All change for CGT and IHT?

Do you need to sell your assets to avoid higher taxation?

The Chancellor’s proposals regarding Capital Gains Tax (CGT) in the Pre-Budget Report, announced on 9 October 2007, were heralded as a simplification. However, the proposals have sparked much criticism, both from investor bodies as well as the accounting profession. Even members of television’s ‘Dragons Den’ have joined the protest against a flat rate tax! Some, particularly those holding shares in private businesses, including AIM companies, hope the changes will be postponed, if not abandoned, but for the time being they are scheduled to take effect on 6 April 2008.

As explained in our Pre-Budget summary report, both taper relief and indexation relief are to be abolished in favour of a single rate of tax for individuals. Other changes to the identification rules and for assets owned on 31 March 1982 will indeed make some aspects less complicated, but the transition to a single rate tax inevitably means there will be both winners and losers.

Since taper relief is largely dependant upon time processes, much depends upon how long you have owned the asset in question. If you are a higher rate taxpayer, whether or not your asset currently qualifies for Business Taper Relief will not necessarily dictate whether you will pay less or more tax under the new regime. For example, under the current regime an asset owned for 15 months will qualify for 50% taper relief if it is a business asset, but nothing if it is not. Both will bear less tax under the new regime, whereas an asset owned on 16 March 1998 will bear more tax in future if it is a business asset and less if it is not.

As Business Asset Taper relief was introduced to replace the old Retirement Relief, an example of the different tax payable under the respective regimes is quite interesting.

Suppose Andrew formed his trading company in 1975 and now wishes to retire. He has an offer of £380,900 for the company which was valued at £50,000 on 31 March 1982. The tax payable is projected as-

If Retirement Relief had applied: £Nil

With Business Taper Relief: £24,290

As proposed: £57,906

By contrast, quoted stocks and shares or an investment property held on 16 March 1998 costing £100,000 and sold for £250,000, would generate projected tax payable of-

With Non-Business Taper: £32,320

As proposed: £25,344

Whilst it remains uncertain that the changes will take place, it could be foolish to realise assets only to find a different outcome prevails. Similarly, many may wish to continue to hold the asset, but at the same time want to mitigate the potential extra tax; possibly by taking advantage of an existing lower rate.

For quoted stocks and shares or property, the higher rate taxpayer will normally pay less tax by deferring the sale, but a basic rate taxpayer could see the tax increasing from 12% to 18%, if he held such assets on 16 March 1998. Provided they avoid the ‘bed and breakfast’ rules, they could benefit from selling the asset and buying the equivalent back later on.

If you are currently close to making a sale and your business assets fully qualify for Business Taper Relief, you will need to think carefully about the timing of the sale. Even if you wish to continue with the business, for instance, where the value has already peaked, transferring your interest into a trust, and thereby crystallising a gain at the current lower rate of tax, may be attractive. Similarly, if a sale is not too far away you may consider the same action.

All change for Inheritance Tax (IHT)?

Under the IHT legislation, everyone is entitled to a ‘nil-rate band’ which is matched with the first part of their death Estate not covered by other exemptions. This band can be reduced by reference to certain lifetime gifts but until now it could not be increased; it has always been specific to the individual and non-transferable. Thus for a married couple (or civil partners) there was just a single nil-rate band available on the second death, even if the first to die had left everything to the survivor. There was a way around this – the inclusion of a nil-rate band discretionary trust in the Will of the first to die – but this made matters more complex and more expensive, particularly where the principal asset was the family home.

The Chancellor has now made life just a little bit simpler, particularly for those married couples whose joint assets fall within the total of two nil-rate bands. He has announced that, in respect of second deaths on or after 9 October 2007, an additional proportion of the nil rate band will be available to use on the death of the second spouse, based upon the proportion of the nil-rate band not used on the death of the first. This will apply regardless of when the first spouse died.

The claim for a transfer of unused nil-rate band will need to be made by the personal representatives of the second spouse. There is no need to make a claim on the first death, nor is there any need to refer to the transfer or the availability of an unused nil-rate band in the Will of the survivor. The change affects those who were married or in a civil partnership at the date of the first death. It does not extend to co-habitees or to those who have divorced.

Many couples will have in place Wills that include provision for a nil-rate band discretionary trust on the first death. There is no urgent need for such Wills to be rewritten, since they will incorporate sufficient flexibility for personal representatives to react to this change in an appropriate manner, but they should be reviewed in due course.

Those who benefit under a trust – particularly if they have a right to income (a life interest or interest in possession) – should be conscious of another set of IHT changes that take full effect shortly. The underlying assets of such trusts are currently treated as part of the beneficiary’s Estate for IHT purposes. It can make sense for the beneficiary, as part of their overall IHT planning, to surrender their interest in the trust when they are at a stage where they can afford to do so. If that interest is to be surrendered in favour of a life interest for others – for example, the beneficiary’s children or grandchildren – either automatically under the terms of the trust or by deed of appointment, it is likely to be tax-efficient to deal with this during a transitional period that expires on 5 April 2008. Beyond this date new rules apply and surrenders of this sort will in general attract an IHT charge.

The Chancellor’s announcement has made IHT just a little bit simpler for the man in the street to deal with. It remains a complex tax, however – not helped by its interaction with the relatively new Pre-Owned Assets Tax – and there are still many people for whom the ability to transfer nil-rate bands means little or nothing. For those individuals and their families there are a multitude of IHT planning techniques available, covering all possible circumstances.

If you would like advice in respect of the issues covered in this Taxflash, please contact your usual UHY Hacker Young partner.

This Taxflash is based upon the Briefing Notes issued to accompany the Pre-Budget Report. The legislation will not be finalised for some time and there may be changes in the detail. If you have any concerns, do refer to our website at www.uhy-uk.com (where any changes will be detailed) or speak to us direct. Every effort has been made to ensure that the facts in this document are correct at the time of going to press. No responsibility for loss occasioned to any person acting or refraining from acting as a result of any material in this publication can be accepted. Registered to carry on audit work and regulated for a range of investment business activities by the Institute of Chartered Accountants in England and Wales.

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