Relief for investors expecting worse capital gains toll in Budget

As expected, the Chancellor ignored all the special pleadings and has increased Capital Gains Tax to eliminate massive tax avoidance by the private equity and hedge fund industry which since 2008 has been turning income taxed at up to 40%, (and since April of this year 50%), into capital gains taxed at only 18%.

From midnight tonight (22^nd June) capital gains on realised assets will be taxed at the current rate of 18% for basic rate taxpayers - but will be increased to a flat rate of 28% for higher rate taxpayers.  There are no reliefs for inflationary gains although entrepreneurs who up until now have been able to realise up to £2 million at a flat rate of 10% will now be able to take profits of up to £5 million at the 10% rate.

There will be a sigh of relief from the vast majority of investors who will still be able to realise up to £10,100 of gains (2010-11) a year tax free which means that investors in bonds and shares will largely be able to avoid CGT altogether – as in the past.  The Chancellor confirmed that there would be no reduction in the nil rate band in spite of strong lobbying from the Lib Dems who wanted to see the nil rate band reduced to just £2,000. 

This would have dragged millions more small investors, in particular those with gains on employee share option schemes, into the CGT net at great cost of collection but with very little overall increase in tax revenue. 

Owners of second homes and buy-to-let properties will continue to pay CGT at the 18% rate if they are basic rate taxpayers.  This should protect the vast majority of those who have bought a second home for their retirement and those who have invested in a couple of buy-to-let properties as most will be basic rate taxpayers in retirement.  The housing market had been predicting a slowdown if CGT was raised to income tax rates and there will be a sigh of relief that the Stamp Duty exemption for first time buyers who pay no tax on properties valued at up to £250,000 will remain in place. 

Chancellor Osborne made it quite plain that the increase in CGT is aimed at taxing the hedge fund and private equity managers who have cost the Treasury millions in lost revenue by avoiding income tax, taking profits rather than paying themselves a salary.  CGT is not a big revenue raiser but in the interest of fairness, the rate has been increased to 28% for higher rate taxpayers.

CGT raised £2.4 billion in 2009-10 – but as much as £7.8 billion in the previous year and has averaged £3.5 billion over the past 10 years.  The Adam Smith Institute warned that a big increase in CGT could actually cost the government as much as £2.48 billion in lost revenues. It argued that higher tax rates will discourage individuals from selling assets, denying the government the CGT they would gain from the sale.

Since 6th April 2008, CGT has been paid at a flat rate of 18% on realised gains above the annual CGT allowance of £10,100 (2010-11).   Taper relief and indexation were abolished in April 2008, removing the tax benefit for long term investing as part of the simplification process.   Reducing the tax, which had previously been paid at the investor’s marginal rate of income tax up to 40%, to just 18% was a surprise - and at a time when it was rapidly becoming apparent that government finances would be stretched, probably a big mistake.

Entrepreneur’s relief reduces CGT for business owners on the first £2 million of gain to 10%.  The lifetime limit was increased from £1 million to £2 million by Alastair Darling in his March Budget earlier this year and has now been raised to £5 million.

CGT was introduced by Harold Wilson’s labour government in 1965, at a flat rate of 30%.  Until then profits had been largely tax free.  Today, there is no doubt that only the rich pay CGT.  Only 1 in 131 taxpayers or 247,000 out of 32.5 million had to pay CGT in 2009, largely due to the fact that there is an annual exemption of £10,100 (2010-11).  There are enough exemptions to exclude all but the very rich from most of this tax.  More than 80% of those subject to CGT declared profits of £100,000 or more with some 2,000 people paying CGT on gains of £1 million or more. 

Figures from HMRC show that in 2008, 53% of investors who paid CGT – some 130,000 individuals out of nearly 30 million taxpayers – paid tax on gains of £25,000 or less and accounted for just 3% of the total CGT collected by the tax man. 

Middle class investors can shelter their assets from tax in pension schemes, PEPs and ISAs where assets roll up free from CGT.  Had you invested the maximum amount in Peps and ISAs every year since they first became available 23 years ago in 1987, you could now have £165,600 sheltered from Capital Gains Tax - and potentially income tax too if you hold gilts or corporate bonds in your account.    A couple could have stashed away £331,200.  Had the money been invested in an index fund linked to the FTSE100 it could easily now be worth as much as £950,000 – and there would be no CGT payable on any of this. 

As Brendan Barber, general secretary of the TUC put it, ‘the vast majority of taxpayers never come into contact with capital gains tax as they are simply not wealthy enough to buy and sell the assets that bring capital gains.  But most will find it incomprehensible that they pay more tax on the wages they earn from putting in a full day's work than the wealthy do from sitting back and watching their assets increase in value.’