The introduction of the Treasury’s hotly debated new Capital Gains Tax (CGT) regime for individuals will leave both winners and losers in its wake – including many senior executives and wealthy investors. For advisers keen to create the best outcome for their clients, closer ties with tax specialists may need to be forged.
The reforms, effective from April 6, 2008, see the previous CGT system scrapped, including the concepts of taper relief and the indexation allowance, although the annual CGT allowance remains. In place of the previous regime is put in place a flat CGT charge of 18 per cent. The upside of this is that executives and wealthy investors alike will typically enjoy a lower CGT rate on their general share portfolios.
“If they’re just passive holders of equity portfolios in companies other than their employer, then quite often they’ll be better off,” says Leonie Kerswill, tax partner at Price- waterhouseCoopers. “This is because they would have gone – after 10 years – down to a 24 per cent tax rate, but now they’re immediately at 18 per cent,” she says.
But there are negative spin-offs too. One of the most obvious is where investors own shares in the company they work for. Previously the capital gains made on such shares qualified for business asset taper relief, reducing the tax rate to as low as 10 per cent after two years for higher rate taxpayers. But this will now be charged at the 18 per cent rate. Company share schemes will be affected as a result.
Mike Warburton, senior tax partner at Grant Thornton says the changes have caused “mayhem”, with some executives moving ahead of April 6 to realise their shares and the tax charge. “But people don’t necessarily want to sell their shares,” he says.
Warburton says those shareholders not keen to sell before April 6, were left with two main options – to “accept the inevitable” and the 18 per cent charge, or transfer the shares into trusts to trigger the gain without actually selling.
While the indexation allowance is to be abolished too, Kerswill points out that those who have held shares long enough to benefit from this allowance can preserved these benefits by transferring shares between husband and wife, or civil partners, to effectively bank the allowance without triggering off a tax disposal for CGT purposes.
On the flip-side, Chris Cole, senior client partner at Towry Law points out that the EIS can be a useful tool for deferring tax liabilities on the gains from non-business assets that will actually be better off being taxed at the new 18 per cent rate. However, such options as these are of little use after April 6.
Meanwhile, the Association of British Insurers (ABI) has raised concerns with the Treasury over the disparity the changes create between the taxation of unit trusts and Open Ended Investment Companies (Oeics), compared to investment bonds.
It believes that unless the taxation on bonds is amended, a serious threat is posed to long-term savers and the long-term savings industry. This is because from April 6, unit trusts and Oeics will enjoy the reduced CGT rate of 18 per cent, while investment bondholders will still be subject to tax at 40 per cent if they are a higher-rate taxpayer, as returns on investment bonds are taxed as income.
“What we have proposed is that instead of being subject to a 40 per cent charge, life bonds be subject to only a 30 per cent charge which gets us much nearer to parity than it would be with a 40 per cent charge,” says ABI spokesman Jonathan French. So far the Treasury remains unmoved.
Cole touches on this point, saying that wealthy investors may need to look again at their existing portfolios, as many have made use of offshore bonds.
“That’s not to say they’ve not got a place, but the question now is where is that place?” he says.
Jason Butler, branch principal at Bloomsbury Financial Planning has some answers. At the wealthier end of the market he sees a distinction developing between the investment tax wrapper allocation for UK resident and domiciled individuals and UK resident non-domiciles as a result of the CGT regime changes.
He also believes the revamp will provide an opportunity for advisers to forge better relationships with tax professionals, in order to help advisers avoid the “considerable risk” associated with advice in this area.
“What we are looking to do for our non-doms is to wrap their investment portfolios inside an offshore Oeic. Basically that enables them to keep things in a non-UK situation, which is important,” Butler says.
“Over the medium term there is going to be a move to individual private collective funds like Oeics: probably sub-funds of an existing Oeic where you can carve out your own portfolios.
“We can also see the use of onshore Oeics for people with substantial portfolios who are UK resident and UK domiciled on the basis that they want to control when they pay CGT,” he says.
Obviously the investment wrapper used will depend upon the type of returns being generated, with those generating capital growth best in a CGT environment, not in an investment bond, unless the client can realise the gains once they are non-resident.
“At the other end of the spectrum, people who have got mainly dividends and/or interest arising who are UK resident high rate tax payers, are almost certainly going to be better off using a bond wrapper, whether it’s onshore or offshore,” Butler says.
“The life companies, especially the technical people, haven’t got their head around all this. They’re worried about the death of investment bonds – well they need to start thinking about the birth of collective fund ‘wrappers’ on a firm by firm and/or a client by client basis,” he says.
“Which means you’ve got to be pretty comfortable with the view that you’re going to be able to ride that out and take a very, very long term view. It just seems to me that if you’re thinking about it, there’s going to be a better time in the next two or three years rather than right now,” he adds. “Most investors are discretionary buyers, so why not wait until conditions are a little more favourable?”
Case study: The price of your company share
Paul Fox, Account Manager, Origen Financial Services
Paul Fox, large corporate team account manager at Origen Financial Services expects the latest changes to the Capital Gains Tax regime to impact heavily upon many executives and indeed anyone holding shares in the company they work for.
Fox gives the example of a client participating in a company Sharesave scheme, who has been paying in £250 a month for five years after being offered share options at £3.30. After five years the client has paid in £15,000, enabling him to purchase 4545 shares, which have a current value of £19 each, or a total value to the client of £86,355.
“If they had managed to get enough of these shares into an Isa there would not be a problem as there is no CGT on proceeds from an Isa,” Fox says.
However, if this is not the case, under the new rules the client, who is enjoying a gain of £71,355 on the shares, must pay CGT at 18 per cent on this gain, less the 2007/2008 personal CGT allowance of £9,200. This leaves a total CGT bill of £11,187.
Under the old rules, with the benefit of business taper relief the client would have been required to pay CGT on £17,838 (25 per cent of the gain), less the CGT allowance of £9,200, leaving a taxable amount of £8,638. This amount would then be added to his taxable income for the year and for an executive or high earner, is likely to be taxed at 40 per cent, therefore incurring a CGT liability of £3,455.
Fox says: “So up and down the country everybody who is in Sharesave schemes, if their company shares have done quite well and if they’re just held on a share certificate and not in an Isa, they’ll be paying tax after April 5 where they wouldn’t have been paying tax before.”
Small Businesses – Entrepeneurs’ Relief
The Chancellor’s initial proposals for simplifying the CGT meant small business owners would be left paying up to 80 per cent more in CGT charges when they came to sell their businesses than they would have previously with the benefit of business asset taper relief.
However, following lobbying of the Government, the Chancellor announced the creation of an entrepreneurs’ relief which: