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Did he get it wrong?
In my last "rant" I pointed out to reader's that the Chancellor has axed the capital gains taper relief rules in his Pre-Budget Report. No sooner had we sat one of the poor trainees down to send our clients a letter about the (serious) implications of this change than the Telegraph reports he's going to back-track and reintroduce "retirement relief" - something his predecessor shelved in 1998.
Most readers will know that I have a cynical view of politically led taxation decisions but this one is proving quite good fun for advisers, and I'll try to pursuade you that tax can be interesting in this article.
Prior to 1998, capital gains were taxed based ont he gain above inflation over time. So, if you bought a farm for £1 million in 1982 (say) and held it at 1998 you had an approximate "indexed cost" of £2 million. If you sold it for £2.2 million your gain was £200,000 - sounds fair! - and the tax was 40% in most cases.
At 1998, the Chancellor froze indexation and brought taper relief in. This relief gave a discount on the capital gain and those with "Business" assets would get a large (75%) discount after a couple of years and those with investment assets got a 40% discount on the gain after 10 years. The rate on the tapered gain was still your top rate in most case - 40%.
I'd like to quote Gordon Brown from 1998 to you....(Budget Speech) - ...
"The capital gains tax regime we inherited rewards the short term speculator as much as the committed long term investor....[we] will introduce a new structure..which will explicitly reward long term investment"
The Budget commentary went further....
"The Governments objectives are to a) encourrage long term investment, b) reward risk taking and promote enterprise and c) introduce greater fairness for CGT payers.
Now I find this fascinating because Alistair Darling is taking us straight back to the "old system" albeit with a lower rate (18%). So, it seems that the Government's objectives have changed and that they no longer want to achieve this aims....
Of course, there has been intense lobbying about the removal of taper but it seems implausible that there will be a total reversal of the decision and the Telegraph leak that there is a proposed reintroduction of retirement relief at 100,000 for business assets is probably enough to ease pressure. After all, 18% is still a low rate...OR IS IT?....and here is where my article gets interesting!...I promise....
The farmer above....his pre 5/4/08 gain is as follows -
Sale Proceeds - 3M
Indexed cost- 2M
Gain 1M
Taper -750k
Gain 250k x 40% tax = 100k
***
His new gain is
Sale Proceeds 3M
Cost (no indexation) - 1M
Gain 2M x 18% tax = 360k
THAT'S AN INCREDIBLE INCREASE - FROM 100K TO 360K!
The reason for this is that the Chancellor has quietly taken away indexation - this allowance was "frozen" at 1998 and that seemed fair. The failure to index cost means that the 18% rate applies to the gain without regard to inflation. This tacitly appears to discourage long term ownership of assets.
It would be interesting for me to insert some extracts from the HMRC manuals here.... (CG10243 and you can view it still at the date of writing this)....
"Capital Gains Tax is charged only on "real" gains. Indexation relief is given for any increase in the "nominal" or money value which is attributable to inflation".
"NOTEL Indexation allowance...has been frozen at April 1998, For details of the replacement provision, taper relief...."
So it is clear that the HMRC believed that indexation was, as a policy, designed to ensure you did not pay tax on inflation and that taper was also designed to prevent unreasonable taxation in this area.
Whilst the 18% rate sounds good, it is a massive boost to those who buy and sell a portfolio of shares over time and/or who have buy to let property. However, for those who have long term holdings of business assets (including shares in unquoted trading companies) they should be taking URGENT advice, particularly if they have held the assets since periods going back more than 10 years.
Closing Notes
I am sorry if this seems like a tax lecture - but it's an area of great sensitivity to many of our clients. As ever, don't rely on the internet for tax planning - take advice!
You will find a newsletter on our website too - with a range of tax news - this will be a quarterly feature - I hope it helps bring a wider range of tax topics to our clients by internet - apparently my blogs have a rather consistent theme (Chancellor bashing).
Written by
Donald Parbrook, Tax Partner
at 1st November 2007
“But, Darling, that was my idea…..”
9th October 2007: Commentary on Pre-Budget Report.
What a PBR – for the first time in years I enjoyed it – maybe Alistair Darling’s delivery sounds less like my old headmaster, or maybe it was the entertaining riposte from George Osborne – either way, it’s the most enjoyable PBR in years.
