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CGT rate rises to 28% from 22 June

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22nd Jun 2010
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Chancellor George Osborne confounded tax experts by announcing an increase in the rate of capital gains tax from 18% to 28% from midnight on 22 June, writes tax editor Rebecca Benneyworth.

How HMRC and tax advisers will deal with the different rates on capital gains during the current tax year will be a matter of some concern.

Widely tipped to be increased to 40% or even 50% the announcement in the end had a soft landing – we will move to a two rate system for CGT with rates set at 18% for the basic rate taxpayer and 28% for higher and additional rate taxpayers.

However, the sting in the tail is that the rate will increase for those due to pay higher tax from midnight on Budget day. As far as I am aware, there has never before been an attempt to increase a rate of tax during the fiscal year – not in relation to taxes raised on a fiscal year basis in any event, and I suspect that the Treasury will be beavering away behind the scenes to sort out the technical detail.

Before diving into any depth, here is a summary of what we know so far:

  • There will be two rates of CGT from 23 June 2010.
  • Prior to that a single rate of 18% applies to all gains.
  • One rate will be 18%, paid by basic rate taxpayers. Gains will be taxed by adding the net gain to the total income for the year to establish whether the taxpayer has basic rate band availability.
  • Any taxpayers with income taxed at the higher or additional rates will bear 28% tax on their gains. Some taxpayers will therefore see a compound rate with gains taxed partly at 18% and partly at 28%.

So in essence, for a full year, the new two-tier tax system will be no more complex than that abolished a couple of years ago when the 18% rate was introduced – when gains were taxed at either 20% or 40% depending on income, albeit with an allowance for inflation in the form of both indexation and taper relief – both of which were considered a retrograde step in terms of simplification.

"Trustees will again feel the full effect of the increase and will be subject to the highest rate regardless of size," confirmed Francesca Lagerberg, head of tax at Grant Thornton.

"HMRC has confirmed that individuals subject to the increased rate of CGT will be able to offset both losses and the annual exemption in the most beneficial way. However, the speed of implementation has provided little time for people to plan with full knowledge of the tax implications," she added.

What of Entrepreneurs' Relief?

There is a consequent change in relief for entrepreneurs, and a change of substance. In deference to the shouts of unfair, the chancellor has increased the lifetime limit for gains which attract Entrepreneurs' Relief from the current £2m to £5m with effect from 23 June 2010. The increase from £1m to £2m was only introduced with effect from the current tax year, so an additional substantial rise is a major step.

The consequential changes will require a modification in the ER formula, which the Q&A document indicates will retain a net rate of 10% on any gains subject to relief.

What is interesting is that there is no mention that the scope of Entrepreneurs' Relief will change or that any of the conditions associated with the relief will be modified. There is scope to look at this again, perhaps introducing a measure of relief for private landlords to support the private rental market, or even tightening the conditions slightly to reduce the cost, but now is probably not the time for root and branch reform of this area.

"On the face of it this would appear to be good news for all entrepreneurs. However, those who anticipated a much higher rise in the rate of CGT may have accelerated capital gains prior to 22 June to capture the previous CGT rates. No additional entrepreneurs' relief will be available against gains crystallised prior to 22 June in excess of the previous lifetime limit. In order to accumulate qualifying gains up to the new limit of £5m, these entrepreneurs will need to crystallise further qualifying gains," said Lagerberg.

The difficult bit
It was not widely predicted that the rate would change mid-year – indeed most commentators thought it very unlikely. Normally CGT is calculated based on the net gains of the year, allowing for offset of losses arising in the year, and treating losses brought forwards separately. All of this will need careful organisation to ensure that the two rates operate properly alongside each other. In essence, the technical structure of the new regime (which will have a life of just one tax year) will have to achieve the following:

  • Tax gains on the date that they arise under the old or the new rules.
  • Consider whether if a taxpayer's income changes radically during the year this will impact on their CGT rate - the current indication is that the income will be looked at for the year as a whole and the gains split either side of 22 June.
  • Determine how losses arising in the year will be treated. Will taxpayers be given a choice about which gains they offset losses against (choosing the later gains if one is a higher rate taxpayer), or will these be time allocated too? If losses are allocated by time rules will need to allow the excess of any pre June losses to be carried forward against post June gains.
  • Determine how losses of previous years will be treated. Will taxpayers be able to restrict losses to post-June gains? This is unlikely and is probably an unnecessary complication – undermining some of the basic principles we have with fiscal year taxes.
  • Determine how the annual exempt amount will be used - whether a taxpayer can choose which gains to set it against.
  • Determine how other aspects of CGT will operate. It seems likely that for example, deferred gains which resurface later will be taxed under the regime on the date that they resurface. How frustrating for a taxpayer who has been temporarily non-resident for three years to find that missing his flight back to the UK today could cost him significant amounts of extra CGT on his arrival in the UK tomorrow!

