Capital gains tax (CGT) reform
The Chancellor surprised everyone with proposed major changes to the CGT regime last October. The changes affect individuals and trustees, but not companies. The Chancellor has confirmed that legislation will be introduced with effect from 6 April 2008 to give effect to a new single rate of CGT at 18% but many business owners will continue to have the potential benefit of a 10% rate.
An annual exemption will remain in place and for 2008/09 this will be £9,600. The annual exemption allows the first element of gains made in a given tax year to be exempt from CGT.
For gains arising on or after 6 April 2008 changes to the CGT regime include:
the withdrawal of taper relief
the withdrawal of indexation allowance
the introduction of Entrepreneurs' Relief
simplification of the share identification rules.
Taper relief was introduced for disposals on or after 6 April 1998 and can reduce the amount of the gain chargeable to CGT. The amount of relief available depends on whether the asset is classed as a business or non-business asset and also on the length of time an asset has been held since 1998.
For gains arising on or after 6 April 2008 taper relief will no longer be available. The chargeable gain will be liable to tax at 18%, after deducting allowable losses, any other reliefs and the annual exemption.
Indexation allowance was, for individuals and trustees, the precursor to taper relief and gave relief for the effect of inflation on the costs incurred on assets. Indexation was frozen as at 5 April 1998. Currently where an asset was held at 6 April 1998 and is disposed of after that date, any gain on the disposal may be eligible for indexation and taper relief.
For gains arising on or after 6 April 2008 indexation allowance will no longer be available.
In response to business leaders voicing their objections to the abolition of taper relief, the Chancellor has introduced a new Entrepreneurs' Relief. The main effects of this relief are:
the first £1m of gains qualifying for relief will be charged at an effective rate of 10%
gains in excess of £1m will be charged at 18%
an individual will be able to make more than one claim for relief, up to a lifetime total of £1m of gains.
The new relief is similar to Retirement Relief, which was phased out with the introduction of taper relief, but the new rules are designed to be simpler:
there will be no minimum age limit
relief will be available where the relevant conditions are met for a period of one year ending with the disposal / cessation.
The relief will apply to net aggregate gains arising on the disposal of:
the whole, or part, of a trading business that is carried on by the individual, either alone or in partnership
assets used in a business which has ceased
shares in a trading company, or holding company of a trading group, provided that the individual owns at least 5% of the voting rights in the company and is an officer or employee of the company
assets used in a partnership or by a company but owned by an individual if the assets disposed of are ‘associated' with a disposal of shares or an interest in partnership assets. The individual must make the disposal as part of the withdrawal of the individual from participation in the partnership or the company
certain disposals by trustees of business assets and company shares where a ‘qualifying beneficiary' has a qualifying interest in the business / shares.
A trading business includes professions but only includes a property business if it is a ‘furnished holiday lettings' business.
A trading company will have the same meaning as currently applies for taper relief.
The introduction of Entrepreneurs' Relief goes some way to removing the problem of the 18% tax rate but the Chancellor's plan for a simple tax system has evaporated. Considerable care will be needed in planning to obtain the benefit of Entrepreneurs' Relief. For example:
the disposal of a property used by an unincorporated business may not qualify if it is not related to the disposal of the whole, or part, of the business
the disposal of shares in a company may not get any Entrepreneurs' Relief if the company has ‘substantial' non-trading activities at the time of the disposal of the shares
the sale of a property used by a company but owned by an individual will only get relief if a number of detailed conditions are satisfied. In particular some shares in the company will need to be disposed of at the same time as the sale of the property
the conditions imposed on trustee disposals may mean that some trust structures which are attractive for IHT saving may not qualify for Entrepreneurs' Relief .
Entrepreneurs' Relief – transitional rules
A number of individuals have made a gain prior to 6 April 2008 and have deferred the gain until after 5 April 2008. Entrepreneurs' Relief may be available when the gain becomes chargeable if the sale of shares in a trading company or the sale of an unincorporated business would have met the conditions for Entrepreneurs' Relief if the sale had taken place after 5 April 2008.
The deferred gains eligible for relief are where:
shares in a trading company were disposed of in exchange for loan notes in another company which are Qualifying Corporate Bonds (QCBs)
the gains made on shares in a trading company or on the disposal of an unincorporated business were reinvested in Enterprise Investment Scheme shares or Venture Capital Trust shares.
If an individual had shares in a trading company which were disposed of in exchange for loan notes in another company which are not QCBs, there may be Entrepreneurs' Relief on the disposal of the loan notes after 5 April 2008. However the loan notes would need to be issued by a trading company in which the individual owns at least 5% of the voting rights in that company and the individual is an officer or employee of that company.
Simplification of the share identification rules
The current rules for the identification of shares and securities for CGT purposes require a complex order of identification, which is dependent upon the dates when the assets were acquired.
Due to the changes to taper relief and indexation allowance, all shares of the same class in the same company will be treated as forming a single asset from 6 April 2008, regardless of when they were originally acquired. However certain anti-avoidance rules will remain.
Inheritance tax (IHT) threshold
As previously announced the IHT nil rate band will rise from £300,000 to £312,000 in 2008 and £325,000 in 2009.
Transferable nil rate band
Transfers of property between spouses or civil partners are generally exempt from IHT. This means that if an individual dies and leaves some or all of their property to their spouse or civil partner, they may not have fully used their nil rate band.
The new rules allow any nil rate band unused on the first death to be used when the surviving spouse or civil partner dies. The transfer of the unused nil rate band from a deceased spouse or civil partner, irrespective of the date of death, may be made to the estate of their surviving spouse or civil partner who dies on or after 9 October 2007.
The amount of the nil rate band available for transfer will be based on the proportion of the nil rate band which was unused when the first spouse or civil partner died.
On the death of a husband 10 years ago, none of his nil rate band was used because the whole of the estate was left to his wife. If the nil rate band is £350,000 when the wife dies, it would be increased by 100% to £700,000.
This welcome change means that where the combined estate of a married couple is below the two nil rate bands (currently £600,000), wills can be kept simple and allow transfer to the surviving spouse. Where estates are already above the double nil rate band consideration still needs to be given to utilising some or all of the nil rate band on the first death.
Interest in possession trusts
The IHT rules for interest in possession trusts (IIP) changed in 2006 so that they became subject to rules which previously only applied to discretionary trusts.
The key effect of those changes is that an IHT charge arises to an individual on creation of such trusts during lifetime and the trust is charged to IHT on distributions and every 10th anniversary of the creation of the trust. Previously the IIP trust was not charged to IHT but on the death of the beneficiary it was included in their IHT chargeable estate.
The implementation of the 2006 changes was delayed for a transitional period for IIP trusts in existence before 22 March 2006 to enable trustees to reorganise such trusts without incurring charges under the new rules. The deadline for this transitional period has been extended to 5th October 2008.
It is also confirmed that the ‘transitional serial interest' provision will apply where the holder of an interest in possession trust at 22 March 2006 becomes entitled to a new interest within the transitional period.