That said, I was left wondering if the Tories got a leak of the Treasury ideas before their conference and used them for their policies or whether the new Chancellor really rushed together the material in a few short days in order to steal the Tory thunder. Either way, today’s PBR seems to be a confirmation that there’s not much choice in politics down south.
However, more important really is the effect that this Budget has on our clients. There are probably two main items to comment upon –
1. The change to Inheritance Tax to allow the use of both nil rate bands on “second death” of the longer living spouse.
2. The abolition of “taper relief” for capital gains and the replacement with a flat 18% rate (why 18%?).
In addition, the changes to the rules for non-domiciliaries will affect some clients as will a relaxation on the Stamp Duty charges for partnerships.
- Inheritance Tax – Extension of Spouse / married “nil band”
The current “nil band” is £300,000 and this has (previously) been promised to increase to £350,000 over the next couple of years. Transfers to a surviving spouse (widow) on “first death” of a married couple are always exempt. This traditionally means that when you die the rate is 0% on 300,000 then 40% above that level unless you leave your estate to a widow (or surviving civil partner).
Let’s assume you are “Mr Darling” (senior) - historically, the problem here has been that on “first death” you want your wife (let’s assume statistics are right and the man goes first) when you die. This means she gets the house in Giffnock and the carefully harvested family investments and ends up with an estate of (say) £600,000 at that time. There’s no IHT when you die because it’s a spouse transfer. However, when she then dies a few years later the nil rate band is (say) £350,000 and her estate is £650,000. We’d expect 40% tax on £300,000 = £120,000 – disaster – Mr & Mrs Darling only ever get one “nil rate band”. For years we’ve been helping ensure clients get their planning right so that through will planning and gifts both nil rate bands are used.
In what appears to be a generous and sensible new rule, the changes allow Mrs Darling to claim Mr Darling’s unused nil rate band. The mechanism seems a little complicated and there are claim conditions but it seems to allow her to get £700,000 (2 exemptions) in a case where he had not used any of his exemption on “first death”.
Who are the winners?- really anybody who had combined estate assets of over the nil rate band and who wanted to leave them to their wife without the use of complicated trusts. The best news is that the Revenue have indicated they will allow it to be used from today for estates of deceased persons who have already lost their spouse at an earlier time.
Who are the losers? People who aren’t married (or in a civil partnership). One supposes a single person could find a terminally ill person with no assets to marry (and pay them to do it) simply to try to get their relief (and remember it’ll be worth about £140,000 soon which is possibly worth the effort of marrying a friend for?...) or enter into a civil partnership with a pal to get it – but that all seems rather far fetched. I imagine the rules will not apply to anybody who has died before today even if their estate is “open” – although that isn’t clear on my first reading of the draft legislation.
- Capital Gains Tax – Taper Relief
In 1998 Gordon Brown introduced some possibly inspirational new tax rules for capital gains.
These rules did away with indexation (inflation adjusting your original cost) on your assets and replaced them with two possible levels of discount on the gross gain over time, the level dependent according to whether the asset was a “business” asset (e.g. trade assets, private trading company shares) or “non-business” asset (general stocks and shares, investment properties).
These rules were then tinkered with almost every year until 2002, after which only minor tinkering was needed.
The general rules were –
Business Assets – hold them for 2 years and get a 75% discount (40% rate becomes 10% effective tax rate).
Non-Business Assets – hold them 10 years to get full 40% discount (40% rate becomes 24% effective tax rate).
We had all become used to this but, unfortunately it occurred to everybody that rich investors were making relatively low risk trading investments and were obtaining a 10% rate on their profits. This was not the intent of the law. (“Private Equity” was the scandal but all they did was enjoy the “right” amount of tax).
We all anticipated some changes or announcement on this. But what happened today was quite surprising to most. Taper was axed. Not only this but if you have held your assets since before 1998, your promised and “safe” indexation to 1998 is being stolen from you. And if you had your assets back in 1982 it used to be your “cost” was the higher of cost or March 1982 value - it is now always the latter.
However, the new tax rate on personal (and trust) capital gains is 18% from 6th April 2008.
This creates some new winners and losers…..
The Winner is….
