CGT shake up requires careful planning for investors

The weekend papers were full of news about the planned increases to capital gains tax (CGT) announced by the new government. Some commentators have argued that this change has been on the cards for some time, although during the Election campaigning it was only the Lib Dems that formally announced their intentions. Subsequently incorporated into the coalition’s policies, we can expect CGT rates for top earners to more than double for non business assets and the exemption threshold to be cut from £10,100 to between £1,000 and £2,000.

These changes will be painful, especially since for the past 2 years, the flat rate of 18% has been extremely generous. But given the poor state of the Treasury’s coffers, the disparity between income and capital tax rates cannot be sustainable.

There have been many articles offering advice on what taxpayers should do in the light of these impending changes between now and the emergency Budget on June 22nd. Our advice is to tread very carefully, for a number of reasons. This article outlines steps one could take, depending on the type of investment held. In all cases, we recommend seeking professional advice to properly weigh up the implications of each.

Property Investors
If you own residential property which is not your principal private residence the chances are CGT on a future disposal will be payable at 40 or even 50%. Many groups are already lobbying about the implications of this to the already beleaguered property market. According to ARLA, the new CGT policy could create a shortage in rental property supply as investors look to sell off their portfolios and may also deter future investors from entering the sector. They are lobbying to have landlords’ residential properties treated as business assets but in our view this is unlikely as historically they have never been regarded as such, and there is no strong argument that they not pure investment assets.

One option therefore is to sell up and take the profit now. Although the current 18% rate can be secured if unconditional contracts are exchanged for a sale prior to June 22nd, it is unlikely that selling in the coming few weeks is an option for most property owners. Alternative tax planning strategies available include making a gift or sale into an existing trust. By gifting or selling a residential property asset into a trust, CGT can be immediately triggered at the rate of 18%. Although this means paying CGT now with possibly no sale proceeds, it will uplift the future base cost of the property and may be preferable to the alternative of taking one’s chances with the new tax regime. This would need careful consideration because inheritance tax may also be an issue.

Based on current reports of generous business reliefs, commercial property owners may be exempt from these issues and may hear some good news when the Budget is announced; whilst commercial property does not qualify for entrepreneurs’ relief, it did qualify for the previous business asset taper relief and so there are hopes that the business asset status of commercial property may be restored in the new regime.

Equity Investors
If you own quoted shares you may wish to sell some to utilise the existing rate and exemptions. It would not be possible to take advantage of the reliefs if you buy the same shares back again within 30 days, because of the ‘’bed and breakfasting’’ matching rules, but spouses could avoid this by buying and selling between each other. Doing this would also provide the ability to use your annual £10,100 exemption now by selling investments before the allowance is lowered, and being taxed on any excess gain at the rate of 18%.

The example below explains in more detail the rules concerning equity disposals:

If you dispose of shares and also acquire shares in the same company and of the same class, for capital gains tax purposes the disposal is matched with acquisitions in the following order:

1. Acquisitions on the same day as the disposal;
2. Acquisitions within 30 days after the disposal;
3. Acquisitions made on or after 6 April 1982 on a ‘pooled’ basis.

These are the “bed and breakfasting“ rules and if you make a disposal and re-acquisition of the same shares in order to uplift the base cost of those shares, you need to be wary of falling foul of these rules. If you re-purchase the same shares on the same day or within 30 days of the disposal, the sale will be matched with the acquisition cost of the new shares, rather than the shares you originally bought, and you will not have achieved the tax saving. If you want to re-acquire the shares quickly, then a sale by a husband and re-acquisition by his wife, for example, will avoid the application of the rules.

Example of tax savings to be achieved by selling shares now and re-purchasing avoiding the above rules:

share disposal proceeds £ 25,000
original cost -£ 5,000
capital gain £ 20,000
less annual exemption -£ 10,100
chargeable gain £ 9,900
CGT @ 18% £ 1,782

on a future disposal of those shares for £40000 the CGT position will now be as follows:

share disposal proceeds £ 40,000
original cost -£ 25,000 (assuming the shares have been re-acquired at the same price)
capital gain £ 15,000
less annual exemption -£ 2,000 (assumed)
chargeable gain £ 13,000
CGT @ 40% (assumed) £ 5,200

Total CGT £ 6,982

if you had not uplifted the base cost of the shares with the earlier disposal, the total CGT would be:

share disposal proceeds £ 40,000
original cost -£ 5,000
capital gain £ 35,000
less annual exemption -£ 2,000 (assumed)
chargeable gain £ 33,000
CGT @ 40% (assumed) £ 13,200

Total CGT £ 13,200

Looking ahead to the future, the impending changes to CGT may see investors focusing on different assets to reduce their liability. So for instance, spending more on renovations to their main residence with a view to recouping the benefits tax-free upon selling; investing in wines or classic cars. It may also be prudent to consider “wrapping” stock market investments in an offshore trust and so avoiding having to pay CGT on individual sales within that ‘’wrapper’’.

Our advice in a nutshell:
Never make decisions purely on the basis of tax liability. Always dispose of assets to make a profit or because you genuinely no longer want them. For residential property owners and non-business assets, take advantage of the 18% rate now by exploring options for selling or gifting into a trust. For commercial property and business owners, weigh up whether you want to take a chance and wait for the business asset relief structures to be unveiled, or whether you would rather take the reliefs on offer now, if the opportunity to do so is available to you.

For more information, contact Paul Webb pw@rjp.co.uk or Lesley Stalker las@rjp.co.uk.