Debate on likelihood and impact of change continues

This blog will look at the following

1. Official concern over ‘the gap’ – between the CGT and income tax rates.

2. Potential impact on business owners.

3. Impact of ‘rate rise fear’ on current (‘pre-rise’) financial planning strategy.

4. Possible longer term impact if rate rise implemented.

Official ‘concern’ :

As CGT is thought to be a relatively low revenue raiser even a significant rise in the rate (especially if it results in more effective planning to reduce/defer/avoid the tax) will not deliver anywhere near the huge take that an increase (even a small increase) that affects a much wider tax base – such as the 1% increase to NIC scheduled to take place from 6 April 2011-would produce.

However, the Treasury is (how can it not be) painfully aware of the massive gap between the top income tax rate (50%) and the CGT rate (18%) in 2010/11 and will be concerned about

(i) the investment behaviour it results in – namely, investors seeking gains over income and product providers looking to create products the growth in which may well have an income component but which nevertheless produce a capital gain

(ii) ‘how it looks’ if those  who would otherwise be subject to the ‘high profile’ 50% additional tax on ‘rich high earners’  easily avoid paying it  by adopting (legitimate) strategies that result in the payment (instead) of 18% CGT.

Such strategies could include investing in structures that produce capital gains or taking rewards for employment in the form of capital assets eg shares in an employer – which may even qualify for an effective 10% rate on realised gains after the application of entrepreneurs’ relief.

Potential impact on businesses :

Any criticism from business owners to the raising of the CGT rate could be relatively easily avoided if special relief for business assets is maintained, or even extended.  For example, by retaining and possibly extending the £1m ‘lifetime’ limit on entrepreneurs’ relief  – as a means of ‘offsetting’ a rise in the 18% rate for those qualifying individuals making a gain of more than £1m.

Some reassurance on this could be gained from history which shows that there has, for some time, been a special relief for gains realised from the disposal of qualifying businesses eg retirement relief, business assets taper relief and entrepreneurs’ relief

Impact on current (pre-rise) financial planning :

In the same way as those business owners who may consider advancing a dividend payment to the 2009/10 tax year that might otherwise have been declared and paid in the next (2010/11) tax year will some be considering triggering gains  taxed  at 18% rather than leaving them unrealised to be taxed at a higher rate?  Well, if it makes commercial sense – yes – and even more so if the gain can be franked by losses or the annual exemption.  Provided the anti-avoidance rules can be avoided, a transfer to a spouse/civil partner with whom you are living (no gain no loss) could facilitate the use of another annual exemption.

If sale and re-acquisition is to take place then care will need to be taken to legitimately circumvent the ‘bed and breakfast’ anti- avoidance provisions.  Bed and SIPP and bed and ISA (keeping in mind that the over 50s can in 2009/10 invest a full £10,200 into an ISA) could be worth considering.

In all cases, any tax due (ie where a gain arises and the exemption is exceeded) on the realisation of a gain in the 2009/10 tax year will be payable in January 2011.

Another strategy to consider could be a disposal to a trust under which you (the investor) can benefit.  This would also trigger any gain and no hold-over relief would be available.  Any taxable gains would suffer tax at 18% and, importantly, the asset transferred would remain available to you as a beneficiary and, if also a trustee, the disposer/investor would retain a say in the legal control of the asset.

IHT would need to be considered and special note would need to be taken of the entry, periodic and exit charge provisions.

Possible longer term impact of a higher rate of CGT:

If the CGT rate is linked to income tax then there may be renewed merit in transferring the ‘gains producing’ asset to a lower or non-taxpaying spouse/civil partner to access a lower rate.  With a ‘flat CGT rate’ and even with a higher flat rate there is no CGT benefit on making a spousal transfer once the transferee spouse’s annual exemption is no longer available.

The ‘protective’ value of ISAs and pensions will certainly increase and investment wrapper choice selection will be affected.

Even with an 18% CGT rate there is tax merit (all other things being equal) in an investment bond as a tax wrapper if a large proportion of the growth in the portfolio is expected to be driven by reinvested income.  Obviously, if capital gain is expected to be a high driver of growth then with the availability of the annual CGT exemption (if it is available) and an 18% or lower than income tax rate of CGT is available then a collective would tend to deliver the best after-tax result-all other things being equal.  For a mixed/balanced fund – it all depends.

A significant increase in the CGT rate (for those whose gains will exceed the annual exemption and especially where the gain significantly exceeds the exemption) will clearly have an impact on wrapper choice and, all other things being equal, will operate to diminish the tax attraction of collectives.  Income from a collective is likely, of course, to remain assessable on the investor regardless of whether it’s taken or not, whereas if a bond wraps the portfolio then the income will not be assessed on the investor but the life company. This means that the maximum rate borne within the life fund will be 20% (on interest/rent) while UK dividends will bear no tax in a UK bond or in an offshore bond. 

I could go on but will close with the obvious conclusion that a change in the CGT rate (and especially if it’s linked to income tax) will, for some investors, have a significant effect on investment wrapper choice.