Tax breaks need to be seen to deliver measurable economic benefits

As Theresa May reviews the policies of the previous regime this summer, she might like to pop ‘ER for investors’ on a misappropriation of language pile.

ER stands for entrepreneur’s relief, a little-known tax break that used to be limited to people who have set up their own business and generated a capital gain.

Now, following what turned out to be George Osborne’s last Budget, ER has been awarded to investors in a business, giving them a lower capital gains tax (CGT) rate of 10% on a separate lifetime allowance of £10 million.

I have nothing against giving incentives to investors per se, but their existing tax breaks, such as the Enterprise Investment Scheme and Venture Capital Trusts, are generous and of questionable effectiveness.

What compelling reason is there to give another tax break to the wealthy when others are facing austerity? And why do it through the backdoor by redefining entrepreneurship to include people who may never have started and built a business?

Let me declare an interest here: I’m eligible for ER through my shares in Freshwater, which I’ve held since founding the company in 2000.

ER did not exist in those days, but there was a similar scheme called taper relief. This rewarded sustained business growth by giving 75% tax relief on a capital gain after two years.

In 2008, Gordon Brown replaced taper relief with ER, which reduced the CGT payable to 18% on an allowance of up to £1m provided the shares had been held for one year and the person played an active role in the company.

On taking over as Chancellor in 2010, Osborne increased the allowance to £5m and lowered the CGT rate for ER qualifying gains to 10%. A year later, he doubled the allowance to £10m.

Most business founders will never see gains of that magnitude, but at least ER retained a degree of integrity as a fiscal tool to incentivise genuine entrepreneurship.

That cannot be said of the change Osborne made in his final Budget, unless you use the word entrepreneur so loosely it covers any kind of money making.

Harvard Business School defines entrepreneurship as pursuing opportunity “beyond resources controlled”. Most founders, they point out, start only with their own time and money but soon find they cannot confine themselves to those resources and must take on added risks.

Anyone who’s started a business will know that this journey is fraught with panic attacks and sleepless nights. The first person you employ, the first lease you sign, the first quote you have to honour – all involve a gamble.

And that’s before you have to take a bank loan secured against your family home or accept a private equity investment with a ‘good leaver/bad leaver’ clause that could deprive you of your entire stake in the business.

To me, the essence of entrepreneurship is being prepared to put everything on the line to make a venture succeed. It’s qualitatively different from a wealthy person risking some money they can probably afford to lose.

Tax breaks need to be justified by a social or economic benefit. But there is no evidence that I can find to support the notion that ever-bigger tax breaks for the wealthy on ever-looser criteria deliver a benefit to anyone other than the recipient.

Osborne’s ER hand-out was hardly mentioned in the media, but Investors Chronicle was quick to spot what it really meant. Its Budget report quoted a tax expert saying: “The increase in the distance between income tax and CGT rates will make drawing on capital each year as a form of ‘income’ even more attractive than it currently is.”

In other words, far from encouraging new investment, Osborne has created another way for the wealthy to avoid income tax.

My three-pronged alternative policy would be: first, restrict ER to entrepreneurs; second, review VCT, EIS and other tax breaks for investors to assess their effectiveness; and third, allocate a chunk of CGT revenue to initiatives that support investment like Jobs Growth Wales and funding for development banks.

It is not good enough for politicians simply to say they are ‘pro-business’. Their policies have to be specific and of measurable benefit to the economy as a whole.

Steve Howell

Steve Howell is chief executive of Freshwater UK, the Cardiff-headquartered communications consultancy, and author ofOver The Line, a novel set in the steroid underworld of South Wales. Available in bookshops and via Amazon. Follow him on Twitter: @FromSteveHowell