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BKL Tax comment on the effect of changes in the capital gains tax regime for share option holders, and warn that time is running out for spouses and civil partners to ‘lock in’ indexation allowance.

Keeping Your Options Open

The changes in the capital gains tax regime that were announced last autumn and confirmed by the Chancellor in the budget have moved the goalposts for those employees who currently hold options over shares under the EMI option arrangement.
 
The capital gains changes initially proposed by the Chancellor would in many cases have increased the amount of CGT payable on a sale of shares from an effective rate of 10% or less to a rate of 18% but following a good deal of pressure, the Revenue announced that a new “entrepreneurs’ relief” would be introduced to soften the effect on businesses of the abolition of taper relief.
 
The bad news is that the new CGT relief does not replicate the provision that allows an EMI option holder to exercise his or her options and pay CGT at a rate of 10% where two years have elapsed from the date the options were granted.
 
The better news is that the 10% rate continues to be available (for gains not exceeding £1m) even where options are exercised immediately before sale but only where the employee has held at least 5% of the company’s shares throughout a period of one year to the date of sale.  Small company employers may now wish to consider providing a 5% shareholding to employees as part of their share scheme arrangements. Other EMI measures introduced by the Chancellor include an increase from £100,000 to £120,000 in the value of unexercised options that may be held by each option holder, and the easing of some of the annual reporting requirements.
 
The reduction of CGT to a flat rate of 18% brings the ‘old style’ approved Executive Share Option Scheme back into favour.  This scheme may be attractive to certain employers as they are open to any type of company, whether it carries on a trade or an investment activity and contrasts with the limitations on the company’s business activity prescribed by the EMI scheme.   Up to now, CGT of 40% would normally be expected to be payable under this approved scheme.  Options may be granted to selected employees and directors but these are subject to the overriding limit that no participant can hold options that have a market value exceeding £30,000.
 
Stephen Deutsch

Locking in Indexation

CGT Indexation Allowance currently inflates the tax-allowable cost of an asset by reference to increases in RPI from the date of acquisition up to April 1998.  This will no longer be available for disposals after 5 April 2008.  However, it is possible to “lock-in” the allowance by the simple expedient of transferring the asset between spouses (or same-sex civil partners).  This effectively converts the indexation allowance into additional base cost.  Indeed some of our clients will already have done this.
 
The draft legislation indicated that this strategy would not be effective for assets already owned (by the transferring spouse) on 31 March 1982.  However, buried in the Finance Bill published is a provision that reverses this.  This is an important change since it is assets that were held on 31 March 1982 which have the largest element of indexation relief: for such assets indexation more than doubles the allowable cost for tax purposes, so locking in the relief is particularly worthwhile for assets of significant value on that date.
 
This late change is provoking but there is still time to effect such inter-spouse transfers before 5 April, if you act quickly.

Note that:

(1) As well as assets with a significant value on 31 March 1982, it may be worth transferring assets acquired subsequently which have worthwhile indexation accrued on them up to April 1998;

(2) Other taxation consequences should be considered including, for example, the effect on any future CGT Entrepreneurs’ Relief of re-starting the period of ownership in the transferee spouse’s hands; and

(3) It goes without saying that you should only make the transfer if you are happy to give up ownership of the particular asset and trust the recipient!

Terry Jordan