Standard Notes are compiled for the benefit of Members of Parliament and their personal staff. Authors are available to discuss the contents of these papers with Members and their staff but cannot advise others.

Capital gains tax : the 2008 reforms Standard Note: SN4652 Last updated: 3 June 2010 Author: Antony Seely Business & Transport Section

In spring 2007 the activities of private equity funds, and certain tax advantages exploited by executives at these firms, came under intense public scrutiny. One concern was the fact that individuals were being taxed on their capital gains at a rate of only 10%, by taking advantage of taper relief on business assets. In his Pre Budget statement on 9 October the then Chancellor Alistair Darling announced a major reform of capital gains tax (CGT), in part to ensure individuals working in private equity would pay a “fairer share” in tax: the withdrawal of taper relief and indexation relief, and the introduction of a single rate of tax set at 18%, to take effect from 6 April 2008. The changes were expected to raise £750 million by 2009-10. The Labour Government’s proposals were strongly criticised, particularly because of the potential impact on business owners approaching retirement, seeking to sell their businesses. There were also concerns about the lack of consultation before Mr Darling’s statement, and the uncertainties faced by taxpayers about how to plan for the changes. On 24 January 2008 the then Chancellor announced that a new ‘entrepreneurs relief’ would be introduced as part of the new tax structure, to mitigate its impact on small business owners. CGT would be charged at 10% on qualifying gains, up to a cumulative lifetime total of £1 million. It was estimated the relief would cost the Exchequer around £200 million a year.1 Despite continued opposition from some quarters, in his 2008 Budget Mr Darling confirmed that the new regime would take effect from the start of the 2008-09 tax year.2

This note examines the background to this reform; a second note examines the history of the tax.3 General information on the operation of CGT is collated on HM Revenue & Customs internet site.4

Contents

A. The debate about CGT and private equity 2

B. Pre Budget Report October 2007 7

C. Announcement of entrepreneur’s relief – January 2008 14

D. Budget 2008 20

E. Appendix: selected press comment 26

1 HC Deb 24 January 2008 cc1627-8 2 HC Deb 12 March 2008 c292; HM Revenue & Customs Budget Note BN48, 12 March 2008 3 Capital gains tax : background history, Library standard note SN/BT/860, 2 June 2010 4 http://www.hmrc.gov.uk/cgt/index.htm

2

A. The debate about CGT and private equity

In spring 2007 the taxation of private equity funds came under intense public scrutiny. In part this was due to a campaign by the GMB Union regarding the takeover of the motoring organisation the AA by the equity firm Permira.5 One concern was the way executives were being taxed at only 10% on ‘carried interest’, by making use of ‘taper relief’, given on capitals gains from business assets. In an interview with the Financial Times in early June, Nicholas Ferguson, a leading figure in the industry, said, “any common-sense person would say that a highly paid private equity executive paying less tax than a cleaning lady or other low-paid workers … can’t be right.”6

A short description of taper relief and its use by the industry was given in the Treasury Committee’s interim report on private equity, published in July 2007:

Business assets taper relief was introduced in 1998 as part of the reforms to Capital Gains Tax (CGT). In its original form, it reduced the CGT payable on business assets that were held for at least 10 years from 40% to 10%. In 2000, the period after which the maximum taper relief applied was reduced to five years, and it was reduced again in 2002 to two years. The original intention was to reward long-term investment, with a view to promoting enterprise and the venture capital industry ... In a typical private equity fund, the partners in the private equity firm invest their own money in the fund (usually 1 to 3% of the value of the fund) alongside the limited partners … When the fund matures, provided it has achieved its hurdle rate, the private equity partners who have invested in the fund are generally entitled to 20% of the profit above the hurdle rate. This is referred to as "carried interest" or "carry" and is subject to CGT. Because the private equity partners also work in the companies which they own, their ownership of stakes in those companies is treated as a business asset and receives the most generous form of taper relief.7

Carried interest is treated as a capital gain, not income – following a memorandum of understanding agreed by the tax authorities. A short history of this agreement was given by a practitioner writing in the technical journal Taxation:

Private equity and venture capital funds have existed for a great number of years. Indeed, it was way back in May 1987 that the British Venture Capital Association, the Inland Revenue, as it then was, and the Treasury entered into a joint memorandum of understanding on the tax treatment of the income and profits enjoyed by venture capital and private equity limited partnerships, in particular regarding carried interest. Carried interest is really another description for the shares of any super profits enjoyed by the private equity investors. This memorandum provided that so long as certain conditions were met by the directors and employees of the general partner (or any corporate body providing services) and they were fully remunerated for their services as directors and

5 GMB press notice, GMB MP's Seek Parliamentary Debate To Secure End Of Tax Relief On Loans Used By

Venture Capitalists To Buy Companies Like AA And Sainsbury's, 5 February 2007; “TUC chief attacks private equity industry”, Financial Times, 21 February 2007

6 “Buy-out tax rate is ‘lower than a cleaner’s’”, Financial Times, 4 June 2007 7 Tenth Report: Private Equity, 30 July 2007 HC 567 2006-07 paras 83-4. The Committee resumed its inquiry

four months later (Treasury Committee press notice no.05 2007-08 Session, 20 November 2007).

