|
The rules of capital gains tax are to materially change for disposals falling on or after 6 April. The “headline” change, the introduction of a single flat rate of 18% of CGT is, in planning terms at least, perhaps less significant than the accompanying changes which have been characterised as “simplification” measures. In particular, the abolition of both taper relief and the indexation allowance potentially increase the burden of CGT notwithstanding the apparent rate reduction. Year end tax planning is therefore especially important this year. This briefing paper outlines the main changes and some planning points to consider in the period running up to 5 April 2008.
In addition, we comment upon the new relief that the Chancellor surprised us with - entrepreneur’s relief - which represents a response to the particular concerns raised by business to the withdrawal of taper relief.
The new rules in outline
For disposals falling on or after 6 April next:
• A single rate of CGT of 18% will apply (subject to the availability of entrepreneurs' relief).
• Taper relief is abolished. Taper relief reduces the effective rate of CGT by exempting a defined proportion of the gain dependent upon the nature of the asset held and the period of ownership. As a result, a disposal of business assets may currently benefit from an effective rate of CGT of 10% after two years ownership and non-business assets 24% after 10 years ownership.
• Indexation allowance is abolished. The indexation allowance represents a deduction in computing a gain reflecting the movement in the retail price index over the period of ownership of the asset based on its original cost or value at 31March 1982: the original purpose of the allowance being to eliminate inflationary gains. For individuals the allowance was frozen at 5 April 1998 on the introduction of taper relief.
• Assets are to be compulsorily rebased at their 31 March 1982 value. Under current rules where an asset was acquired before 31 March 1982 the taxpayer can compute his gain based on either the original cost or market value at 31 March 1982, choosing whichever produces the lower gain. From 6 April the base cost of all assets owned at 31 March 1982 must be the market value on that date.
“Entrepreneurs’ relief”
In response to the intensive lobbying against the withdrawal of taper relief, the Chancellor announced on 24 January a new relief – entrepreneurs' relief. We still await publication of the draft legislation detailing this new provision (now expected on 12 March, Budget Day) with the result that the summary below is based on what has been announced by way of press release.
“Entrepreneurs’ relief” - what is it?
A relief whereby an individual’s first £1m of qualifying gains will enjoy an effective rate of CGT at 10%. Gains above £1m will revert to a rate of 18%. The main features of the relief are:
• Effective from 6 April 2008.
• The £1million limit is a cumulative LIFETIME Limit. It is per individual rather than per business and may be claimed on successive occasions to a maximum of £1 million.
• The relief is available against gains realised on the disposal of shares in a trading company (or holding company of a trading group) by a director or employee who owns at least 5% of the shares and is able to exercise 5% of the voting rights.
• The relief is also available for disposals by a sole trader or partner(s) of the whole or part of a trading business including professions, vocations and furnished holiday lets (but not other property businesses).
• The relief is extended to “associated” disposals being those assets used by the business or company for its trade but owned by the partner or shareholder.
• The qualifying assets must have been held for 1 year.
Issues that remain to be clarified
The following represent some of the issues which remain to be clarified:
• Is the relief automatic or may it be disclaimed in order to utilise other available reliefs or capital losses?
• Is a “working time” commitment to apply in order to satisfy the employment condition for shares in a qualifying company?
• Will the relief extend to 5% holdings acquired by employees on the exercise of share options (that are usually exercised just before a company sale)?
• Will the 5% holding include that of associates (spouse, family members etc)?
• Will gains deferred against loan note consideration qualify for relief? A further briefing note will be produced on publication of the draft legislation. Having regard to the changes to be introduced, what planning might be considered?
Realise gains before 5 April 2008
The main losers under the new regime are those that expected an effective 10% CGT rate (with the benefit of taper relief) on the sale of their business assets or shares in their trading companies and who now face an 80% increase in their tax bill.
A third party sale will generally be commercially impossible given the imminence of 5 April. Where negotiations are currently being undertaken ensure that an unconditional contract is signed before 6 April 2008 to secure that the disposal falls under the existing rules.
In the absence of a third party sale, a disposal might be engineered by way of a transfer to a “controlled” party. Options here might include a gift to a family member, transfer to a company or settlor interested trust. Each of these possibilities requires very careful consideration having regard to individual circumstances and other collateral tax consequences.
A disposal (whether to a third or controlled party) in order to crystallise a gain with the benefit of taper relief is only attractive if a cash realisation of those assets is a real possibility in the medium term. A CGT liability on the disposal will fall due on 31 January 2009 and will require to be financed.
Loan notes
Where gains have been deferred into loan notes (on a previous company sale) consideration should be given to negotiating an early redemption in order to realise the deferred gain under the current regime. Where cash-flow is an obstacle to redemption
the possibility of a “loan back” might be considered. Alternatively, the loan notes might be transferred to a controlled party as discussed above, again subject to careful consideration of the commercial and collateral tax consequences of such a transfer.
other assets Clearly those with “non-business” assets (for example, rental properties, second homes, etc.) and especially those who acquired these assets after March 1998 should (subject to indexation considerations - see below) consider deferring any disposals until after 5 April next in order to benefit from the new flat rate of 18%. Where a sale is currently in prospect consider deferring an unconditional contract until after 5 April 2008.
Indexation allowance
What is indexation allowance? It is a relief deducted from pre-taper taper gains and is available on all assets purchased before April 1998. It is calculated by reference to the movement of the retail price index from the date of the asset’s acquisition (if later, 31 March 1982) to April 1998, when it was frozen for individuals. The maximum allowance available has the effect of deducting
the cost of the asset again and the effect of its abolition may significantly increase the CGT cost on a disposal as demonstrated by the following example:
With No Indexation Indexation
Sale proceeds 400,000 400,000
Asset cost (acquired March 1982) (150,000) (150,000)
Gross Gain 250,000 250,000
Indexation allowance 1.047% (157,050) Nil
Taxable gain £92,950 £250,000
Tax at 18% £16,731 £45,000
In this example the abolition of indexation allowance has increased the CGT tax charge by £28,239, an increase of nearly 70%!
Action to be taken before 6 April 2008
Review your asset/share portfolio in order to identify those assets that may have accrued significant amounts of indexation. These would include assets/shares with a significant base cost (whether purchased directly, transferred or inherited) and acquired prior to April 1998. Main asset categories are likely to be investment properties, second homes, quoted shares or any inherited shares. Consider the possibility of “banking” the indexation relief by way of a transfer to your spouse. The simple transfer of an asset to the spouse (or civil partner) enables the original cost and accrued indexation relief to be passed to the spouse (or civil partner) as “rebased” for CGT purposes. This planning is also thought to be effective in passing the benefit of indexation allowance based on the value of assets held at 31 March 1982, although this remains to be confirmed by HM Revenue and customs.
In certain circumstances a crystallisation of the gain (as discussed above with respect to taper relief) might be considered in order to benefit from the accrued indexation allowance.
For more information
Please contact Jacqueline Taylor at haysmacintyre
|