CGT and BADR rate increases – what has happened so far?

As predicted by our own head of Tax Nicola Parkinson, the CGT raise that took effect immediately on 30 October 2024 was fairly modest; from 20% to 24% (for higher rate taxpayers).  Changes to the BADR rate from 10% to 14% were announced at the same time but to take effect from 6 April 2025 with a further planned increase to 18% to start from 6 April 2026.  The lifetime limit of £1 million of gains that BADR can apply to has not been changed and so the relief continues to be most relevant to owner-managers in lower value companies and managers who hold smaller stakes in larger businesses (subject to such individuals meeting the minimum 5% voting and economic rights conditions for BADR, amongst other conditions).  Gains in excess of £1 million over an individual’s lifetime will be subject to the usual CGT rates.

Given the impending rate rise, there is an obvious timing motivation for managers to crystallise gains before 6 April 2026.  With just over 11 months to go, this presents an opportunity for PE funds in the mid-market to encourage attractive owner-managed businesses either to cash out sooner with complete sales and/or structure new co-investments to partially realise gains to date at a lower tax rate.

To roll or not to roll?

When considering deal bids, a key consideration for founders or managers that wish to reinvest alongside a sponsor is often the availability of rollover relief.  Such relief essentially allows existing shareholders to “roll” their existing gain, which would otherwise be taxable, into an asset (other than cash) that has been exchanged in return for their shares.  This allows sellers to defer their tax bill to the extent that they have not fully cashed out of the business.  However, where the conditions for BADR will no longer be met by a manager’s new shareholding it is possible for managers to elect to pay tax at the BADR rate so that they can benefit from the reduced tax rate, albeit as a “dry” tax charge.

We predict that such elections or simpler structuring that does not need to meet the specific tax rollover requirements could increase in light of the impending rate change even where the BADR conditions would be satisfied following a roll into new securities.  While a dry tax charge can be a nuisance to fund in cash terms for managers, it could well be more tax-efficient for managers to pay 14% now instead of 18% after 6 April 2026 or even 24% if they don’t qualify for BADR on a future exit (whether due to a further change in law or due to circumstances in the business requiring dilution). Sponsors may be able to reduce deal structuring costs and the number of transaction documents if rollover relief is not required.

Cash out and start afresh?

In light of the recent and impending rate changes to BADR and CGT, the question arises whether equity is always the best way to incentivise managers upon acquisition by a PE sponsor.  Unfortunately for actors in the private equity world, tax-advantaged option schemes such as EMI and CSOPs are typically unavailable for use given that the independence criteria will rarely be satisfied with a sponsor that holds a majority shareholding alongside management.  That essentially leaves shares, particularly growth shares, as the primary means of equity incentivisation for managers in UK companies.  If structured from the outset with an existing or pre-formed management team, growth shares can offer a tax-efficient means of keeping managers’ skin in the game until exit.  After all, even the increased 24% CGT rate is well below the higher rate income tax rate of 40% and does not attract NICs for the employee or employer.

However, awarding managers with shares carries practical costs – such as obtaining independent share valuations, negotiating shareholders agreements and funding legal advice for managers – and can also cause tax and administrative headaches to manage throughout a PE sponsor’s tenure in a business.  This is particularly so where there is turnover of management that requires buybacks, transfers or warehousing of shares and where late additions are made to a management team who will suffer a higher buy-in cost.

Alternatives to pure equity – such as phantom share schemes, unapproved options or KPI-driven LTIP “pots” – undoubtedly carry higher costs in the form of income tax and NICs for both managers and the employing entity.  However, the upsides can include:

• far greater flexibility, including the possibility for personalised target-setting;
• significantly reduced administrative costs (no need for independent share valuations!); and
• the ability to add future managers with minimal buy-in costs and removing participants is straightforward.

Management incentivisation: How we can support you

The Tax team at Walker Morris has a wealth of experience in structuring and executing incentives packages of all kinds, whether equity based, tax advantaged option schemes or bespoke cash LTIP arrangements. We regularly advise both PE sponsors and management teams on equity investment considerations in the context of M&A and we understand how to tailor arrangements to suit the specific commercial drivers in each context. Contact us today to discuss how we can help with the incentive arrangements in your next deal.