Indications in the Budget pack are that taxpayers will generally be able to offset reliefs and losses in the most favourable way possible. There are bound to be other technical complications coming out of the woodwork over the coming weeks, but no doubt the change was regarded as essential to complete mid-year – and not of course for the additional CGT revenue it would raise (otherwise we would indeed have seen the potentially higher rates bandied about) but to protect the additional income tax that would otherwise have been lost. The current prediction is that this change will raise a very modest sum in CGT, but will protect a further £1bn a year in income tax revenues – a point that has been largely glossed over by the naysayers for the last month or so.

The consensus in AccountingWEB.co.uk's Budget discussion group was that it would be better to hold back the increase until next April, but the experts were wrong.

"The questions and answers published by HMRC accompanying details of the rate increase states that the CGT rates for 2011/12 will be decided in the 2011 budget. This should act as a note of caution to those who believe that a further rate rise is unlikely," warned Lagerberg.

***

Reaction

Frank Haskew, head of ICAEW’s Tax Faculty said:
“Capital gains tax has undergone a number of changes since its introduction in 1965 which does little to create confidence in the tax system. Government should make no further changes to the CGT regime for the lifetime of this Parliament to provide long term certainty to investors and entrepreneurs.”

John Whiting, tax policy director, CIOT
"The chancellor’s choice of a 28% higher CGT rate is a pragmatic way of avoiding the necessity of complex tapering or indexation allowances. However, the system will not be as simple as many people will have heard it: the basic rate taxpayer who makes a significant gain will find themselves paying the higher CGT rate on some of the gain as their combined total of income and gains exceeds the higher rate threshold.

“The immediate nature of the change does raise some practical difficulties over the use of losses and the annual exemption. It would have been better to wait for the start of the next tax year, although one can understand why immediate action was thought necessary.” 

Barry Marshall, UK head of tax at PricewaterhouseCoopers LLP
"The rise in capital gains tax to a flat rate of 28% from tonight, was less than many had feared. However, the chancellor’s desire to keep the tax simple means that entrepreneurs will be disappointed he did not introduce a lower rate for business assets".

Andrew Hubbard, tax policy director, RSM Tenon
"Even though the rise will force people to dig deeper into their pockets, many will be breathing a huge sigh of relief.  Things could have been far worse, with today’s rise in CGT much less than we had been led to belief.

“This might however be a false dawn. Today’s Budget showed just how deep a hole the economy is in, and it’s realistic to expect that further increases may be introduced in the foreseeable future.”

Liz Brion, head of media tax, Grant Thornton
"The capital gains tax increase for higher rate investors will be an unwelcome announcement as transactional activity in the media sector is just beginning to recover. However this is balanced by an increase to the 10% rate band for those selling their trading companies where the first £5m of gains can benefit from entrepreneur's relief; it is just a shame this relief was not extended to employee share schemes".

Patrick King, tax principal, MacIntyre Hudson
"To date, Entrepreneurs Relief (ER) has operated with the 18% capital gains tax (CGT) rate applied to the qualifying gain after it had been reduced by 4/9ths. This resulted in an effective rate of 10% on the full gain. Today’s announcement replaces the 4/9ths reduction with a new 10% rate for qualifying gains. This could give rise to problems when entrepreneurs look to sell their business and some of the gains are taken in the form of loan notes which will not qualify for ER when ultimately cashed in.
 
“Take, for example, a businessman who sells at a gain of £1m with half this amount taken as a loan note, payable in three years time. Under the old ER framework, the gain on the loan note would be reduced by 4/9ths and subsequently taxed when received at 18%. Following today’s changes, because the loan note itself won’t qualify as a business asset for ER purposes, the full gain would be taxable at the new rate of 28%. (18% to the extent the taxpayer is within the basic tax rate band.) As ever, the devil is in the detail. Hopefully this apparent anomaly will be addressed in the Finance Bill.”

