Capital Gains Tax ReformAs you will be aware, the Chancellor surprised everyone in his Pre Budget Report on the 9 October 2007 with major changes to the CGT regime. This factsheet outlines the main proposals, which may be subject to amendment. 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. Secondly, a number of changes will be made for disposals made on or after 6 April 2008 to simplify the CGT regime, including:
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. For example consider the situation of a higher rate taxpayer who is planning 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. Of course, everyone’s circumstances are different, so there will also be some winners. The following examples provide some examples of the differences in tax bills if assets are sold before or after 6 April 2008. If you are in any doubt about an appropriate course of action please speak to us before selling any assets so that we can advise you of the best way forward. 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. Capital Gains Tax - Taper Relief A capital gain arises when certain capital (or 'chargeable') assets are sold at a profit. The gain is the sale proceeds (net of selling costs) less the purchase price (including acquisition costs). From this a deduction is made to reduce the gain to an amount which is taxable. How Taper Relief Works Taper relief is based on the length of ownership and reduces the gain by a percentage. The percentage depends on the period of ownership of the asset and the type of asset - the percentage relief is higher for business assets (see definition below). The pre-1998 system involved the deduction of an indexation allowance based on the increase in the retail prices index over the period of ownership of the asset. It was designed to remove the inflationary element of any gain. Where assets are sold after 5 April 1998 but were originally purchased before that date the calculation has to accommodate both sets of rules. Indexation is calculated up to April 1998. This is deducted from the gain before taper relief is deducted. Amount of taper - non-business assets Taper relief is given by reference to the number of complete years of ownership after 5 April 1998. In addition a bonus year is added where the asset was acquired before 17 March 1998 (Budget Day). The taper relief table is as follows.
Amount of taper - business assets For disposals of business assets there is a different table.
The CGT regime is therefore very attractive provided that the asset has been a business asset throughout the period of ownership (or since April 1998 if acquired earlier than April 1998). Definition of Business Asset The following assets are currently eligible for business asset taper relief:
Change in the assets status In some circumstances an asset will not wholly qualify for full business asset taper relief. This may be due to a change in the definition of business assets or because the asset has not always been used for a qualifying purpose. In these circumstances part of the gain will qualify for business asset taper and part for non business taper relief. Please contact us for further information on this point. Matching Rules for Shares There have always been special rules to decide which shares have been sold where there is a part disposal of a shareholding in a particular company. In the taper relief system, share sales are matched with the most recent acquisition. This results in the lowest amount of taper being given. Assuming the shares in question are a non-business asset, no taper will be given on a shareholding which was acquired within three years of the sale. If however a sale is made in 2007/08 of non-business asset shares acquired before 5 April 1998, 40% taper will be given. Use of annual exemption The annual exemption for 2007/08 is £9,200. The opportunity to make tax free gains up to this level should not be overlooked. There are ways around this.
Losses Capital losses must be set against gains before taper relief is calculated. In effect, the loss is tapered. Where there are several gains made in the year the losses can be set against the gains in the order that produces the lowest tax charge. In effect losses should first be set against gains with the lowest taper relief.
Where losses are brought forward from earlier years, they only have to be used to the extent that the gains in the year are not covered by the annual exemption. Deferring Gains Through EIS Investments The Enterprise Investment Scheme (EIS) allows individuals to defer capital gains made on the disposal of any asset so long as the gain is reinvested in shares in a qualifying unquoted trading company (EIS). The deferred gain crystallises on a subsequent disposal of the shares unless certain conditions are breached before that time. Please note:
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%.
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 first unless 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:
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