After the economic disruption and global uncertainty caused by the Covid-19 pandemic, the U.K. economy has posted a remarkable initial recovery. Part of this recovery is being fueled by heightened investment activity. Investors have not been deterred by the experience of Covid-19; instead, the release of pent-up demand has sparked a burst of activity across the private sector. Most notable has been the volume and scale of merger and acquisition (M&A) activities taking place.
The M&A sector has been thriving both in the U.K. and abroad, and there are no signs of this abating. Recent research from the Office for National Statistics shows that M&A deals were up by 5 billion pounds, to 10.6 billion pounds ($14.5 billion) in the second quarter of 2021 compared to the first quarter of the year.
Additionally, new EMEA projects on Datasite’s platform, which are deals at their inception rather than when they are announced, are up 37% between January and September in comparison to last year.
On this basis, it is clear that U.K. and broader EMEA M&A activity is poised to continue to climb in the coming quarters.
The spike in M&A activities has not been without criticism. However, U.K. Chancellor Rishi Sunak has said that the private equity interest should be seen as “a sign of confidence in the UK economy.”
This has led to revisions around SPAC (special-purpose acquisition company) rules and dual-class listings, with the Chancellor keen to put forward measures that will “make Britain an incredibly attractive place for companies to raise capital.” Another recent pledge is to make it easier for companies to create prospectuses for IPOs (initial public offerings) without “specific legal liabilities.”
The Chancellor’s goal is to create an open market, dismantle defensive barriers that cause stagnation, and help the City of London to boost its global competitiveness.
The Chancellor’s take on private equity deals is timely given a new budget announcement is just around the corner. Scheduled for Oct. 27, 2021, the 2021 autumn budget is a highly anticipated event.
Though the full impact of Covid-19 on the economy has yet to be realized, Sunak’s fiscal management has so far focused on offering support to businesses, consumers, and investors. While this approach has proven successful, the key obstacle the Chancellor now faces is public debt. The government understands that measures are warranted, be it through tax reforms or spending cuts.
While industries and sectors wait to see what type of approach the Chancellor will take, including those involved in the M&A space, it is important to consider which prospective tax reforms are on the table and how a more active regulatory environment could impact the future of M&A activity in the U.K.
Capital Gains Tax—in Need of Reform?
A core tax linked to business sales in the U.K. is capital gains tax (CGT). This tax is paid on profit made when an individual sells an asset that has increased in value. Prior to the pandemic, CGT was often scrutinized for its complexity and misalignment with income tax thresholds. In response, the Chancellor ordered a review of CGT by the Office of Tax Simplification (OTS) in mid-2020, supported by recommendations of how the tax could be reformed.
As part of the proposals, the OTS recommended aligning the CGT rate more closely with income tax rates. It further suggested reducing the CGT allowance to under 4,000 pounds from its current level of 12,300 pounds. The ensuing report was released in November 2020, and the proposed reforms were expected to be part of the Chancellor’s next fiscal announcement.
As it turned out, the Chancellor decided to hold back on a CGT overhaul, freezing the CGT allowance until 2026. The decision was likely part of a broader move to encourage investment activity in the U.K., at a time when there was no indication when lockdown measures and social distancing rules would end.
Six months on, circumstances have changed significantly. The success of the vaccine roll-out has resulted in most lockdown measures being lifted. Businesses are adjusting to the post-pandemic environment, and now is a critical time to consider reforms that go beyond the pandemic, address fundamental economic concerns, and future-proof the City.
Capital Gains Tax and M&A
CGT is of direct interest to those involved in M&A. This is because qualifying business owners selling assets must pay CGT, including M&A transactions. Following through on the OTS recommendations and increasing CGT rates will affect those business owners considering a buyout. Linked to this is whether the Chancellor will also make changes to CGT reliefs currently in place.
In the U.K., the business asset disposal relief (previously known as entrepreneurs’ relief) ensures sole traders or partners who have owned a business for at least two years are liable for a CGT rate of 10% on qualifying gains. This relief is subject to a 1-million-pound lifetime limit on gains and has been implemented to incentivize business activity. However, current reports suggest that reforms to CGT could include the removal of the business asset disposal relief.
If the CGT is changed, it may not impact M&A activities immediately. The high number of deals in the pipeline, combined with the market’s momentum, will take some time to work out. It will be more interesting to see the long-term effect it will have and whether it will deter business leaders from selling their assets. Based on the current economic environment, it is too early to make that call.
Will the Chancellor Reform CGT?
Certainly, the current CGT may be one aspect that has contributed to the high volume of M&A activity, and why many business leaders are keen to complete and finalize buyouts prior to new rates coming into force. However, there are also long-term economic benefits that arise from M&A and private equity.
The 2021 autumn budget will be a delicate balancing act—the Chancellor must ensure that public debt is addressed while avoiding measures that deter future investment activities. He has made it clear that private equity interest in the U.K. is positive for the economy. Yet, with rising interest rates and the cost of debt leverage on the horizon, buyers and sellers will need to weigh a variety of factors in their investment decisions.
Still, for the time being, the M&A outlook is positive. Deal volume is expected to finish the year on a high, and it will take some time for any CGT reforms to be implemented and effective. The Chancellor is no doubt aware of this and will work to ensure that the U.K. remains a global hub for thriving investment activities.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Merlin Piscitelli is EMEA chief revenue officer at Datasite, a leading SaaS provider for the M&A industry.
The author may be contacted at: firstname.lastname@example.org