Gain or pain?

Mike Truman looks at the likely impact of UK Chancellor Alistair Darling's proposed changes to capital gains tax (CGT)

To say that the announcement of the proposed changes to CGT in the pre-Budget report last October was a surprise would be something of an understatement. A system that had undergone no serious changes since 2002 was seen to be coming to full maturity as non-business assets held since before 1998 finally qualified for full 60% taper relief. While there were criticisms that private equity firms should not benefit from the 10% rate of CGT on business assets (famously, though not entirely accurately, summarised by Nicholas Ferguson, chairman of SVG Capital, as 'paying less tax than a cleaning lady'), there was little criticism of the rate as it applied to 'genuine' entrepreneurs.

The longer I stay in the tax profession, the more often I seem to see 'new' rules which look very similar to those in force when I first started as a trainee inspector of taxes in the late 1970s; indeed, the proposals announced by the UK Chancellor, Alistair Darling, take the basic structure of CGT back (more or less) to its inception in 1965. Taper relief and indexation allowance are both to be abolished. Rebasing at 1982 values is to remain, but with many of the transitional elements removed. There is to be a single, independent, rate of CGT, but it is 18% rather than the 30% that applied from 1965 until 1989. Even the new entrepreneurs' relief is based on the retirement relief built into the original legislation.

Winners and losers

So who are the winners and losers from the proposed new system? The biggest winners are those who invest in non-business assets. That will include the more active investors on the stock market, who in the past would get little or no taper relief on their gains because they did not hold shares for the minimum three years necessary to obtain some - and certainly not for the 10 years that took their effective rate down to 24%.

Second, home owners are also major beneficiaries. While it is sometimes possible to obtain a measure of main residence relief by the careful timing of an election, the significant property price increases over recent years mean that many owners are sitting on large unrealised gains. Even those who bought their properties before March 1998, and who therefore (with the bonus year for doing so) qualify for full non-business asset taper relief on a sale in 2007/08, face a 24% tax charge if they do sell. By waiting until 6 April, it appears they can reduce that by a quarter to 18%, although they will lose the benefit of any indexation on ownership prior to March 1998.

The biggest losers are, of course, entrepreneurs and other shareholders of unquoted companies, who will find that their tax rate increases from 10% to 18% unless their gains are covered by entrepreneurs' relief. While this is (as has been highlighted by many opponents of the change) an increase of 80% in the amount of tax paid, it is also worth pointing out that the amount of the gain that the entrepreneur will retain only drops by about 9%, from 90% to 82%.

Reactions

The reaction from trade bodies was swift and damning. The Confederation of British Industry (CBI), Institute of Directors, Federation of Small Businesses, and British Chambers of Commerce sent an open letter to the Chancellor saying it was a 'bolt from the blue' and that it would undermine enterprise and have an adverse effect on small business. The Trade and Industry Secretary and former CBI chairman, Lord Digby Jones, seemed to go 'off-message' when he said that many companies believed the Treasury's plan to be 'a terrible thing'.

In response, a further statement by the Chancellor about the proposals was originally planned for December 2007, but was subsequently delayed for more consultation, and eventually was issued just as this article was going to press in mid-January. The main proposal is for an entrepreneurs' relief on the first £1m of lifetime gains (see box).

Reaction from professional bodies tended to be more muted, concentrating on the lack of transitional reliefs and the short time between announcement and implementation. Their problem was that they have consistently called for simplification of the tax system, and there is no doubt that the new proposals are simple. It is therefore difficult for them to criticise the principles of the reform too strongly.

In the meantime, business owners and their advisers have to decide whether to take action before 5 April, a decision made all the more difficult by the prospect of an, as yet, unspecified level of further relief. While the loss of taper relief has attracted most attention, loss of indexation allowance can be just as significant in some cases. The consensus view is that it is possible to crystallise the indexation without creating a liability to tax by using provisions that result in a transfer at a no-gain no-loss value. However, because taper relief is given in charging the gain to tax rather than in calculating the gain itself, the most obvious ways to trigger the taper relief (sale, incorporation or transfer into trust) will all also result in a liability to pay tax, albeit at the current rates. It is only a sale that can also provide the wherewithal to pay the resulting tax bill; on incorporation or transfer into trust, the tax liability will have to be met from other funds. No wonder tax practitioners are finding it hard to decide what to advise.

Mike Truman is editor of Taxation magazine, published by LexisNexis.