Radical Changes to Capital Gains Tax
 
After the announcement of fundamental and radical changes in the capital gains tax regime in the October Pre Budget Report, the draft legislation has now been published.

The main changes proposed are the introduction of a flat rate of CGT of 18% and the abolition of taper relief, the latter having been introduced to encourage entrepreneurial activity. It was not surprising that the abolition of taper relief was met with immense protest from the business community and private equity industry. The Chancellor has responded to the intense lobbying activity by introducing a new Entrepreneurs’ Relief.

There are clearly winners and losers resulting from these proposed changes. The losers are the entrepreneurs who have been building their trading businesses over a number of years.

The introduction of the 18% rate for gains will also mean that there will now be a substantial difference between the taxation of gains at 18% and the taxation of income at 40%. This will give taxpayers an incentive to maximise gains at the expense of income.

It is important to review capital assets held now to ascertain whether any actions should be taken before 5 April 2008.
 
  Main Changes
 
Following the announcement in the Pre-Budget Report in October 2007, the draft legislation relating to the changes to the domicile and residence rules has now been published. These rules will affect all non UK domiciled individuals who are resident in the UK. The new rules will come into effect from 6 April 2008. However, these rules are not final as there is a Consultation process under way which does not end until 28 February 2008 and the legislation may change before Royal Assent in Summer 2008. There could, therefore, be other material changes to the current draft legislation.

It is important that those who are affected by these rules review their affairs and seek professional advice. There is very little time between now and 5 April 2008. The draft rules published are retrospective in relation to non UK resident trusts and urgent action before 5 April 2008 may be required to avoid future tax charges. The changes incorporated in the draft legislation are much worse than those expected when the Consultation document was issued. The rules are onerous and in some cases, the trustees will have to gather information about past gains and payments made by the trusts.
 
  If assets qualify for business as set taper relief
 
Years Held Higher rate Basic rate
0 40% 20%
1 20% 10%
2 10% 5%
 
  If assets qualify for non business as set taper relief
 
Years Held Higher rate Basic rate
0 years 40% 20%
1 40% 20%
2 40% 20%
3 38% 19%
4 365 18%
5 34% 17%
6 32% 16%
7 30% 15%
8 28% 14%
9 26% 13%
10 24% 12%
 
  • Indexation allowance will be abolished for all disposals by individuals and trustees after 5 April 2008. Companies will continue to benefit from indexation allowance on corporate gains. In some cases, the abolition of indexation allowance will substantially reduce the allowable expenditure on a disposal of assets after 5 April 2008.
  • From 5 April 2008, the base cost of an asset will be the value as at 31 March 2008 if it was acquired prior to this date or the actual cost. The mandatory use of the value of the asset as at 31 March 1982 may produce a higher gain if the cost of the asset was higher.
  • The multiple share pools and complex share matching rules are simplified with the exceptions of same day and 30 days and bed and breakfast transactions.
 
  New Entrepreneurs' Relief
 

The basic features of the proposed new relief are set out below.

  • The Entrepreneurs relief will be give on the first £1million of cumulative qualifying gains.
  • An effective rate of 10% will apply to the cumulative qualifying gains by applying a 4/9 reducing fraction to the gain and then charging the reduced gain at the CGT rate of 18%.
  • The relief will apply to disposals of interests in a business or partnership and shares and securities in a trading company in which the person making the disposal is a director or employee who has at least 5% of the ordinary voting share capital.
  • The £1million is a lifetime allowance but it is not clear if the clock starts on 6 April 2008 or whether previous disposal have to be taken into account.
  • The relief will be available to individuals but also to trustees. The trustees will be eligible for the relief where a beneficiary has an interest in possession and is an employee of the company or involved in carrying on the business.
 
  Action Required
 
It is important that a review should be carried out all assets to ascertain if further action is required before 5 April 2008.

The following example set out some scenarios where urgent action may be required.

  • If you have assets, such as shares in a private trading company or an interest in a business or a commercial property let to the right type of tenant, qualifying for business asset taper relief now, consideration should be given to safeguarding the 10% CGT rate.
  • If you have assets bought a while ago which would be eligible for substantial indexation allowance, we should consider banking the indexation allowance before 5 April 2008. The abolition of the indexation allowance can in some cases more than halve the allowable expenditure on a disposal of an asset after 5 April 2008. There will be assets which if sold on 5 April 2008 could give rise to a loss but if sold a day later would give rise to a gain because indexation allowance will not be available.
  • Conversely, if you are selling an asset now which has not qualified for business asset taper relief it might be beneficial to delay the sale until after 5 April 2008 and benefit from a CGT rate of 18%.

With 5 April 2008 fast approaching, it is essential that professional advice is sought quickly to ascertain the effect of the proposed changes to your portfolio of assets.