The last indexation allowance tables have just been released. It is always sad to say goodbye to an old friend, especially one which has been so helpful in reducing tax payable.
Born in 1982
Capital gains tax was invented in April 1965. Before that, the income from the sale of assets was subject to income tax, or not taxed at all. The 1970s saw significant levels of inflation in the UK, and it was deemed to be unfair to tax people on the growth in the value of their assets that was simply due to the increase in general prices.
Hence, taxpayers were given the option to rebase the cost of their assets at 31 March 1982, and to adjust that 1982 value by the rate of inflation – measured by the retail price index (RPI), until the date of disposal. This adjustment was called the indexation allowance.
The effect of the indexation allowance has been to take out the growth in the value of the asset due to general inflation and leave the residue of “added value” to be subject to tax. However, the indexation allowance can’t create or increase a capital loss on disposal of an asset.
Frozen in 1998
In April 1998, indexation allowance was frozen for gains made by individuals and trustees. The allowance could still reduce the base value of the asset, but only for periods of ownership up to 5 April 1998. Taper relief was supposed to replace the effect of indexation allowance for periods from 6 April 1998 onwards.
From 6 April 2008 taper relief was abolished, and indexation allowance was also removed completely from the CGT computations of individuals and trustees. Since then those taxpayers have paid CGT on the growth in value of their assets including the effect of inflation, but companies have continued to reduce their asset values by the indexation allowance.
End is nigh
The Autumn Budget on 22 November 2017 announced the removal of indexation allowance from 1 January 2018. The last month for which allowance indexation can be calculated on the disposal of an asset is for December 2017. Tables of indexation allowance for disposals made in December 2017 have just been released.
It is telling that the policy paper on this issue talks about “removal” of the indexation allowance. However, the allowance has not been removed – yet. It has been frozen. Disposals by companies in January 2018 and later periods will deduct the indexation allowance in the calculation of the gain, but only for periods of ownership up to December 2017. How long will it be until the indexation allowance is completely removed?
What will be lost
Indexation allowance can mean a company pays much less tax on a gain than an individual would pay on the same disposal.
For example, when disposing of a residential property a company will pay corporation tax at 19% on the gain after indexation. An individual with income in the higher tax bands pays CGT at 28% on the unindexed gain. A basic rate taxpayer will pay CGT at 18% on the portion of the gain which sits within their available basic rate band, but a significant property gain will rapidly use up any spare basic rate band. The individual can set their annual exempt amount (£11,300 for 2017/18) against the unindexed gain, which is not available to the company.
Plan to sell
Where your client is planning to sell properties, or any other assets, out of their company it may be better to sell sooner rather than later, to take advantage of the indexation allowance while it is still available.
However, transferring the ownership of a property purely to crystallise the indexation allowance may not be worthwhile, as the legal costs and land taxes (SDLT, LBTT in Scotland, and LTT in Wales - from 1 April 2018) will eat into any tax savings.
About Rebecca Cave
Consulting tax editor for Accountingweb.co.uk. I also co-author several annual tax books for Bloomsbury Professional and write newsletters for other publishers.