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Matthew Hutton MA, CTA (fellow), AIIT, TEP, presenter of Monthly Tax Review, reports on the Government's recent announcement of a new Capital Gains Tax (CGT) relief, and provides some observations on the CGT landscape based on proposed changes to the regime.   

Context

1. The Chancellor announced on 24 January, a new relief (‘entrepreneurs’ relief’) from CGT for gains arising on the disposal of a business.

The relief

2. The relief will take effect from 6 April 2008 alongside the CGT reform programme announced at the Pre-Budget Report.

3. The relief will be available in respect of:

• gains made on the disposal of all or part of a business, or
• gains made on disposals of assets following the cessation of a business, by certain individuals who were involved in running the business.

4. The first £1 million of gains which qualify for relief will be charged to CGT at an effective rate of 10%. Gains in excess of £1 million will be charged at the normal 18% rate.

5. An individual will be able to make claims for relief on more than one occasion, up to a lifetime total of £1 million of gains qualifying for relief.

Background note and further details

6. At the Pre-Budget Report the Chancellor announced a major reform of the CGT regime. From 6 April 2008, there will be a single rate of CGT of 18%. As part of this change the tax-free annual exempt amount (currently £9,200) will remain, but taper relief and indexation allowance will be withdrawn. Draft legislation relating to the changes proposed at PBR has been published on the HMRC website.

7. The new relief will reduce gains liable to CGT (at the single 18% rate) by 4/9ths, resulting in an effective 10% rate (5/9ths × 18%). The relief will be available for gains of up to £1 million on disposals of a business by an individual.

Example

Sarah sells her trading business and realises gains of £450,000 (before entrepreneurs’ relief). She has made no other claims to the relief, and the whole of the gains are eligible for relief. If she claims the relief, the gains of £450,000 will be reduced by 4/9ths (£200,000) and £250,000 of the gains will be liable to CGT (subject to deduction of any allowable losses and the annual exempt amount).

8. The conditions for the new relief will be based broadly on the CGT 'retirement relief' (at TCGA 1992 ss163 and 164 and Sch 6) which was phased out between 1998 and 2003, but the new rules will be simpler. There will be no minimum age limit for entrepreneurs’ relief. And in general, entrepreneurs’ relief will be available where the relevant conditions are met for a period of one year, instead of the retirement relief qualifying period of up to 10 years. Draft legislation will be published shortly.

9. The relief will apply to gains arising on disposals of the whole or part of a trading business, (including professions and vocations, but not including a property letting business other than furnished holiday lettings), which is carried on by the individual, either alone or in partnership. Where a business is not disposed of as a going concern, but simply ceases, relief will be available on gains on assets formerly used in the business and disposed of within 3 years of the cessation of the business.

10. The relief will also apply to gains on disposals of shares (and securities) in a trading company (or the holding company of a trading group) provided that the individual making the disposal:

• has been an officer or employee of the company, or of a company in the same group of companies, and
• owns at least 5% of the ordinary share capital of the company and that holding enables the individual to exercise at least 5% of the voting rights in that company.

The terms 'trading company', 'holding company' and 'trading group' will have the same meaning as they currently do for the purposes of taper relief on business assets. Because of this, there will be no requirement to restrict the gains on shares by reference to any non-trading assets held, as was the case for retirement relief.

11. Where an individual qualifies for entrepreneurs’ relief on a disposal of shares or securities under the previous paragraph, relief will also be available in respect of any 'associated disposal' of an asset which was used in the company’s (or group’s) business. For example, if a company director who owns the premises from which the company carries on its business, sells the premises at the same time as he sells his shares in the company, the sale of the premises may count as an 'associated disposal' and any gain attract entrepreneurs’ relief. The relief due on an associated disposal will be restricted where the asset in question was not wholly in business use throughout the period it was owned.

12. A similar rule will allow relief on an 'associated disposal' by a member of a partnership who is entitled to relief on disposal of his interest in the assets of the partnership. (Again, relief will be restricted where the asset in question was not wholly in business use throughout the period of ownership.)

