How CGT move will hit tax bills

Published on Saturday 23 February 2008 16:38

With changes in capital gains coming into effect this April, Valerie Smart looks at the winners and losers...

EVER since last October's Pre-Budget Report, the world of capital gains tax (CGT) has been an uncertain one. This most complex of taxes is now being simplified.

The changes due to come into force from April will raise more money. However, while some will win, greater numbers are likely to lose. So who ends up on which side?

Capital Gains Tax basics

CGT is basically a tax on the disposal (which includes sale or gift) of assets that have been held for investment. That typically means property such as second homes and buy-to-let, businesses, shares and assets such as antiques and art. Employees in their company's share-save schemes may also be caught.

In essence it is a simple tax: the gain is the difference between the proceeds (what you get for it) less what it cost you. You are given a personal allowance (currently 9,200) which you can realise tax-free in any tax year. Above that, gains are taxed at the taxpayer's marginal (highest) rate of income tax. In other words, basic-rate taxpayers lose 20% and the better off lose 40%.

The calculation gets more complex with two key reliefs:

&#149 Indexation allowance: this increases the costs that can be deducted in line with the increase in the retail price index (RPI) from the time the money was spent. However, it only runs until 1998 and so only gives relief for inflation up to that time.

&#149 Taper relief: this effectively replaced indexation. It reduces the proportion of the gain subject to tax. There is a distinction between business assets (where the taxable proportion reduces to 25% after only two years) and non-business assets (where it takes 10 years to get down to 60% of the gain being chargeable). Most properties, antiques and shareholdings in companies other than one a taxpayer works for will count as non-business assets.

Employees with a share-save scheme are taxed on the difference between the exercise price and the price they sell at. However, historically these have been treated as a business asset, thereby cutting the gain to 25% of the amount due. This typically resulted in staff paying 5%, or higher earners 10%.

What's changing?

From the start of the new tax year on April 6, 2008, indexation allowance and taper relief will disappear completely. Instead, gains (now calculated without reference to any sort of inflation protection) are to be taxed at a simple flat rate of 18%, with no differential between higher-rate and basic-rate taxpayers.

Winners and losers

Business asset owners in general lose, seeing their tax rate go up from 10% (25% of the gain, usually chargeable at the 40% tax rate) to 18%.

However, last month the Chancellor announced an 'entrepreneurs relief' which will tax gains of up to 1m (a lifetime allowance) at a lower rate of 10%. The proviso is that these are gains on the disposal of a business, or where the seller had a shareholding of at least 5% in a company they worked for.

It is unlikely that employee shareholders, who currently benefit from business asset treatment, will be helped by this new relief. Private equity investors, seen by many as the target of the tax-raising side of these changes, may or may not benefit.

As for non-business asset owners, on the surface they will benefit from an apparent tax rate reduction. Their current rate of tax can be up to 40%, sometimes reducing to 24% (ie 60% of the gain at the 40% tax rate), but from April it will be just 18%. However, many who have held assets for a long time, particularly second properties, will have built up a significant entitlement to indexation allowance. That is cancelled from April and will often wipe out any gain from the overt tax rate reduction.

Additionally, anyone who was entitled to pay at least some of any CGT bill at the basic rate of tax (20% for CGT) will normally see the tax rate on that part of the gain going up, because the 18% rate will apply to the full gain as there will be no tapering.

Combining these factors means it is easy to show situations where the tax bill will double and in some cases increase even more markedly.

Can anything be done?

Much attention has been focused on the impact on those who have worked over many years to build up a business and now see their expected tax rate increasing significantly. That has led to the new entrepreneurs relief. But many who have saved and invested over a long period will also see a significant increase in their anticipated tax bills.

There are limited possibilities for arranging sales before the start of the new tax year. Alternatively, if there is a significant amount of indexation allowance available, it may be possible to arrange a transfer to a spouse (or civil partner) before April 6, which has the effect of 'fixing' the indexation allowance.

The CGT allowance (9,200) is always available. It will often be useful for shareholdings where disposals can be split over a number of years, but is not much help for adversely affected property owners.

• Valerie Smart is a tax director with PricewaterhouseCoopers

PROPERTY GAINS

Alf and Betty bought a cottage in 1978 as a weekend retreat but have let it out for the past 10 years. They have decided to sell the property.

Under current CGT rules:

Proceeds of sale: 150,000

Less: value in 1982 (30,000) and indexation allowance (31,400)

Less: taper relief (35,440)

Less: CGT annual exemption (9,200 each)

Taxable gain: 17,380 each

Alf pays 40% tax > 6,952; Betty pays 20% tax > 3,476

Couple's total CGT bill: 10,428

Under CGT rules from April 6:

Gain: 120,000

Less: annual exemptions (19,200)

Taxable gain: 100,800

Couple pay 18% tax (9,072 each)

Couple's total CGT bill: 18,144