Caspar Noble, private equity tax partner, Ernst f& Young

“The main concern of the private equity (PE) industry pre Budget was the impact, particularly on carry, of the increase in capital gains tax rates. Post Budget it still seems as if, in most cases, carry will be chargeable as capital gains; with the rate increased from 18% to 28%. Although this represents a circa 55% tax increase, it is not as great as many had expected. The Chancellor noted that the rate had been chosen as the maximum at which it was felt the UK could remain internationally competitive. In the context of PE many are likely to feel this is the case, especially given the increase in rates on carry proposed in the US and some other jurisdictions.

"It remains to be seen whether the increased Entrepreneurs Relief (10% rate up to a lifetime limit of £5m) is likely to have application to the PE industry in the UK. As businesses operating in the UK, PE based managers will also be potentially impacted by more general measures such as higher VAT rates.”
 

Catherine Robins, tax partner, Pinsent Masons
"This is somewhat lower than the increase which had been expected in some quarters (a headline rate of 40% had been rumoured), which will come as a relief to many. In addition, there has been an extension in the lifetime limit for 'entrepreneur's relief'. The first £5m of lifetime gains on qualifying 'business assets' will now qualify for an effective 10% rate (instead of the first £2m previously).

"However, the government has not relaxed the strict qualifying criteria for entrepreneur's relief. Specifically, despite lobbying from the private equity sector, shares will still only qualify if they are held in a 'trading company', and the shareholder is an employee with a holding of at least 5%. This will be disappointing news for many management shareholders, and also 'carried interest' holders, who frequently do not meet the 5% qualifying condition, as there had been hopes of a more thorough overhaul of the regime.

"On the other hand, however, owners of assets such as property investments, which would generally not qualify for entrepreneur's relief, will be relieved that they have not suffered a higher increase in their liabilities."

Clare Hartnell, global head of property and construction, Grant Thornton
"The CGT increase was the main area of concern ahead of the Budget. I am relieved it was not as bad as anticipated and as the change will take place at midnight tonight, it avoids the market being flooded with properties as sellers try to take advantage of the 18% rate".

David Whiscombe, a partner, BKL Tax and UK200 Group member
"The increase in CGT was heavily trailed and is nothing like as bad as it could have been.  At 28 per cent, the rate is only slightly higher than the lowest non-business rate of 24 per cent which applied in the days of taper relief - which rate was earned only after ten years’ ownership - and the unexpected increase to £5m in the Entrepreneurs’ Relief lifetime limit sweetens the pill".

Niki Dixon, head of technology, Grant Thornton
"The rise in capital gains tax (CGT) would appear to diminish the attractiveness of investing in the technology sector. In this tighter lending environment, venture capitalists and Angel investors have been a vital source of funds for both start up and more established technology businesses. This rise in CGT offers no acknowledgement of the risky nature of such investments."

Lisa Macpherson, national director of tax, PKF
"The immediate increase in entrepreneurs’ relief to £5m is welcome: it now gives business owners CGT relief of up to £900,000 over their lifetime – a real incentive to build a business. Setting the new top rate of CGT at 28% for non-business assets is also better news than many had expected. However, there are no extra reliefs for long term investors and the way these changes take effect will cause confusion for taxpayers in practice".
 

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Galaxian
By Galaxian
22nd Jun 2010 21:39

Very limited planning window

Did any readers' clients pop down to see their solicitor this afternoon to transfer non-businbess assets to a settlor interested trust? This must be the shortest planning window ever!

Actually the rate goes up from 23rd June not the 22nd as the title suggests.

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By cfield
23rd Jun 2010 12:54

Will this affect the 50% tax rate?

As capital gains will once again be treated as the top slice of income for tax purposes, will this also have an effect on the definition of income for the new 50% rate? I may be wrong about this, but as I understood it before capital gains were not part of the equation for deciding whether your income was over £100k. Does this change with the post 22 June CGT regime? If so, will gains between 5 April and 22 June will be caught by this too?

Chris F

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By grahamatgward
23rd Jun 2010 15:15

how is basic rate status determined?

"Gains will be taxed by adding the net gain to the total income for the year to establish whether the taxpayer has basic rate band availability"

For investments does this mean that the whole net gain (return on selling - purchase cost) will be added to your income to see if it tops out in basic rate territory or into a higher rate band, or will only the gain less the CGT allowance (currently £10,100) be added to your income?

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