Guide to Budget CGT changes

Tax lawyer Shimon Shaw, of Matthew Arnold & Baldwin, gives his views on the Budget’s CGT adjustments.

In the run-up to the emergency Budget many IFAs saw an increase in the enquiries relating to Capital Gains Tax (CGT). The feared increase in CGT rates to 40% or 50% did not materialise and we are left with what is generally thought to be a much more reasonable figure of 28% for higher earners.

The changes took effect from midnight on 22 June, so there is probably no more planning to be done. However, it is worth taking the time to review how things stand now.

• The rate of CGT will remain at 18% for individuals with total taxable gains and income of less than the upper limit of the income tax basic rate band (currently £37,400).
• The 28% rate will apply to those whose income and gains are over the basic rate band. Gains (or any parts of gains) above that limit will be taxed at 28%.
• For trustees and personal representatives of deceased persons, the rate is increased to 28% on all gains (previously 18%).
• The rate of CGT for gains qualifying for entrepreneurs’ relief remains 10%. There is an increase in the lifetime limit on gains qualifying for entrepreneurs’ relief from £2m to £5m.
• The annual exempt amount for 2010/11 remains at £10,100. Any gains up to this amount are exempt from tax.

The detailed provisions

Individuals will need to consider their total taxable income and gains after all allowable deductions (including losses, the income tax personal allowance and the CGT annual exempt amount) to determine the correct rate of tax.

If the total is less than the upper limit of the basic-rate income tax band (currently £37,400), gains up to this level will be taxed at 18%. Above this, the rate will be 28%.

For trustees and personal representatives, the rate will be a flat 28%. Gains arising in 2010/11, before 23 June 2010, will be liable for CGT at 18% and will not be taken into account in determining the rate (or rates) at which gains of individuals arising on or after 23 June 2010 should be charged.

There is an important planning point here. If the legatees of an estate are lower-rate taxpayers, it is often advisable to appoint the assets to them (with no taxable gain). When the legatees dispose of the assets, realising a gain, this may then be taxed at 18%. Trustees should also consider appointing assets to beneficiaries

subject to the lower rate of tax. Upon the appointment there would be a possible CGT charge, but it is possible to hold over the tax charge. When the beneficiary disposes of this asset, the tax charge will be based on their, not the trustees’, rate of tax.

Tax-efficient investments

The CGT relief upon investing gains in shares under the Enterprise Investment Scheme (EIS) allows (subject to certain conditions) for the tax to be deferred until the EIS shares are disposed of in the future. The rate of tax on a gain deferred in this way will be the rate (or rates) at the time the deferral ends. Gains on disposals before 23 June 2010 that are deferred until 23 June 2010 or later will therefore be liable to CGT at 18% or 28%.

In working out the CGT payable, taxpayers will be able to deduct losses and the annual exempt amount in the way which minimises the tax due.

The Budget note includes an excellent example of how these changes will work in practice. In 2010/11 X’s taxable income, after all allowable deductions and the personal allowance, is £27,400. The upper limit of the income tax basic rate band is £37,400. X sells an asset in May 2010 and realises a chargeable gain of £17,000.

In November 2010 X sells another asset, realising a chargeable gain of £25,100. X has no allowable losses to set against these gains, and the AEA for 2010/11 is £10,100. Neither of the gains qualifies for Entrepreneurs’ Relief.

X’s taxable income is £10,000 less than the upper limit of the basic-rate band (£37,400 to £27,400). X sets the AEA against the later gain (because part of that gain is liable to tax at the higher CGT rate), leaving £15,000 taxable (£25,100 to £10,100).

The first £10,000 of the £15,000 is taxed at 18% and the remaining £5,000 is taxed at 28%. The £17,000 chargeable gain X realised in May 2010 before the change of rates on 23 June 2010 is taxable at the old 18% rate.

For trustees and personal representatives, the CGT rate will be 28% for gains arising on or after 23 June 2010, except where entrepreneurs’ relief applies.

Entrepreneurs’ relief

The ray of sunshine for business owners was that the lifetime limit for Entrepreneurs’ relief of £2m will increase to £5m. Prior to 6 April 2010, this was set at £1m.

Therefore, gains on disposals of certain business assets individuals and certain trustees will be taxed at a rate of 10%. Trustees may benefit from this relief if a beneficiary of the settlement meets the conditions.

In determining at what rate (or rates) an individual should be charged to CGT on any other gains, those gains qualifying for entrepreneurs’ relief are set against any unused basic-rate band before non-qualifying gains.

There are transitional provisions that need to be understood when advising clients. If a individual or trustees have made qualifying gains above the previous £2m limit before 23 June 2010 (£1m limit before 6 April 2010), no additional relief will be allowed for the excess above the old limit.

However, if they make further qualifying gains on or after 23 June 2010, they will now be able to claim relief on up to a further £3m of those additional gains (or up to £4m where the earlier £1m limit applied).

The approach to CGT typifies the general approach in the Budget: unpleasant, but it could have been worse.

Looking at CGT in isolation, most taxpayers will be able to stomach a rate lower than 30%, and we are unlikely to see everyone holding on to their assets until better times, as was predicted in the run up to 22 June. The increases to Entrepreneurs’ Relief will certainly be a comfort to business owners, and many are likely to find themselves even better off than before the Budget. The impetus in the future will be to ensure that business ownership is spread around enough to maximise the benefit of this relief.