The property investor who builds a portfolio of rental properties (say) in recent years and does not keep them for a long number of years. He can sell properties and pay 18%. Previously his rate might have been as high as 40% - if he sold within 3 years of purchase, with a maximum discounted rate after 10 years of 24%.
The investor who has stocks and shares in quoted companies and/or the individual who has a company that trades but fell foul of being a “trade” for business assets rules because he had lots of surplus cash/investments in his trading company.
The Losers Are….
The honest business owner who held shares in the family trading company for many years. He anticipated having indexation and taper relief to reduce the effective tax rate on the gross unindexed gain on the future sale to a rival firm to around 7% (say). If the sale doesn’t get done before April next year that rate will be 18%.....crikey!
Anybody whose asset stands at a value not hugely greater than the indexed cost, such that the loss of indexation is greater in terms of extra tax than the drop in actual rate.
It’s going to be interesting but broadly, investors will win and traders lose here! If you were thinking of selling your "tapered shares" with a 10% you've got under 6 months to do it!.....
In the meantime….
These rules are set to hit the statute in April – however, we don’t have draft legislation and there’s to be some consultation. It may be that if you have a “business asset” you will want to “bank your taper” - there are ways to do this at the moment (for many, but not all) but bear in mind it accelerates your tax bill. Certainly, the rush to incorporate sole traders and partnerships will have one “final flurry” where goodwill is being used to maximise the tax benefit of that option.
The next few weeks will no doubt see analysis appear in the tax press, but I am happy to chat to any clients worried about the matter. The changes are very significant for owners of trading businesses!!
- Domicile and Residence
Those of you who were patient enough will have noted I picked up on domicile in my last epistle. It is interesting to see the PBR lift the Tory proposals here.
The proposals are –
a. Non-domiciled persons (broadly, people who have origin outside the UK and who might some day return) can only claim non-domicle for tax and enjoy paying no tax on unremitted foreign income for 7 years without consequence.
b. After 7 years they have to pay an annual fee of £30,000 or pay tax on worldwide income and gains.
The interesting point here is to consider whether this might encourage some foreign people to quit the UK and whether this will matter. It seems likely that the “super-rich” will pay the fee and continue to enjoy relatively benign UK tax residence whilst those born here will have to emigrate to get equivalent treatment. Strange, but true.
If you do emigrate, the guidance used to be that in checking the number of days you were in the UK, days of arrival and departure generally didn’t count. It is now being put into law that they DO count as UK days. This will affect a number of taxpayers, mostly people claiming non-residence whilst making frequent trips to the UK. It is, to be fair, the case that Milne Craig have tried to advise departing clients not to trust the “days in UK” guidance from HMRC too much – it was never law – just guidance.
4 Income Splitting – Family company and shares – watch out!
Following humiliation in the House of Lords over a recent case (Arctic Systems) it is confirmed that there is a review on going to introduce measures in Budget 2008 to prevent a company declaring dividends which are really income of one person to another person to save tax. We will watch this one with real interest!
Summary
Although the above is only a snapshot in four key areas for our business, the PBR contained 28 HMRC notes on matters as diverse as fire safety equipment capital allowances and facilitation of the use of biobutanol.
Hopefully the above are the most interesting points for most of our clients.
As ever, I’m delighted to hear from our clients with comments. These are my personal views based on an “instant snapshot” and, no doubt, the dust will settle and some other “nuggets” will be discovered in the paperwork over coming weeks (including the 2p in the pound business rates supplement your local authority can charge you). Oh, and the much heralded "planning gain supplement" has been axed - with no apology for the millions of pounds spent since 2004 developing the draft rules and on consultation - if they'd just listened to the property industry at the start....
Regards
Donald Parbrook
PS - as proof of how predictable the Chancellor was, have a look under the "tax" menu below at my PBR predictions on 5th October - I got 6 out of 8 of my tips right this time....do I get a gold star?
Donald.parbrook@milnecraig.co.uk
** THE VIEWS ABOVE ARE DONALD’S AND ARE NOT NECESSARILY THOSE OF THE FIRM. NO LIABILITY CAN BE ACCEPTED FOR ANY LOSS OR OTHER CONSEQUENCE OF PLACING RELIANCE UPON THE ABOVE. SPECIALIST TAX ADVICE SHOULD BE TAKEN ON THESE MATTERS **
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