Enterprise tax reliefs still tangled in Budget red tape

The economy grew by more than 2 per cent last year and will probably hit 3 per cent this year. There has been an explosion of enterprise activity reinforced by a dot.com euphoria, which despite the occasional share price "readjustment", seems to have created a sea change in attitudes.

The economy grew by more than 2 per cent last year and will probably hit 3 per cent this year. There has been an explosion of enterprise activity reinforced by a dot.com euphoria, which despite the occasional share price "readjustment", seems to have created a sea change in attitudes.

In the midst of this flurry of commercial activity, the Chancellor, Gordon Brown, has styled himself as a champion for enterprise, announcing a variety of tax breaks and incentives in his last two Budgets.

These clearly have their place, although access to capital and the availability of skilled help, not tax, are usually the more immediate concerns driving start-ups. But allowing that tax will invariably have a place on the entrepreneurial agenda, what do the new Richard Bransons and Martha Lane Fox wannabees need to look out for?

Perhaps the headline measures in this year's Finance Bill, due this Friday and designed to incentivise and reward investment, are those that relate to capital gains tax taper relief on business assets. After all, the motive of entrepreneur and business angel is usually to make a gain.

All shareholders in an unquoted trading company now qualify for a higher rate of taper relief and this will benefit many start-up companies. A typical shareholder profile may include a director owning 20 per cent but not working full-time in the venture and a full-time employee with 4 per cent of the shares. Both qualify for taper relief at the higher business rate. Before, neither would.

Although welcome, the relaxation in the definition of business assets in itself creates complications. Gains may be subject to different rates of taper depending on the relative periods of ownership as either a business or non-business asset. The apportionment is on a strict time basis and does not take account of the asset's value at any given point in time.

In theory, the new rules will mean a tax rate of only 10 per cent (5.5 per cent for lower-rate taxpayers) if the shares are held for four years. This is extremely low. It would be tempting for a busy entrepreneur, concerned primarily on creating the gain to tax in the first place, to accept this as a reasonable rate and not think about it further. This would be a mistake. Like all tax reliefs,the detailed rules are extremely complex and easily broken.

For example, innocent commercial situations can affect the way an individual's holding period is calculated. Changes in the company's activities can restart the taper-clock for all investors so they lose the benefit of the taper accrued up to that point. This can include a trading company involved in investment activities, regardless of their scale.

In business start-ups, the acquisition date of the shares is not important. The date of commencement of trade matters, since this generally causes the taper-clock to reset and start again. Clearly, it is important to trade, not just prepare to, as soon as possible.

The taper rules also apply to all shareholdings by employees in quoted or unquoted companies. The Government recognises the recruitment and retention of key employees is vital in the new economy, for their skills and creativity will underpin the enduring growth of businesses.

But there are pitfalls and it is easy to trigger anti-avoidance provisions inadvertently. For example, giving employees shares that carry conversion rights could result in any gain on the ultimate sale of the shares being taxed as income, not capital, depriving the employee of all taper relief. It may also produce a national insurance charge for the employer, although the Chancellor has promised to look at this further.

Ironically, these employee reliefs threaten to overshadow the new Enterprise Management Incentive Scheme, previously touted as the entrepreneur's essential companion. But the scheme still has its merits. It allows up to 15 employees of small companies (with assets less than £15m) to be able to receive options over £100,000 worth of shares free of income tax and national insurance (employers and employees). Unlike other options the capital gains taper-clock will start running from the time of the grant, not the acquisition of the shares.

The downsides are that options can be granted only to employees who spend a substantial amount of time working for the company. This is not always easily fulfilled in start-ups, which often employ key individuals part-time. In addition, the value of the shares must be agreed with the Inland Revenue, which can be difficult if there has been no market in the shares and values are rising.

Two other schemes entrepreneurs should note are the Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCTs) both of which have undergone minor changes to encourage entrepreneurial and business angel investment in small, higher-risk unquoted companies. There is also the entirely new corporate venturing relief to encourage relationships between big business and the enterprise economy. These schemes are complex to administer and it is again easy for the rules to be breached by innocent commercial decisions.

And once the business is up and running? The red tape includes a wealth of social legislation, VAT returns and PAYE. But the corporation tax burden remains benign. From last Saturday, the rate of corporation tax for businesses with profits under £10,000 is 10 per cent, and the starting rate for medium sized businesses remains 20 per cent.

Some initiatives may be rendered ineffective by bureaucracy, but in the tax arena the Chancellor is pursuing his vision of an entrepreneurial Britain. The only note of caution is that the increasing complexity of the tax legislation makes it all easy to trip without realising it - and the consequences can be expensive.

The authors are tax and business advisers at Arthur Andersen, and specialise in helping entrepreneurs.