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The new Conservative/Lib Dem coalition government has just published the text of the Coalition Agreement made between the parties. Should you wish you may view this via the link below. The agreement states that it is the intention of the new government to increase the rate of Capital Gains Tax (“CGT”) for “non business assets”.  For the purposes of CGT second homes and buy-to-let properties owned by individuals, partnerships and trusts are considered to be “non business assets” as are stocks and shares, art, antiques etc.

The Liberal Democrat manifesto undertook to charge taxpayers CGT at their highest Income Tax rate. This would have meant some taxpayers paying 50% tax on gains instead of the current 18%. However although not stated in the Agreement subsequent comments by the new government indicate that the maximum rate payable will be capped at 40% rather than 50% which probably reflects the compromise position agreed by the parties.

It has to be of concern that there is no clarity on whether there will be any indexation allowance (as used to be the case) which raises the spectre of people having to pay tax on inflation rather than just on a real increase of value. Inflation Tax rather than Capital Gains Tax? Rather unfair.

The Liberal Democrats also proposed to reduce the annual tax-free allowance from the current £10,100 to just £2,500 but again the Coalition Agreement is silent on this matter. Perhaps negotiations are ongoing.

The only thing that is really clear is that many more people will be paying CGT and they will be paying much more of it. Indeed, the coalition government have indicated that they expect to triple their take of CGT from the current £2.4 billion to £7.5 billion.

The coalition agreement states that the parties will seek to agree “generous exemptions” for “entrepreneurial business activities” but without any indication of what form such exemptions will take. Rumours suggest that the existing entrepreneurs’ relief will be widened or a regime comparable to the previous system of taper relief or the even earlier indexation relief will be reintroduced.  If so, there will need to be complex transitional rules. But none of this helps anyone with “non business assets” including, as above, second homes, buy to let properties, stocks and shares, art, antiques, wines etc. Surprising as it may seem the definition of “business assets” for CGT purposes does not include buy to let property and landlords don’t get rollover relief either so this change could have a drastic affect on the rental market.

The Emergency Budget

The new government intend to present an emergency budget at 3.30 pm on Tuesday 22nd June. No doubt we will all be tuned in to get the full depressing details of how the Liberals and Conservatives are going to start clawing back some of the overspend that Gordon Brown, as Chancellor and as Prime Minister, was responsible for.

It has been suggested that changes to the CGT regime will not come into effect until 6th April next year. However it is also possible, perhaps even probable, that given the economic mess left by the outgoing Labour government the changes could be brought in by the autumn. In fact some commentators think that any increase could be brought in with immediate effect (1st July?) or even backdated to 6th April this year. I tend to discount the idea of backdating but I could well be wrong. It isn’t unknown, either for me to be wrong or for legislation to be backdated. Both are quite unacceptable!

The Current Position

  • CGT is payable on the disposal of any asset apart from a taxpayer’s sole or main home. Let’s not get into the “flipping” of homes to avoid CGT – as practiced by many MPs, not to mention Mr Speaker Bercow – here.
  • For CGT purposes a disposal occurs on the date of an unconditional agreement to sell, always assuming that the agreement is completed in due course.
  • There is a single rate of CGT which is 18% on all gains made from disposals effective on or after 6th April 2008.
  • Where appropriate Entrepreneurs’ Relief applies. This gives an effective 10% rate of CGT on the first £2 million of gains made on or after April 2008 relating to the disposal of qualifying holdings in trading companies, where the shareholder is an employee or officer of the company. 
  • Trust interests are also eligible to be included in the Entrepreneur’s relief regime.

Who Will Loose Out When The Rates Go Up?

  • Holders of non-business assets (e.g. individuals or partnerships with buy-to-let or second homes and many investors in investment or listed companies) who may find themselves paying tax at 40% instead of the current 18%, and 
  • Holders of business assets who do not qualify for entrepreneurs’ relief. Again they will pay at 40% rather than 18%.

Admittedly some people may only have to pay at 20% but it is possible that the gain itself could be sufficient to push them into the 40% band or that a decrease in the tax-free allowance could mean them paying tax on gains which previously would have been zero rated.

 Will There Be Any Winners When Rates Go Up?

There could be winners if the thresholds for entrepreneurs’ relief are increased. Also if a form of taper relief or indexation is reintroduced in respect of business assets not currently eligible for entrepreneurs’ relief or non business assets in general.

 What Can Be Done to Save Tax Now?

