Monday, December 23, 2024

Budget Dismay for UK Startup and Business Founders

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Come back, Kwasi, all is forgiven. Well, that would be a stretch, speaking as one of hundreds of thousands of people whose mortgage bill increased thanks to Kwarteng’s catastrophic budget. But, for business founders, it’s been a hurtful few days of build up to Rachel Reeves’ budget reveal. Her autumn budget, launched today, has already been subsumed by the debate around Labour’s definition of “working people.”

The us-and-themness of it all would feel particularly divisive, if it hadn’t been so ill defined from the get-go (it’s pretty hard to “other” a group when you can’t even say who they are).

Is a startup founder a working person? How about their first five hires, each on a salary with a monthly paycheck, but also given an equity stake in the business (that will now be liable for an increased capital gains tax rate) as incentive for contributing at its earliest stages? How about a sole trader, or someone who simply saw an empty space on the high street and braved the UK’s virtually unprecedented energy, staffing and rent overheads to start their own business there?

With capital gains tax rising to 24% for higher earners, potentially unwelcome changes to Business Asset Disposal Relief, and a double-whammy of increases to employer national insurance contributions and the national minimum wage, the budget makes for a tough read for anyone founding or running a business in the UK. Profit margins are likely to tighten, and the eventual payoff when selling your stake just took a hit.

“These measures, announced today, will have a massive, and outsized, impact on the UK’s medium sized businesses,” says James Robson, CEO of SME business loan comparison site FundOnion. “It is the businesses with revenue over £500k and less than around £10m that will bear the brunt of these tax rises. This is a mistake that will have huge unintended consequences in the years to come, as small firms take decisions against growth, hiring and investment and medium size firms find themselves unable to do those things without significant difficulty.”

“It’s a triple threat,” adds Warren Mead, CEO of Sumer. “Huge employers’ national insurance hikes, minimum wage increases, and higher taxes on gains. This is a business-busting budget.”

Revealing her budget today, Reeves has said that the only way to deliver growth is to “invest, invest, invest.” To make this possible, she’s unveiled a £40bn roster of tax raises (the largest in 30 years). But, “growth” is an ever elusive concept. Truss and Kwarteng’s uncosted tax cuts couldn’t deliver it. It’s now to be seen if Reeves’ budget can truly create an environment for growth that’s welcoming to entrepreneurs, and ultimately rewarding for their innovation and effort.

The inevitable capital gains tax hike arrives

For startup founders, entrepreneurs, and anyone working for a business that offers shares as a business benefit, the anticipated increase to capital gains tax (CGT) has built an unwelcome tension in recent weeks.

The great fear among entrepreneurs was that Reeves would announce a parity between CGT and income tax – which would be particularly impactful for higher rate tax payers.

In this context, the announced tax hike felt milder than had been anticipated, but it will still be a bitter pill for numerous startup founders and their staff who are holding onto company shares in the hopes of realising a payoff for their hard work.

As confirmed today by Reeves, the government will increase the lower rate of capital gains tax from 10% to 18%. The higher rate, meanwhile, will rise from 20% to 24%.

Reeves was bullish on how, despite this tax rise, the UK’s position as a destination for entrepreneurs could still be defended. “The UK will still have the lowest capital gains tax rate of any European G7 economy,” Reeves said.

Mercifully for the startup community, the spectre of a higher rate CGT of up to 40% never materialised. However, UK business founders are still reacting to the announced CGT hike with dismay.

“Bluntly, the new capital gains tax structure wont help to inspire entrepreneurs to take risks and build companies, and will make attracting investment more challenging,” says Greg Cox, CEO of Quint Group.

“As a small business owner, the cost of business in the UK is really high – there is a breaking point and we are reaching it,” says Natasha Guerra, founder and CEO of Runway East. “ As a flexible workplace operator, we are housing some incredible entrepreneurs who are pioneering radical businesses, but we need to be cost competitive to unleash opportunity and stay attractive – and that requires a competitive tax regime.”

Business Asset Disposal Relief likely to disappoint

While the CGT change hasn’t been as bad as anticipated, there’s a caution over the additional context of an unchanged lifetime limit for Business Asset Disposal Relief, which is to remain fixed at £1m.

That lifetime limit may not be due to change, but business asset disposal relief will remain at 10% this year, rising to 14% in April 2025, then to 18% from 2026.

While this news has been somewhat eclipsed by the lower-than-expected CGT increase, experts are warning it may create a less welcoming investment environment in the UK.

‘The changes to Business Asset Disposal Relief are disappointing and feel somewhat against the government’s ‘pro-growth’ agenda,” says Jon Dawson, Head of Creative, Media and Technology at haysmacintyre. “The revised rate of 18% (14% in 2025/26 then 18% in 2026/27) appears to offer very little incentive to people starting a business in the UK.

“We must remember the original relief designed to incentivise entrepreneurs from 2008 to 2020 – Entrepreneur’s Relief, as it was formerly known – was at 10% on the first £10m,” Dawson continues. “A business selling for £10m in this period could have attracted tax of £1m. Under the new regime, a business selling for £10m could attract tax of £2.34m.”

