The increase in the rate of
capital gains tax for
non business assets.
The recent Liberal-Conservative coalition agreement included the following statement in relation to capital gains tax:"We further agree to seek a detailed agreement on taxing
non-business capital gains at rates similar or close to
those applied to income, with generous exemptions for entrepreneurial business activities?"
Although we don't have any details yet, it's pretty clear that a rise in CGT is on the cards.
The current rate of CGT (18%) is extremely low in comparison to the rates of income tax, and it's been speculated for sometime that it will be increased in line with the rates of income tax.
Before April 2008, all capital gains were taxed at your highest marginal tax rate. Therefore if you were a 40% taxpayer you'd pay CGT at 40%, if a basic rate taxpayer you'd pay at 22%. This applied to both business assets and non business assets.
There was then taper relief which reduced the rate of CGT depending on the type of asset sold and the length of the period of ownership. This could reduce the effective CGT rate to 10% on business assets (after 2 years ownership) and 24% on non business assets (after 10 years ownership).
There was therefore a big difference between business and non business assets.
The 2008 tax changes brought in a blanket CGT rate of 18%, with Entrepreneurs Relief to reduce the effective CGT rate to 10%. This was of huge benefit to owners of non business assets as they saw their rate of CGT go from a minimum of 24% (and often much higher than this if they'd owned for less than 10 years) to 18%.
By having a flat 18% rate of CGT the other issue of course is that it gives a much stringer incentive to be an investor than a trader for tax purposes. This was made even more marked after April 2010 when top earners could be subject to 50% income tax. On a £200K receipt this was the difference between £100K tax and £36K which is a huge difference.
We don't have details of the increase but it sounds as though the increase will be along the same lines as before, with capital gains on non business assets being taxed at the taxpayers applicable rate of income tax (ie 20%, 40% or 50%). Business assets will continue to qualify for generous tax treatment and you'd expect this to remain at 10%.
This raises a number of issues.
Firstly, it will crucially depend on how they define non business asset for CGT purposes. In the past there has been numerous different defintions for different tax reliefs.
Under the old taper relief definition assets used for the purposes qualified. They also qualify even if used for the purposes of your personal trading company. So most properties etc owned personally by business owners would qualify.
In terms of shares the following shares used to qualify for business asset status:
- Shares in unquoted trading companies and unquoted holding companies of a trading group.
- Shares quoted on the Alternative Investment Market (AIM).
- Shares in quoted trading companies and quoted holding companies, if the shareholder is an employee of the company or can exercise at least 5% of the voting rights in the company.
- shares in non-trading companies if the shareholder is an employee of the company and does not own more than 10% of the shares.
By contrast the new Entrepreneurs Relief provides a much tighter definition for business assets and includes shares in a persons personal company.This means they need to own more than 5% of the shares and be a full time working officer or employee.
It is very unlikely that the new definition would be anywhere near as generous as the old taper relief definition, given the current economic position. I'd therefore expect a very strict definition of business assets limited to shares in personal trading companies (ie where you own a significant interest in the shares) or assets for use in your business.
This will mean that most investors in shares, forex, futures and of course property would find themselves now subject to the much higher rate of non business asset CGT.
For financial investors this will inevitably lead to trading status looking much more attractive. If you're a higher rate taxpayer for instance the difference between trading and investor status would essentially be the 1% NIC charge. Sure, for CGT purposes you get the annual exemption, however by opting for trading status you get a much wider expense deduction which can lead to significant tax savings.
Using a company
If you're successful in being classed as a trader it also paves the way to set up and carry out your trades from a limited company.
Whilst you're an investor you'd be caught by the close investment company rules if you used a company -- but once you obtain trader status using a company can potentially reduce your rate of tax from 50% to 21% or 28%, if you retain profits in the company.
You'll definitely see more use of trading companies if the non business rate of CGT goes up.
The other tax saving opportunity that will look even more attractive is becoming non UK resident. If you're sat on property or shares with substantial gains for many people moving abroad and potentially paying no CGT will be even more appealing if the CGT rate is 50%.
Similarly finanical investors who can often secure investor status much easier than property investors will frequently look to base themselves offshore to take advantage of the nil rate of CGT.