TaxPersonal TaxAnalysis – What is Gordon Brown’s incentive?

Analysis - What is Gordon Brown's incentive?

I was talking last night to an American friend about differences in standards of service on the two sides of the Atlantic. One of the factors we identified was that in the US a person opens a cake shop because he wants to sell cakes; in the UK he all too often opens a cake shop because he wants to set up a chain of cake shops that he can sell to a big conglomerate.

To what extent does the tax system encourage this phenomenon? When Gordon Brown talks about helping small businesses is he intending to help them to grow and compete with larger ones or is he happy to fuel the growth of a small number of multinationals by creating a climate in which they can invest their earnings in acquisitions rather than in internal growth?

And does it matter? Jobs are jobs whether they are created and remain in the small business sector or they are created there and then transferred to the big business arena. I am not a economist but have a feeling that it may matter as when a person sells a business, a large part of the proceeds does not go directly back into the economy. It goes in savings, in big houses or yachts or similar assets.

What is Gordon Brown trying to do? For example his new employee share ownership trust scheme in this year’s Finance Act is the first share scheme that seems to me to actually encourage share ownership, which I have always understood to imply share retention.

The growth in value of the shares in an ESOT is tax free (after an initial minimum holding period) for as long as the employee chooses to leave them there. This is a clear encouragement for an employee to acquire and maintain a stake in his employer company.

In contrast the Enterprise Management Incentive Scheme introduced in the same Act seems to me the ultimate in the encouragement of short-termism.

It grants tax exemption only while the employee does not hold the shares.

Once he acquires them the growth in value, including the value arising at the time of exercise of the option, is taxable, albeit at the rate of 10% only if he does not exercise the option for four years. Granting full taper relief in this way seems to me to provide an incentive not to hold the shares but to cash in one’s chips immediately on the exercise of the option.

The scheme seems almost to have been designed as a means to give a substantial bonus to the employee based on the growth in value of the company during the option period but taxed at a very low rate. If that is the objective why go through the paraphernalia of requiring an option scheme?

If it is not, what is the objective? It does not seem to be anything to do with the share ownership. It does make sense if the small business strategy is not to build up businesses with an independent life of their own but to use the small business area as a breeding ground to try out new ventures before bringing them within the corporate claws of big business.

The third strand of the Finance Act’s enterprise strategy, the corporate venturing scheme, also seems consistent with such an objective. I find it difficult to envisage small companies that want to retain a long term independence welcoming an investment by a larger company, particularly at the early stage of the company’s growth when the value of the shares is very low. There are easier ways to raise finance than to give a large competitor access to one’s financial affairs and one’s new technology.

However, for a company that is set up to be sold it may well be attractive.

Finance and help from a big company will enable the value to be generated more quickly and the desired capital gain on sale realised earlier. It also provides a potential exit route as the company that takes the initial shareholding is an obvious purchaser for the remainder in due course.

In an ideal world the tax system should be used to raise revenue not to achieve extraneous social or even economic objectives. If the tax system is to be used for such purposes it is incumbent on the chancellor to spell out more clearly his objectives. After all there cannot be much of an incentive if no-one knows what he intends to incentivise.

– Robert Maas is a partner at Blackstone Franks.

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