In October 2007 the Chancellor announced that he would introduce a number of Capital Gains Tax (“CGT”) changes to apply to all CGT disposals taking place on or after 6 April 2008. The most contentious of these was the proposal to abolish taper relief, which has been reported extensively in the press as an increase in the rate of CGT from 10% to 18% for some taxpayers.
Since then there has been concerted lobbying of the Chancellor but in a recent announcement the Chancellor made it clear that his principal proposals would be put into effect unchanged. He would however introduce a new CGT relief designed to help certain entrepreneurs. Under this proposal, up to £1 million of certain gains can still be taxed at 10%. £1 million is a lifetime allowance and not an annual allowance. This note highlights the key proposals and the action that might be taken before 6 April 2008 to accelerate (or possibly postpone) CGT disposals and so minimise the effect of, or even benefit from, the change in rates.
The delay by the Chancellor in making the further announcement and the need to wait for the actual draft legislation on the new entrepreneurs’ relief until mid-February means the timescale for implementing tax planning is short.
Overview of the key features
- Changes only affect CGT for individuals and trusts.
- Changes apply to “disposals” made on or after 6 April 2008. A disposal occurs on the date of an unconditional agreement to sell (assuming that agreement is completed in due course).
- Introduction of a single rate of CGT of 18% on all gains made from disposals on or after 6 April 2008. There is no automatic“grandfathering” of gains made (but not realised) up to that date, which would allow all gains up to that date to be taxed at 10%, with subsequent gains taxed at 18%.
- Abolition of taper relief. Taper relief currently divides shares into “business” and “non-business” assets. Gains on business assets are taxed more favourably. A higher rate taxpayer qualifying for full business taper would currently pay CGT at an effective rate of only 10% if he had held his shares for two years or more. A higher rate taxpayer qualifying for full non-business asset taper relief would currently pay CGT at 24% after holding shares for ten years.
- Abolition of indexation relief. This will only be relevant where the asset was held before 6 April 1998 (when further indexation relief stopped and taper relief was introduced).
- Introduction of a new entrepreneurs’ relief. A 10% rate of CGT will be available for the first £1 million of gains made on or after 6 April 2008 by disposing of 5% plus holdings in trading companies, where the holder is an employee or officer of the company. Trust interests are also eligible to be included. (It is to be hoped that pre-6 April 2008 gains already made will not be included in this limit, although this will not be known until the draft legislation is published).
Winners and Losers
Some will gain – in particular,
- holders of non-business assets (eg individuals with buy-to-let or second homes and many investors in investment or listed companies) who will have a tax rate of 18% whereas currently the lowest would be 24%, and
- holders of business assets for less than two years, who would pay tax at 40% if they had held the asset for less than one year and 20% if they had held it for just one year.
These investors may benefit from waiting to sell shares until the new tax year when the rate of tax will be 18%.
However, there are likely to be more losers. These include many:
- shareholders in unquoted or AIM-listed companies
- employees holding shares in their employing companies
- holders of loan notes or those expecting shares or loan notes under earn-outs
who currently qualify or expect to qualify for full business taper and pay tax at an effective rate of only 10% but who will pay tax after 5 April 2008 at 18% (subject to the availability of entrepreneurs’ relief).
Shareholders with large indexation allowances are also adversely affected. A shareholder who acquired an asset on 31 March 1982 would currently be entitled to relief equal to approximately 105% of his cost, but this will disappear as of 6 April 2008.
What can be done?
All those investors who lose out from the changes might be able to trigger a pre-6 April 2008 disposal and save tax in the long run by using one or more of the following methods.
- Where a sale is being negotiated or is in the offing. If the disposal happens before 6 April 2008, the tax rate will be 10%; if after, it will be 18%. Clearly, there will be pressure to “dispose” of the shares – ie enter into an unconditional contract – before 6 April 2008. The most obvious buyer is the proposed purchaser, but if a sale cannot be finalised before 6 April it might be that the shares could be put into trust before 6 April 2008 with the trust then selling to the ultimate purchaser. A suitable trust should be capable of being set up in a short timescale with a minimum of formality and without negative IHT consequences. The gain on the value of the shares at the time they were given to the trust would be subject to tax at 10%; only the balance should be subject to tax at 18%. Provided that the contract with the trustees is appropriately structured tax only becomes payable as and when the sale to a third party purchaser occurs.
- There is no imminent sale. The shares could still be transferred into the trust using the above route. The tax only becomes payable as and when the sale to a third party purchaser occurs. However, before moving the shares the impact on the availability of the new entrepreneurs’ relief as well as estate planning would need to be considered
- An imminent sale on a share for share or share for loan note basis. Normally, there is no disposal on the exchange – a disposal is only recognised when the replacement shares or loan notes are sold. The rollover of gains is not automatic though and with a little structuring the date of sale of the original shares can be made the tax point and gains to date taxed at 10% albeit at the expense of paying the relevant tax on 31 January 2009. The advantage of this is that only future gains would be taxed at 18%. 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 would be less tax in the long run.
Loan notes may become less popular anyway. Traditionally rolling into loan notes has worked to the sellers’ advantage and allowed extra taper to be earned before the loan notes are redeemed and cash is received, and so reduce the overall tax rate. However, as all capital gains will automatically be taxed at 18% whenever the gain is made we may see a decline in seller enthusiasm for loan notes after 6 April 2008 as the CGT rate cannot be lowered by deferring receipt other than if the entrepreneurs’ rate were to become available. However, small shareholders may still wish to maximise use of the CGT annual exemption in different years by taking advantage of loan notes.
- Where loan notes are already held. A loan note holder may want to investigate whether a sale or early redemption can be made before 6 April 2008 so as to bring into charge the deferred gain on the shares exchanged for the loan notes. This might be done by putting the loan notes into an appropriate trust. Typically, loan notes are likely to have some form of restriction on assignment so that consideration would need to be given to whether putting the loan notes into trust would be permitted. Alternatively, re-negotiation with the issuing company may be possible by offering to take up a newly issued loan note with the cash proceeds (a loan note exchange for loan notes would not be good enough as the gain would simply be rolled over/held over again).
- Where indexation relief is available the investor should calculate the available indexation now. If indexation relief is significant, in some cases it might be possible for a spouse/civil partner to transfer an asset to the other spouse/civil partner in order to preserve indexation relief. For example, say one spouse had acquired an asset for 140 and has indexation allowance of 20 on that asset. If he retains the asset, he will lose the benefit of the indexation allowance on 6 April 2008, but if he transfers it to his spouse before that date, the spouse will be treated as having a base cost of 160, which will survive the change in legislation.
Clearly, it is necessary to look at the circumstances in each case. Individual attitudes to risk, tax planning, cost, likely future investment returns and the relevance of the future method of reaching a 10% rate of tax via the entrepreneurs’ relief are all factors that would need to be considered, and, needless to say, specific circumstances would always have to be looked at.