13. Trustees will also be able to benefit from entrepreneurs’ relief on gains on assets used in a business. In order for trustees to benefit, a beneficiary of the trust with an interest in possession relating to those assets must be involved in carrying on the business in question, personally or as a partner. In the case of shares, such a beneficiary must qualify as an officer or employee of the company in question. The conditions under which trustees qualify for relief will be generally similar to those for retirement relief. In particular, the £1 million maximum limit on gains eligible for relief will apply to the trustees and the qualifying beneficiary jointly.

(HMRC news release 24.1.08)

Some observations

At the PBR, the measure was presented as a revenue raiser, of some £700 million per annum.  The introduction of the entrepreneurs’ relief reduces this by £200 million to £0.5 billion, so the Chancellor is going to have to make up the shortfall somewhere. 

One consequence of the single rate noted at para 93 of HMRC's explanatory note is that the settlor-interested rules for UK settlements are no longer required and so ss 77-79 are repealed.  Such gains will in future be taxed on the trustees and not on the settlor, with compliance implications from 2008/09.

What about an inter-spouse transfer before 6 April 2008, with a view to ‘banking’ indexation allowance given the no-gain no-loss rule in TCGA 1992, s 58?  Over the last three months or so, there has been some doubt in the case where the transferor owned the asset at 31 March 1982. TCGA 1992 Sch 3, para 1 applies where a person acquires an asset through a no-gain no-loss disposal after 31 March 1982, and all prior disposals of the asset since that date have also been no-gain no-loss disposals; in such case that person is treated as having owned the asset at 31 March 1982.

It was then suggested that s 56(2) effectively banks indexation allowance regardless of when the transferor acquired the asset.  HMRC’s FAQ 1 certainly seems to imply as much.  But the problem, pointed out to me by Rachael Dronfield at Grant Thornton, is that s 56(2) applies indexation allowance not to the March 1982 value but to the transferor’s original base cost. New legislation will apply from 2008/09, repealing both s 56(2) and s 55(6)(b). As a result, on a disposal by the transferee after 5.4.08, he/she will have a base cost equal to the unindexed March 1982 value (overriding s58), under Sch 3, para 1 and s 35. HMRC need to address the point.

Interestingly, the entrepreneurs’ relief as it has emerged is slightly different and more generous than was presaged by most newspapers that morning which had predicted a relief at half the standard rate, ie 9%, on qualifying gains up to £750,000.  Now, therefore, going forward into 2008/09 we have a single rate of CGT: the standard rate of 18% (with qualifying gains covered by entrepreneurs’ relief reduced by 4/9ths, an effective rate of 10%).

This relief is obviously far more significant than the reported reintroduction of ‘retirement relief’ in the newspapers on 31 October 2007, under which the first £100,000 of qualifying gain would be exempt.  There was, of course, no official announcement on that at the time, other than confirmation that the matter was being discussed.  Incidentally, one other possibility which was apparently being canvassed within official circles, was that of giving taxpayers an option to rebase all assets (not just business assets) as at 5 April 2008, so triggering a disposal (with tax payable on 31 January 2009). 

In the event, whatever the debate on the level of the entrepreneurs’ relief, that relief is more closely targeted, and does meet to large extent, the representations which have been made by and on behalf of the business community.  Whether it will satisfy completely is of course another matter.  At least it means that those who fall broadly within its scope do not have to consider immediate action.  Those whose prospective gains are of course very much larger than £1 million may well need to be considering the sort of action which was outlined at Item 1.1(c) of Monthly Tax Review  January 2008.
Particular issues for affected taxpayers and their advisers to consider are as follows:

(a) whether the asset(s) concerned fall(s) within the scope of the relief, i.e. being all or part of a business; or assets owned following the cessation of a business; or assets attracting relief as an ‘associated disposal’ used in a partnership business; or qualifying trust assets (see 13 above).

(b) As to unincorporated assets, many of the issues familiar from the old retirement relief come back into play; and

(c) What needs to be done to ensure that shares will qualify?  While it is any trading company, whether private or listed, the individual must be an officer or employee (presumably part-time or full-time, though not yet clarified) and must own at least 5% of the ordinary share capital which gives voting rights.  Happily there is no restriction, as was the case for retirement relief, to any non-trading assets held within the company.  And the old associated disposal rules are also reintroduced where the business is run by a company or by a partnership, as are certain trustee cases.  It seems that the 5% must be owned by the individual himself, without regard to holdings of connected persons. 

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