PRE-BUDGET STATEMENT - CAPITAL GAINS TAX (CGT)

Nearly 10 years ago Gordon Brown stood up at his first Budget speech and announced a number of fundamental changes to the capital gains tax system.

The major change was the introduction of the concept of 'taper relief' which he hoped would stimulate entrepreneurial activity:

'The reform will help investment through encouraging longer-term holding of assets by reducing the effective rate of CGT on longer-held assets. It will stimulate entrepreneurial activity by rewarding longer-term investment in businesses.'

Currently taper relief provides a generous relief for owners of 'business assets' with an effective maximum CGT rate of 10%, if they have been held for two years. Whilst owners of 'non-business assets' pay tax at maximum rates of between 24% and 40%, depending on the length of time the asset has been held. The maximum relief being given where the asset has been held for 10 years.

This will change on 6 April 2008 following Alistair Darling's shock announcement to withdraw taper relief. In his speech the Chancellor justified the blow to small business owners stating:

'I can tell the House the changes I propose to capital gains tax also, taken together with the tax loopholes I am closing, will ensure that those working in private equity pay a fairer share.

So from April next year I will withdraw the capital gains tax taper relief, and in its place there will be just one rate of 18%, one of the most competitive single rates of any major economy.'

The change will simplify the capital gains regime, in addition to the withdrawal of taper relief, there will also be the withdrawal of indexation allowance, applicable to assets held before April 1998, changes in asset valuation rules for assets held before March 1982 and a condensed set of rules for calculating gains on share disposals.

The rules will be welcomed by some and a blow to others. If advice has been previously given with respect to holding periods applicable to capital gains tax it will be beneficially for this to be revisited.

It is likely that in the months leading up to 5 April 2008 there will be increased activity from the perspective of business disposals and the transfer of businesses to companies. These transactions will aim to benefit from the current generous full business-asset taper relief with an effective maximum CGT rate of 10% before it increases to 18%.

By way of an example:

In 1995 Bob set up a new trading company with share capital of £1,000. He sells it for £500,000 in March 2008.

Under the current rules the gain will be calculated as follows:

If the sale had been delayed until after 5 April 2008 the gain would have been as follows:

The new rules may be a further negative for the housing market as owners of second homes look to delay sales until after 6 April 2008 when more preferable tax rates apply.

The example below illustrates this point:

In 1995 Kate purchased a holiday home in Devon for £100,000. She sells it in July 2008 for £250,000. 

Under the current rules the gain would have been calculated as follows:

From 6 April 2008 the gain will be calculated as follows:

NOTE: The examples above ignore the annual capital gains tax exemption that may be available.