individuals rushing to sell their trading businesses before Business Asset Taper Relief expires on 5 April 2008 may still be caught by the increase in Capital Gains Tax (CGT) announced in the Pre-Budget Statement if they plan to use an earn-out agreement.

"This hike in the capital gains tax payable on disposal of business assets is triggering a mass exodus as shareholders aim to sell up before the 5 April 2008 deadline to minimise their capital gains tax liabilities, but many will be caught out by the structure of the deal," explained tax manager Chris Riley.

"Businesses are frequently sold using an earn-out agreement, and payments under such arrangements will probably be made past the new CGT rate deadline, meaning sellers may still therefore be liable for the new 18% rate," added Riley.

He continued:

"Changes to CGT mean that taper relief will be abolished for all disposals of privately owned companies and trading assets such as properties used in a trading business, with effect from 6 April 2008. This alone will represent a potential increase in the rate of the tax of up to 80% (the difference between the previous effective 10% rate and the new 18% rate). In addition, Indexation Allowance will also be scrapped and the loss of the flexibility of the 'kink test' (which in some cases, for assets owned before March 1982 could increase the level of allowable costs) may increase that differential further."

"It is understandable why business owners would want to accelerate a sale in order to avoid paying additional tax. But business owners need to make sure that the deal is a good one commercially and not be bamboozled into an unsatisfactory sale in order to complete in a hurry, especially when it is possible that the sale will not entirely avoid the new rules because of an earn-out arrangement. Investors must consider all the implications, and not purely the tax consequences of selling business investments, potentially at a discounted value, before the 5 April 2008 deadline."

Riley concluded:

"But individuals can still benefit from the 10per cent rate whilst it is still in force by selling entirely for cash prior to 5 April, or by ensuring that any earn out mechanism used provides that proceeds under the earn out can be cash-settled. This creates potential cashflow issues for the vendor, as the tax liability will crystallize immediately, which will need to be balanced against the potential overall tax saving. A considered approach is needed to address the proposed capital gains tax changes."

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