Capital Gains Tax Reforms & Fact Sheet

As you will be aware, the Chancellor surprised everyone with his Pre Budget Report on the 9 October 2007 by announcing major changes to the CGT regime.   Subsequently Mr Darling, in order to answer the protests from certain quarters,  has also announced relief on the first £1million of lifetime gains from the sale of business assets ("Entrepreneurs Relief").

What are the main changes?

Firstly, legislation will be introduced next year to create a new single flat rate of CGT at 18% for 2008/09 for individuals (this includes sole traders and partnerships) and trusts. Please note that this does NOT apply to assets held by limited companies.

Secondly, a number of changes will be made to the tax treatment of disposals made on or after 6 April 2008 to ‘simplify’ the CGT regime, including:

•                     the withdrawal of taper relief;

•                     the withdrawal of indexation allowance; and

•                     simplification of the share identification rules. 

What will these changes mean for you?

The most significant change for owners of business assets is the withdrawal of taper relief.  Currently, gains are treated as the top slice of income which often means a 40% tax charge. However if business assets are sold the gain may be reduced by up to 75% due to taper relief. That works out at an effective CGT rate of 10% for a higher rate taxpayer and just 5% for a basic rate taxpayer.

For example consider the situation of a higher rate taxpayer who is planning in the near future to sell a business asset which will make a gain of £1,000,000. Business asset taper relief is available at 75%, so, in simple terms, only £250,000 is chargeable at 40%, a bill of £100,000.

Under the new rules, the whole of the £1,000,000 will be chargeable at 18%, a bill of £180,000. So clearly this individual would want to sell this particular asset before 6 April 2008 if at all possible. This may be applicable for both those wishing to sell to third parties and those considering incorporation of their existing unincorporated businesses and continuing to own and manage them.

Of course, everyone’s circumstances are different, so there will also be many winners, especially among those who are not able to claim business asset taper relief, such as ordinary shareholders. Their situation can be very complex as some will be better off selling some shares now and others later.  Our fact sheet sets out the changes in more detail and provides some examples of the differences in tax if assets are sold before or after 6 April 2008. Please be aware that this change is intended to raise additional tax for the Exchequer, which means that more people are going to be worse off than better off.

If you are in any doubt about an appropriate course of action please contact either myself on 01730 234500 (mikekirby@antrobus.biz) or Mark Jarrett (markjarrett@antrobus.biz) before selling any assets so that we can advise you of the best way forward. Please also note that we will not charge you for a brief initial consultation, which will be aimed at assessing whether you should take additional action.

A few other points to bear in mind:

1. Please don’t leave things until the last minute. If we need to involve solicitors, we have already been told that they are building up backlogs of work with regard to these matters.

2. There are ways of “locking in” gains at lower rates, even if you intend to retain assets for many years to come. This may involve the payment of some tax now, but with savings later as you can establish a much higher “base cost”. Something close to the old “bed and breakfast” method may well be possible.

3. Rollover relief – if you have rolled over gains from previous transactions, please review these with us, as the whole gain will be taxed at the 18% rate if left until after April 6th 2008. It may be sensible to crystallise such gains before then.

4. It is possible that property and other assets owned by individuals should now be put into limited companies or trusts. Again, this could involve paying some tax now (actually January 2009) in order to save a much larger tax bill at a later date.

5. This is a “last chance” to consider creating very tax efficient goodwill on incorporation. We have talked to a number of clients about this already, but please do not hesitate to call if you think that this is something that you should be considering.

You should also be aware that many business groups are calling on the government to delay or amend the decision to increase the effective tax charge on business assets, and in particular to re-introduce some additional form of retirement relief, so you may wish to take this into account in making a decision to sell. We believe that this is unlikely to be very generous. We will, of course, keep you posted on any significant changes to the government’s proposals.

Lastly, please tell any friends and relatives who may be in similar situations about these opportunities as we would be happy to assist them. It may well be that there are many people who do not have an accountant at present, who should be considering a review of their assets including their shareholdings. We will very gladly talk to them without any obligation to see if there are any actions they should consider taking.

 

FACT SHEET

CGT rates of tax

Individuals making capital gains currently treat those gains as the top slice of income. This means that, currently, tapered gains are charged at 10% where gains plus taxable income do not exceed £2,230; 20% between £2,231 and £34,600; and 40% on any balance. For trustees the rate of CGT is 40%.

For 2008/09 there will be a single rate of CGT set at 18%, which will apply to individuals, trustees and personal representatives.

Every tax year individuals are allowed to make gains of up to the annual exemption without paying any CGT. This year’s annual exemption is £9,200. Although it has been confirmed that the annual exemption will be retained for 2008/09 the amount of the exemption has yet to be announced. We have included an estimated amount of £9,500 in the following examples for illustration purposes.

