Rebecca Benneyworth reviews options for CGT planning prior to the proposed reforms in April 2008.
Practitioners are scurrying round trying to get to the bottom of the planned reform of Capital Gains Tax, due early next year. The representatives of those most affected by the abolition of business asset taper relief have put their case to the Chancellor, who, it seems, is in “listening mode” at present.
Meanwhile, as the busy tax return season advances towards us, practitioners are faced with the pretty dreadful task of reviewing their client base to establish who needs urgent advice about the changes. The problem for most is that each client will need advice specific to his or her situation, and there may be many complex factors to take into account. Here are a few of the issues.
Basic rate taxpayers
Those who were expecting to pay tax on a band of gains at basic rate (which for CGT is of course 20%) have been disappointed by the changes. Provided taper relief would be sufficient to reduce their gain to below 90%, then they face a tax increase next year as compared to this year – 85% x 20% is only 17% as opposed to the new flat rate of 18%. However, if full non business taper were available, the net gain of 60% would be taxed at 20%, producing a compound rate of 12%. So these taxpayers will see their rate rise by 50% on disposals delayed until next tax year. However, once the gain is sufficient to attract 40% tax now, the compound rate becomes 40% x 60%, or 24%, and the taxpayer is better off by waiting.
So how big do the gains have to be to wait, and what sort of money could be saved for a basic rate taxpayer by advising to sell now?
If we take a taxpayer with no income at all, but substantial gains, the loss of taper relief of 40% would work like this :
|
Net Gain |
Rate |
Tax |
Gross gain |
|
|
|
|
(40% taper) |
|
9,200 |
0% |
0 |
15,333 |
|
2,230 |
10% |
223 |
3,717 |
|
32,370 |
20% |
6,474 |
53,950 |
Total |
43,800 |
|
6,697 |
73,000 |
Next year, that gross gain of £73,000 would produce a tax charge of 18% of £63,800, or £11,484, so the maximum saving is on gross gains of £73,000 and amounts to £4,787. After this, the benefits are eroded by the increase in tax charge from 2007/08 to 2008/09. The benefit of selling early disappears at gross gains of £152,783, at which point it is tax neutral to sell either in 2007/08 or 2008/09, with a tax charge of £25,845 in both cases.
However, this is a pretty unlikely scenario, as one might expect a person with such substantial assets (including over £150,000 of unrealised gross gains on investments) to have at least some income. But it does at least give a feel for the sorts of sums involved.
Bank annual exemption?
Those who are ambivalent about bed and breakfasting (to the extent that this can be done nowadays) might like to observe the following : To “bank” an annual exemption with taper relief of 40% allows one to realise gains of £15,333 this year. No tax payable. Next year, the same gain would produce tax of 18% of £6,133 or £1,104. Worth doing? How long would it take to advise clients about that?
Loss of indexation
The computations regarding loss of indexation are more complex, and firms with CGT software may find that this is the easiest way to go about it. Essentially, lost indexation must also mean lost taper, as the asset must by definition attract at worst maximum non business taper. A double whammy! Even taxpayers with higher rate tax due on their gains will need to consider what to do next.
Loss of the “kink test”
This will be relevant to those with original cost at more than the 1982 value – I suspect more likely for shares than property. At present, if the 1982 value is higher, the kink test would allow the disposer to select that for the basis of computation of gain – in future all disposals will use 1982 value. So the losers will be those who would have chosen original cost. Once again, quite detailed computations will be needed to establish the impact of the change, and how much tax will be saved.
Last and definitely not least – business asset taper relief
At least here is one that everyone understands. The loss of business asset taper relief of the maximum amount hits every taxpayer hard. Higher rate taxpayers will see their effective rate of tax rise from 10% to 18%, and if any basic rate element is affected, the gain would be taxed at only 5%, giving an even more substantial increase in the tax due.
The problem here is how to access the taper? Many business owners will be unable to realise their gains to take advantage of the current rate. They may not be ready to sell, or may not be able to find a willing buyer in the time available. The use of trusts may look attractive, but these are not without problems of their own, and the costs may in some cases pose a significant burden – in addition to financing the tax payable in the absence of cash proceeds.
Where an asset has mixed business and non business taper, it’s back to detailed calculations of the gain and the net taper relief applying to the gain on the whole asset to decide when it is best to sell.
There remains little doubt about one thing – it is going to be a very busy few months for practitioners!
Rebecca has written a detailed guide to the changes and how to assess the impact on your clients, with a number of tables intended to provide a simple route to the “who should sell now?” decision. It is published by Uktaxworld and can be purchased direct from their online shop at www.uktwshop.com.
Links:
Pre-budget report: CGT reform in the spotlight