It could be advantageous for investors who stand to lose out from the potential changes to trigger a disposal prior to the introduction of the changes.  They may be able to save tax in the long run by using one or more of the following strategies.  Note that for these purposes let’s assume that the changes take effect from a future date – say 1st October 2010. As explained above the effective date could be later, earlier or even backdated.

1) Sale currently being negotiated or planned

Probably most relevant to second homes or investment property but could also be applicable to shares or other assets. If the disposal of the asset happens before our notional date of 1st October 2010, the tax rate will be 18%; if it happens after that date, it will be higher. This will be at least 20%, but unless the gain is small and the taxpayer has a low income then 40% is likely to be the applicable rate. Ideally an unconditional contract should be entered into before 1st October 2010. If this is not possible, or is uncertain, it might be advisable to sell the assets (perhaps for debt) to a trust or other entity before 1st October 2010. The trust or entity would then sell the assets to the ultimate purchaser. A suitable trust should be capable of being set up in a short timescale with a minimum of formality. The gain on the value of the property at the time it is given to the trust or entity would be subject to tax at 18%.  Only any gain made between the asset going into trust or entity and being sold to the final purchaser would be liable to tax at a higher rate. Provided that the contract with the trustees is appropriately structured the 18% CGT would only become payable as and when the sale to a third party purchaser occurs. Similar arrangements may also be possible with connected persons such as family members or companies.

2) No sale imminent or planned

The assets could still be transferred into trust etc. using the above route. The tax only becomes payable as and when the sale to a third party purchaser occurs.  However, before any transfer takes place the impact on estate planning would need to be considered.

3) Imminent sale on a share for share or share for loan note basis

Normally there is no recognised disposal on an exchange of shares on this basis. A disposal is only recognised when the replacement shares or loan notes are sold. However the rollover of gains is not automatic. With a little structuring, the date of sale of the original shares can be made the date of the tax point. This means that gains to date would be taxed at 18%, albeit at the expense of paying the tax early and funding the tax independently rather than out of sale proceeds. The advantage of this is that only any future gains would be taxed at higher rates. While this would negate one key traditional tax benefit for a seller on a share for share/loan note exchange, which is deferral of tax on the whole gain until a later disposal, the overall benefit in the long run should be a smaller tax bill.

4) Holding assets long term in a Company

Companies do not pay CGT but instead any gains they make are taxed at the appropriate rate of Corporation Tax. Currently this ranges from 21% to 28%. There is no mention of the Conservative pledge to reduce the lower rate to 20% in the coalition agreement. In the UK a private company costs very little to set up and maintain and individuals may be able to transfer assets to a company and recognise a capital gain at a maximum taxable charge of 18%. In addition there currently is a £10,100 tax-free band. In future any capital gain will be based on the value at the point of transfer to the company and only charged at the lower corporation tax rate. Gains become income for the company and can be paid out to company shareholders in various tax efficient ways.

5) Holding shares in an ISA (Individual Savings Account)

It has always been possible for individuals to hold shares in an ISA which not only wiped out any capital gains tax within the ISA but allows income to be taken from the ISA tax free. However there are annual limits to the value of shares or other assets that you can put into an ISA. Because of the individual tax-free allowance for CGT many people did not bother to hold their shares in this way preferring to use their ISA allowance for cash or other assets. It may now be worthwhile reviewing this on a case by case basis and holding shares in this manner in future. It is possible for taxpayers to transfer existing shareholdings into an ISA particularly where they can take advantage of the current CGT tax-free band or even where the value of shares has fallen so there is little or no gain. Do take care though that if you transfer shares in at a loss you may not be able to carry forward the loss against future years gains.

Warnings

1) This article is not proposing or even suggesting that all or any of the above methods will work in all or any specific cases. The purpose of this article is to raise awareness of the impending increase and to indicate that there may be courses of action that taxpayers might like to investigate in order to save tax. Such investigation must be undertaken with an appropriate professional advisor who is in possession of the full details of the taxpayer’s personal circumstances.

2) There is a risk that by taking quick action a tax charge could be triggered on a disposal which might in the post-Budget regime be exempt, perhaps by falling within a widened business assets regime, should one be introduced.

3) A taxpayer’s attitudes to risk, tax planning, cost, likely future investment returns, cash flow, the details of any future regime and estimates of when rates may start to come down, are all factors that need to be considered. As well as the future of the capital gains annual exemption itself.

See Also

What Is Capital Gains Tax

What Is Corporation Tax

A Quick Guide to Individual Savings Accounts

How Much Can I Put in an Isa?

The Liberal Conservative Coalition Agreement

 

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