The withdrawal of taper relief

Taper relief was introduced for disposals on or after 6 April 1998 and can significantly reduce the amount of the gain chargeable to CGT. The amount of relief available depends on whether the asset is classed as a business or non-business asset and, also, on the length of time an asset has been held since 1998. The reduction for business asset taper can be as high as 75% of the gain, with a 40% maximum available for non-business assets.

For any gains arising on or after 6 April 2008 and any held over gains coming into charge on or after that date, taper relief will no longer be available. The chargeable gain will be liable to tax at 18%, after deducting allowable losses, any other reliefs and the annual exemption.

What does this change mean for me?

If you are entitled to the maximum business asset taper relief, you are likely to have an effective tax rate of 10% rather than 18% for disposals in the 2007/08 tax year.

If you are entitled to the maximum non-business asset taper relief, you are likely to have an effective tax rate of 24% (60% x 40%) for disposals in the 2007/08 tax year, rather than 18% proposed in 2008/09. You may be better off selling after 5 April 2008 but you may also need to consider the effect of the withdrawal of indexation allowance (see below).

The withdrawal of indexation allowance

Indexation allowance was, for individuals and trustees, the precursor to taper relief and gave relief for the effect of inflation on the costs incurred on acquiring and improving assets.  Indexation was frozen as at 5 April 1998. Currently, where an asset was held at 6 April 1998 and is disposed of after that date, any gain on the disposal may be eligible for both indexation and taper relief.

For disposals on or after 6 April 2008 indexation allowance will no longer be available.

What does this change mean for me?

If you acquired investment assets before 1998 you need to consider the effect of the loss of indexation allowance. For example, an asset purchased in September 1988 would qualify for a 50% uplift in cost if sold before April 2008.  This may reduce your effective tax rate to below 18%, particularly where the original cost is a significant proportion of the sales proceeds as illustrated by the example below.

 

Example	Sale in 2008/09	Sale in 2007/08
	£	£
Current market value of asset	600,000	600,000
Less:  Cost of asset in Sept 1988	(360,000)	(360,000)
Less: Indexation allowance (0.5)	(180,000)	-
Gain before taper relief	60,000	240,000
Less: Taper relief (40%)	(24,000)	-
Gain after taper relief	36,000	240,000
Less: Annual exemption	(9,200)	(9,500)
Taxable Gain	26,800	230,500
CGT at 40% / 18%	£10,720	£41,480
Effective Tax Rate	4.5%	17.3%

 

The indexation allowance applies to the original cost of the asset, so if this was low the loss of indexation allowance may not be so important, even if the asset has been held for longer. An asset purchased in April 1982 would qualify for indexation allowance of over 100% if it is sold before 6 April 2008 but the base cost in 1982 may be low compared to today’s market value.

 

Example	Sale in 2007/08	Sale in 2008/09
	£	£
Current market value of asset	600,000	600,000
Less:  Cost of asset in April 1982	(50,000)	(50,000)
Less: Indexation allowance (1.006)	(50,300)	-
Gain before taper relief	499,700	550,000
Less: Taper relief (40%)	(199,880)	-
Gain after taper relief	299,820	500,000
Less: Annual exemption	(9,200)	(9,500)
Taxable Gain	290,620	540,500
CGT at 40% / 18%	£116,248	£97,290
Effective Tax Rate	21.1%	17.7%

    

Simplification of the share identification rules

The current rules for the identification of shares and securities for CGT purposes require a complex order of identification, which is dependent upon the dates when the assets were acquired. Shares of the same company and same class are treated as if the last shares acquired since 5 April 1998 are disposed of firstunless the shares are disposed on the acquisition date or within 30 days of that date.

Due to the changes to taper relief and indexation allowance, all shares of the same class in the same company will be treated as forming a single asset from 6 April 2008, regardless of when they were originally acquired. However, ‘same day’ and ‘30 day’ anti-avoidance rules will remain.

What does this change mean for me?

In general you will be better off under the new system (if your shares are non-business assets) by selling in 2008/09.

Normal planning rules continue to apply regarding the utilisation of your annual exemption each year.

Other more complex areas

Capital gains can arise in many other situations. Some of these, such as gains on Enterprise Investment Scheme and Venture Capital Trust shares, and rolled over gains on share for share or share for loan note exchanges, can be complex. Please talk to us before making any decisions.

Things that will not change

And finally, many existing reliefs will continue to be available, such as:

•       private residence relief;

•       business asset roll-over relief, which enables the gain on a business asset to be deferred until a point in the future;

•       business asset gift relief, which allows the gain on business assets that are given away to be held over until the assets are disposed of by the donee; and

•       any unused allowable losses from previous years, which can be brought forward in order to reduce any gains.