This disappointment at the less-than-welcoming entrepreneurial environment created by the BADR changes has been echoed elsewhere.

“Capital gains tax rates reward business owners who habitually take significant personal and financial risk to drive growth in the UK economy,” says Seb Wallace, Investment Director at Triple Point Ventures. “The government’s hike in the higher band of capital gains tax to 24% without increasing Business Asset Disposal Relief is disappointing, but it remains within the limits of what may be manageable for entrepreneurs.

“The nature of this risk is vastly different from the risk an employee takes to earn income, and it deserves to be recognised as such. Any move to increase capital gains tax for business owners without a material increase in Business Asset Disposal Relief risks a flight of talent out of the UK. It is something we are hearing many founders talking about.”

Inheritance tax and business property relief

There are few more politically polarising tax issues than inheritance tax. Reeves landed a surprise today in extending by two years the freeze on the inheritance tax threshold for property at £325,000. This will now remain in place until 2030.

But for business owners looking to bequeath their business property to family members, there was a more eye-catching announcement in the stated reforms to business property relief.

“The first £1m of combined business and agricultural assets will continue to attract no inheritance tax at all,” Reeves stated. “But for assets over £1m, inheritance tax will apply, with a 50% relief at an effective rate of 20%.”

This 50% relief and 20% effective rate now extends to AIM shares, in a relatively welcome note for investors and business founders. Nervousness abounded ahead of this announcement, given the possibility of AIM inheritance tax relief being removed entirely.

“The threat of removing inheritance tax relief from AIM shares has dragged on the market for months,” says Nicholas Hyett, Investment Manager at Wealth Club. “Today at least provides some certainty about what the future looks like, even if the IHT relief on offer has been cut in half.

“The cut to tax relief will probably weigh on valuations long term, making it more expensive for small UK companies to raise funding,” Hyett warns. “But, not abolishing it altogether has avoided the worst-case scenario of significant disruption as capital fled the market.”

“Inheritance tax has been an underappreciated risk to the UK tech ecosystem,” adds Jon Dawson of haysmacintyre. “Being able to pass shares in high growth early-stage technology companies in a tax neutral way makes investment in unlisted UK growth companies very attractive to some. Applying a 50% relief on shares on the AIM offsets some of these effects, but expect some earlier stage businesses to look at setting up in more tax-friendly jurisdictions.”

Keeping investors in the UK

In a change that might just have felt aimed at Rishi Sunak’s household, Reeves announced that the government would remove “the outdated non-dom tax regime.” Domicile status will be excised from the tax system from April 2025. This will be replaced by a “simpler residence based regime, designed to bring the best talent and investment to the UK.”

However, the removal of non-dom status was greeted with a note of caution in some quarters. “Changes to the non-dom regime may lead to those with significant wealth and serial entrepreneurs looking to start their next venture outside the UK,” warns Jon Dawson of haysmacintyre. “This is unlikely to significantly affect those in the earlier stages of their entrepreneurial journey. But, a greater impact on the technology sector could be access to capital if those non-dom individuals with significant wealth choose to reside elsewhere and may transfer their investment overseas as a result.”

Tax relief policies for entrepreneurs can play a key part in making the UK as attractive a destination as possible for companies looking to invest in the biggest growth sectors of our time, including AI.

“If the government is serious about making the UK a global hub for artificial intelligence, we need to see more grants or tax relief for capital expenditures that will encourage companies to invest in this technology,” says Andrew Burman, Principal, Tax Technology, at Ryan. “This will make it more feasible for businesses to adopt new equipment or technology that will help streamline their operations and drive long-term commercial success.”

Would founders and investors actively seek to leave the UK, if the reception to today’s budget is truly poor? It’s an unlikely outcome, given London’s enviable position in the finance and startup global ecosystem, but research has found the risk remains.

“In the run up to today’s budget, we saw numerous reports of entrepreneurs planning to move abroad if the budget didn’t deliver for them, with our own research of 500 business owners revealing that almost half would consider leaving the UK if the tax changes were clearly unfavourable,” says Toby Tallon, tax partner at Evelyn Partners.

“But, perhaps the greater risk is inactivity,” Tallon continues. “If the business owners lose confidence in the government’s economic or fiscal plans, they might decide that striving for that extra growth is not worth it if the rewards are more heavily taxed.”

Other business voices have joined this note of warning. “With the increase in CGT rates, including on the sale of businesses, the budget did not include much to cheer already under-pressure business leaders,” says Thomas Adcock, Tax Partner at Gravita. “If you want to sell your business in the future, now may be the time to start.

“High earners and investors have already been leaving the UK due to rumoured tax rises, and now that these changes have been confirmed, this trend is likely to continue,” Adcock says. “In our experience, it is not just non-doms that are leaving, but the Budget today will likely not encourage them to stay either.”

In better news for the UK’s prospects for attracting and keeping entrepreneurs, Research and Development tax relief rates haven’t been changed in this budget. “It’s a smart move by the chancellor to leave R&D tax relief rates untouched”, says Nigel Holmes, Director, Research and Development, at Ryan. “Before today, we were starting to see clients hold back on decisions to access government initiatives such as R&D tax credits and grant funding, as they couldn’t confidently plan these into their forecasts.

