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CGT reform – who is hurting most? By Rebecca Benneyworth

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26th Oct 2007
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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

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Replies (6)

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By User deleted
29th Oct 2007 16:57

Halving relief
Much forgotten is the halving relief. I have a number of clients that this affects and their effective base costs are now the original pre-1982 acquisition costs as they are not allowed to rebase at 1982 (so the policy adviser told me).

What about these taxpayers and those who would never have benefitted from business asset taper relief?

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By lonkies.yahoo
30th Oct 2007 10:24

Consultation and transitional measures required
This summary by Rebecca reinforces the Tax Faculty request to the Chancellor that introduction of the new measures should be delayed until proper consultation with interested parties has taken place. At the very least there should be a transitionary period, as there was for the phasing out of retirement relief.

Giles

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By User deleted
30th Oct 2007 16:55

Should anyone listen to what account have to say about this?
Remember to include how match the tax payer saves from next year due to the fact that there will no longer be a need to get an accountant to work out capital gains tax. As well as the saved frees, you need to take into account the saved stress by not having to deal with an accountant.

Yes some people do loose out by making it simple (including me with Aim shares), but most people gain from having a more simple system. However accountants will loose out therefore should anyone listen to what account have to say about this?

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By User deleted
30th Oct 2007 20:36

Simplification? Ah bless!
Dear Ian Ringrise. If you find that dealing with us accountants is stressful, you have probably chosen the wrong one. I would also most humbly suggest that it may be optimistic to assume that a tax has been simplified just because the Chancellor has said so. Still, what you have never heard of can't worry you.

Thank you for your concern that we may "loose" out. Most of us would be delighted if there was a real simplification of the world's most complicated tax regime. As if.

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By dpmartin
31st Oct 2007 17:32

Re: Sitting on QCBs
Hi David,

You mentioned that the frozen Taper Relief on a gain deferred into QCBs will be lost due to Para 16 Sch A1 TCGA 1992.

On review of that Section, it appears to suggest that for certain cases (including QCBs) the Taper relief is calculated based on the original calculation, not the date of crystallisation. In other words, the Taper Relief would be preserved.

It also suggests this is the case for gains deferred into EIS / VCT shares.

If anyone has any further thoughts on the possible effect on QCBs, EIS & VCT I'd be interested to read them.

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By User deleted
20th Nov 2007 10:25

Non QCBs
I have a client who sold out for cash and non QCBs. How can we crystallise the gain and take advantage of TR - assume we could use a settlor interested trust?

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