Sometimes it's the smart moves that are best avoided

IN the litany of fiscal headaches facing the Brown government, it ranks way behind the damage done by the 10p income tax band fiasco. Alistair Darling's decision to simplify taxes on capital gains (CGT) and introduce an across-the-board rate of 18% from April did, however, stick in the throats of many UK entrepreneurs.

Labour had previously introduced a 10% rate, applicable to the sale of many business assets. It also reduced the holding period before the sale of such assets qualified from 10 years to two. It had done so in the name of stimulating an enterprise economy.

When Darling's decision, in effect, raised that base rate of CGT again - by a whopping 80%, the government was immediately accused of killing enterprise in this country stone-dead.

Put another way, entrepreneurs who had grown used to keeping 90% of any gain they made on the disposal of their business would now get to keep a mere 82%.

Anyone facing CGT of up to 40% on the disposal of other assets, from a share portfolio to land or property, would see their tax bill slashed by more than half. But that was mere context. Enterprise would be snuffed out, we were told, if that base-end hike from 10% to 18% stood.

The chancellor did try to mollify his critics, by re-complicating his simplified system, allowing the first £1m of entrepreneurial gains to continue to be taxed at the 10% rate. Still, as the April deadline approached, there was a stampede of business owners seeking quick sales to minimise their tax bill.

Yet it appears that hundreds of other UK entrepreneurs who couldn't line up a sale before that April deadline were persuaded to exploit a tax loophole that now threatens to cost them significant sums of money.

As is always the case with controversial tax changes, financial advisers had been hard at work devising avoidance strategies. This one, applicable to those expecting gains above that £1m threshold but unable to strike a deal before April, involved signing, there and then, an unconditional sale agreement with another party, typically a trust, that would only complete once a third-party buyer could be found.

But, crucially the unconditional sale agreement to the trust would incur tax at the 10% rate, not 18%. A number of high-profile entrepreneurs, including the founder of a leading women's fashion chain and the creator of an upmarket brand of potato crisps, went for it.

There were immediate costs - stamp duty on the transaction and, of course, those clever accountants' fees. But they are as nothing compared to further costs that could crystallise next January. Tax costs.

Since April, the prevailing economic climate has deteriorated sharply. In a growing number of sectors, finding buyers for private businesses is proving a tougher proposition, thanks, in part, to the credit crunch.

So entrepreneurs who exploited that loophole to sell their business unconditionally to a trust, but who are now watching buyer interest dry up, are having to come to terms with the fact that, come the end of January, HM Revenue & Customs will be looking for 10% of the putative gain on that disposal in CGT.

They will be looking for payment, even if the final proceeds from the sale have failed to materialise. For the tax liability dates from the signing of the unconditional sale agreement with the trust, not from the date of securing a third-party buyer for the business. That, after all, was the whole point of the avoidance strategy in the first place.

And what if the owner tears up that agreement and, in the absence of a final buyer, takes back control of the assets again? Should government, mindful of the earlier furore over the increase to 18%, simply accept no taxable gain has been made? This observer, for one, hopes the taxman insists a capital gain has still crystallised and insists 10% of it, putative or not, is his.

This is another lesson in how big investment decisions should never be taken primarily on the basis of what tax will or will not have to be paid. The history of tax avoidance - even in its government-sponsored guises like the late and unlamented Business Expansion Scheme - is littered with examples of unintended and unforeseen losses. It is not the business of government or its fiscal agencies to bail out those who find themselves entangled not in oft-lambasted red tape, but in the unravelling consequences of too-clever-by-half tax avoidance.

If some entrepreneurs do find themselves on the receiving end of a fat tax bill for the sale of a business that never actually was, I'm afraid my reaction will be: Hell mend them. Even at the 18% rate of CGT which now prevails, they will still pay less than the rest of us do from what we gain every month from employment.

They presumably knew the risks. If they didn't they should change their financial adviser. But they should be told to cough up.