Brendan Burgess
Founder
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From: https://www.esri.ie/system/files/publications/BP202201.pdf
Page 35 (PDF 46)
Entrepreneur relief
Entrepreneur relief is a reduced CGT rate of 10 per cent that applies to chargeable gains – up to a lifetime limit – on certain eligible assets. Foremost among these are assets owned by a trading company (or holding company of a trading group) of which the shareholder has been a full-time employee or director and who has owned at least 5 per cent of the shares for a continuous period of three years in the five years immediately prior to disposal. The office of the Revenue Commissioners estimates that 875 taxpayers availed of the relief in 2018 (the latest year for which data is available) at a cost of €92.4 million, significantly more than the €27 million per year anticipated when the measure was introduced.26 This implies an average cost of more than €100,000 per claimant, with almost 200 claims for more than €1 million of relief.
As argued by Roantree and Miller (2019), entrepreneur relief creates an array of economic distortions. First, it provides a strong incentive to set up a business in which to retain profits, putting pressure on anti-avoidance rules which attempt to define when companies are ‘artificial’ avoidance devices. Second, it gives companies an artificial incentive to ensure that any individual employee’s shareholdings are above an arbitrary 5 per cent threshold. Third, it encourages owner-managers of companies to retain profits in the company rather than take them out as dividends or salary, and self-employed individuals and partnerships to retain business assets until they are ready to stop doing business altogether. Entrepreneur relief creates these incentives regardless of whether – in the absence of tax considerations – business owners would rather spend their money sooner or could invest it more profitably elsewhere, or whether assets could be more profitably used by others. This potentially exacerbates what Bloom and van Reenan (2010) suggest are already poor levels of management practices among domestic firms in Ireland by discouraging the disposal of business assets to those who could manage them better.
The justification for applying lower tax rates to people who own their own business than to the rest of the population is far from clear. Preferential capital gains rates are often defended as essential to reward difficult and risky entrepreneurial activity. But the difficulty and risk associated with entrepreneurship do not in themselves justify favourable tax treatment as these are typically rewarded through a higher pre-tax return. What is needed (though not sufficient) to justify the existence of entrepreneur relief is some rationale as to why the market will lead to too few entrepreneurs when the tax system is neutral between legal forms (Adam and Miller, 2021). A good example of this is there being insufficient investment in research and development (R&D) because innovators do not reap sufficient rewards from their innovation, with some spilling over to other businesses that can learn from the experiences of the innovator. This provides a good rationale for policies such as the R&D tax credit, which a Department of Finance (2016) evaluation found was a reasonably effective if expensive way of stimulating R&D activity by private firms.
However, there is little evidence to suggest that reduced rates of CGT are well targeted at alleviating any concerns around business start-ups, or that those who qualify for entrepreneur relief carry out activities associated with large spillovers. Indeed, evidence from the UK shows that few entrepreneurs who availed of a similar relief there knew of its existence when starting their business, and even fewer reported it having influenced the timing or nature of their disposal (HMRC, 2017). This suggests that the relief is more likely to generate efforts to avoid tax on retirement than its intended purpose of spurring entrepreneurship or investment – something that Miller et al. (2019) find good evidence to support. Indeed, this evidence was cited by the British Treasury in its decision to restrict the similarly designed relief in that jurisdiction, now called Business Asset Disposal (BAD) relief. This move by the British government may provide more scope than previously available for a future tax-raising Irish government to follow suit, alongside a more comprehensive review of the incentives provided for start-ups and whether they are achieving their stated aims.
Page 35 (PDF 46)
Entrepreneur relief
Entrepreneur relief is a reduced CGT rate of 10 per cent that applies to chargeable gains – up to a lifetime limit – on certain eligible assets. Foremost among these are assets owned by a trading company (or holding company of a trading group) of which the shareholder has been a full-time employee or director and who has owned at least 5 per cent of the shares for a continuous period of three years in the five years immediately prior to disposal. The office of the Revenue Commissioners estimates that 875 taxpayers availed of the relief in 2018 (the latest year for which data is available) at a cost of €92.4 million, significantly more than the €27 million per year anticipated when the measure was introduced.26 This implies an average cost of more than €100,000 per claimant, with almost 200 claims for more than €1 million of relief.
As argued by Roantree and Miller (2019), entrepreneur relief creates an array of economic distortions. First, it provides a strong incentive to set up a business in which to retain profits, putting pressure on anti-avoidance rules which attempt to define when companies are ‘artificial’ avoidance devices. Second, it gives companies an artificial incentive to ensure that any individual employee’s shareholdings are above an arbitrary 5 per cent threshold. Third, it encourages owner-managers of companies to retain profits in the company rather than take them out as dividends or salary, and self-employed individuals and partnerships to retain business assets until they are ready to stop doing business altogether. Entrepreneur relief creates these incentives regardless of whether – in the absence of tax considerations – business owners would rather spend their money sooner or could invest it more profitably elsewhere, or whether assets could be more profitably used by others. This potentially exacerbates what Bloom and van Reenan (2010) suggest are already poor levels of management practices among domestic firms in Ireland by discouraging the disposal of business assets to those who could manage them better.
The justification for applying lower tax rates to people who own their own business than to the rest of the population is far from clear. Preferential capital gains rates are often defended as essential to reward difficult and risky entrepreneurial activity. But the difficulty and risk associated with entrepreneurship do not in themselves justify favourable tax treatment as these are typically rewarded through a higher pre-tax return. What is needed (though not sufficient) to justify the existence of entrepreneur relief is some rationale as to why the market will lead to too few entrepreneurs when the tax system is neutral between legal forms (Adam and Miller, 2021). A good example of this is there being insufficient investment in research and development (R&D) because innovators do not reap sufficient rewards from their innovation, with some spilling over to other businesses that can learn from the experiences of the innovator. This provides a good rationale for policies such as the R&D tax credit, which a Department of Finance (2016) evaluation found was a reasonably effective if expensive way of stimulating R&D activity by private firms.
However, there is little evidence to suggest that reduced rates of CGT are well targeted at alleviating any concerns around business start-ups, or that those who qualify for entrepreneur relief carry out activities associated with large spillovers. Indeed, evidence from the UK shows that few entrepreneurs who availed of a similar relief there knew of its existence when starting their business, and even fewer reported it having influenced the timing or nature of their disposal (HMRC, 2017). This suggests that the relief is more likely to generate efforts to avoid tax on retirement than its intended purpose of spurring entrepreneurship or investment – something that Miller et al. (2019) find good evidence to support. Indeed, this evidence was cited by the British Treasury in its decision to restrict the similarly designed relief in that jurisdiction, now called Business Asset Disposal (BAD) relief. This move by the British government may provide more scope than previously available for a future tax-raising Irish government to follow suit, alongside a more comprehensive review of the incentives provided for start-ups and whether they are achieving their stated aims.