“These regimes, including full expensing and the Annual Investment Allowance for Capital Allowances, are all lifelines for businesses looking to innovate and grow. Now we know this funding is here to stay, we hope to see more firms capitalising on these reliefs, and playing their part in putting the UK on the map as a global technology leader.”

Employer national insurance contributions rise to 15%

There were no surprises to be found on employer national insurance contributions, which Reeves has confirmed will increase by 1.2%, to a new level of 15%. Combined with the increase to the national minimum wage (see below), this is likely to be daunting news for small business owners across the UK.

On top of this, the minimum threshold at which employer NICs apply will come down, from April next year. The former minimum of £9,100 will give way to a new threshold of £5,000.

Reeves has stated the employer NICs increase will raise an additional £25bn, but is likely to come at a cost for businesses obliged to hold back on pay rises, pause hiring plans, or accept smaller profit margins.

“An increase in National Insurance contributions could increase the financial burden on businesses,” says Ira Guha, Founder of Asan Cup. “After a certain point, businesses may find it difficult to improve wages or they may hold off on hiring new talent. This could have an impact on the job market, which will eventually impact working people.”

Greg Cox, CEO of Quint Group, reflected ruefully on the announced changes to employer NICs. “Today’s rise in employers’ national insurance is yet another challenge for small businesses that have been battling economic headwinds for the last half-decade,” Cox told us. “At a time when interest rates are set to fall, releasing some pressure and improving liquidity for businesses and consumers, this additional NI burden is an unwelcome cost that threatens to stifle growth, hiring, and productivity.

“If the government is serious about fixing the foundations of our economy, it should back businesses, not burden them. For a government that wants to encourage national renewal, today’s announcement will set many small firms back.”

Minimum wage increased by 6.7%

As trailed ahead of the budget, the national minimum wage is in for a serious hike of 6.7%. The jump to £12.21 an hour will come into effect from April, and will be welcomed by employees up and down the country – even though it still falls below the £12.60 recommendation of the Living Wage Foundation.

For business owners, the increase will present a challenge. Combined with the employer NICs hike, the true cost of an employee is set to rise for millions of UK small businesses. This could yet impact the number of staff that employers feel able to take on. Reeves, meanwhile, will be betting big on the increased spending power of the “working people” receiving the minimum wage hike, which may in turn support the growth of those businesses.

Hospitality and retail sectors get a mixed bag

In some welcome news for the struggling high street, Reeves announced a 40% relief on business rates for the retail, hospitality and leisure sectors.

It’s good news, too, for pubs and bars, with a 1.7% cut to duty on draft (but not bottled or canned) alcoholic drinks. Could a resulting cut to the price of a pint be enough to tempt back the UK’s drinkers after a rain-soaked summer dampened the UK’s mood for beer gardens?

Unfortunately, the other changes announced by Reeves, such as the increase to national minimum wage and the hike to employer national insurance contributions, may yet mean that punters won’t enjoy a pub price cut.

Recent changes to UK tipping law also mean that there’s less wriggle room on the revenue for those running bars, pubs and restaurants. Much of this is welcome news to those waiting tables or pulling pints, but the increased business rates relief and small cut to alcohol duty are unlikely to offset the biggest overheads being felt by the hospitality industry.

Chief executive of UK Hospitality, Kate Nicholls, says the increase to NICs would “particularly hammer sectors like hospitality, where staffing costs are the biggest business expense”.

She added: “Hospitality businesses are much less able to stomach yet another cost increase when they’re already managing increases in other areas like wages, food, drink and energy.”

A bruising budget for UK business?

The UK’s entrepreneurs and small businesses owners will be scrabbling to assess the impact of today’s budget announcement.

For employers, profit margins are likely to get tighter, with the increase to employer NICs and the rise in national minimum wage next year likely to be particularly tough for the hospitality and retail sectors.

Let’s remind ourselves of some key stats. The UK is home to 5.5 million small and medium-sized enterprises, of which 4.1 million are self-employed or sole traders. Hurt those business founders, and you ultimately hurt the 99% of the country’s workforce that they employ.

For startup founders, there’s somewhat welcome news, in that the worst anticipated changes to capital gains tax didn’t, ultimately, materialise. But, even the smaller announced uplift to CGT will sting, and give pause to plenty of would-be business founders wondering if the long hours and hard graft will ultimately pay off.

“Entrepreneurship involves a lot of risk, which needs to be rewarded relative to taking the more typical path of full time employment and job security,” says Greg Cox, CEO of Quint Group. “While the UK remains one of the world’s top fintech hubs, with a thriving ecosystem and remarkable talent base, today’s hikes will mean some entrepreneurs will think longer and harder about building a company and firms will need to keep finding creative, sustainable ways to grow in yet more adverse economic conditions.”

Returning to the “working people” element so hotly (but inconclusively) debated in the days leading up to the budget, Seb Wallace, Investment Director at Triple Point Ventures, argues, “We must separate the conversation about capital gains from unearned income, such as property investments, from gains earned by hard-working entrepreneurs who are actively driving economic growth.”

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