3

employees, they would not be considered to have acquired their partnership interests or their shares in the super profits by reason of their employment. This meant that their shares of these super profits would be taxed as capital. Until 2000, when the Treasury extended business asset taper relief to any investment in an unquoted company and indeed to most employee shareholdings, the differential between taxing partners’ shares of such profits as capital or income did not really matter. Even more beneficial was the further change introduced back in 2002 that reduced the holding period relating to business asset taper relief from four years to two. This meant that, provided their investments were structured in accordance with the conditions laid down in the first memorandum and the subsequent one issued on 25 July 2003, assuming they were UK resident and/or domiciled, partners could enjoy their share of such super profits at a tax rate of no more than 10% (as opposed to 41% if these monies were being subject to income tax and National Insurance as earnings).8

An editorial in the Financial Times commented, “private equity is playing by the rules but those rules are very generous”:

There is no doubt that, technically speaking, these profits - [carried interest] - are capital gains. They arise from a capital investment. But because that investment is so small and because private equity partners only get to make it by virtue of their jobs, the question is whether such gains are actually not employment income … The distinction only matters, however, because of generous tax reliefs that can cut capital gains tax on shareholdings by three-quarters. The result, for a private equity partner who would normally pay tax at 40 per cent, is an effective rate of just 10 per cent. These tax reliefs were supposed to encourage small businesspeople to risk their savings in start-ups. But fiddling with the tax system almost always produces unintended consequences and unintended beneficiaries. This taper relief cost £6.3bn in revenue foregone during the last tax year and there is now a strong case for limiting its scope.9

Writing in the paper at this time Martin Wolf argued, “Mr Brown [when Chancellor] thought he could induce people to do what he wanted. He has, instead, created loopholes through which the well-advised rich have ridden coaches and horses.”10

A further article noted that the exploitation of taper relief by private equity was not an “isolated example”:

Time and again, a tax break that is big enough to make a difference to the behaviour of entrepreneurs and investors ends up being exploited in a way that was not intended. Tax officials are left scrambling to close loopholes after too much money ends up subsidising low-risk assets, supporting businesses with no intention of expanding or cutting the tax bills of wealthy individuals. Meanwhile, there is no clear evidence that the tax incentives serve the purpose for which they were originally intended …

8 “Dialogue of the deaf”, Taxation, 26 July 2007 9 “Editorial: A carry on about carried interest”, Financial Times, 6 June 2007 10 “A new chancellor and a new chance”, Financial Times, 29 June 2007

4

Taper relief has ended up costing the Treasury much more than expected, having risen more than tenfold over the past four years. In 2006-07, it cost £6.02bn, much more than the £3.9bn collected in capital gains tax. Nobody knows, however, how much extra capital gains tax would be collected if the rules were tightened up. Champions of the new capital gains tax regime say that its real value lies in persuading entrepreneurs to remain in the UK after they sell their companies. But researchers are unclear whether it has succeeded in one of its original goals of creating an incentive for more workers to start businesses. A survey last year by PwC, the professional services group, found very little awareness of taper relief and other incentives among small companies. Tax simply does not come into the thinking of most entrepreneurs, according to Rebecca Harding of London Business School. "There are some fantastic measures out there for setting up a business, but unless people have a really good accountant they don't understand what the benefits are."11

The rising cost of taper relief was set out in a written answer at this time:

Jim Cousins: To ask the Chancellor of the Exchequer if he will (a) update the estimates given for the cost of capital gains tax business paper relief in 2001-02 and 2002-03 in his Tax Ready Reckoner November 2002 and (b) give an estimate for the years from 2003-04 to 2007-08. Jane Kennedy: The estimates of the cost of the relief as published in the Tax Ready Reckoners and in table A3.1 of Financial Statement and Budget Reports are for business and non-business assets combined. Taper relief is dependent upon the volume of disposals, which in turn is driven by changes in asset prices, particularly share prices. The movement between 2001-02 and 2002-03 was also influenced by the maturing of business asset taper relief. The latest estimates of the Exchequer impact of taper relief for 2001-02 to 2006-07 are as follows. Estimated cost (£ million) 2001-02 550 2002-03 3,500 2003-04 2,750 2004-05 3,500 2005-06 4,620 2006-07 6,020 Figures for 2005-06 and 2006-07 are available in the ‘Estimated costs of the principal tax expenditure and structural reliefs’ table at http//www.hmrc.gov.uk/stats/tax_expenditures/table1-5.pdf. Figures for 2007-08 are not available. The estimated costs are not the same as the yield from abolition of taper relief as they do not take into account any behavioural changes which would occur if taper relief was abolished.12

Further to this, the 2008 Budget report estimated that the cost of taper relief for 2007-08 would rise to £7.2 billion.13

11 “Tax loopholes leave private equity investors to clean up”, Financial Times, 11 June 2007

12 HC Deb 24 July 2007 cc999-1000W

5

In June the Treasury Committee took evidence from a number of witnesses from the industry, who gave differing views of the importance of taper relief:

Wol Kolade of the BVCA drew a link between taper relief and the success of the UK's private equity industry. Jon Moulton of Alchemy said that taper relief was only "a small portion" of the factors affecting his tax bill, and expressed the view that "you are getting some tax and if you are not careful you might not!" However, Peter Taylor of Duke Street Capital told us that he did not believe "a rate of 15 or 20% [instead of 10%] would be a material disincentive to entrepreneurs like ourselves to create value over the long term."14

The Committee went on to suggest that the taxation of carried interest should be reviewed:

We note that partners in private equity firms typically contribute no more than 1.5% to 5% of the equity in a fund in return for the carried interest, and that there is a case to answer as to whether the carried interest is genuinely a capital gain. But we also accept that great care would be needed in making any changes to avoid damaging an important part of the UK economy. We recommend that the Treasury and HM Revenue and Customs consider the tax treatment of carried interest as part of their review of the taxation of employment-related securities, and that they publish the results.15

At the report stage of the Finance Bill 2007, the Government resisted a new clause tabled by the Conservatives, and supported by the Liberal Democrats, which would have required the Treasury to produce a report on the cost of the tax relief granted to private equity companies and venture capital funds through the application of taper relief on carried interest. In his response the then Economic Secretary, Ed Balls, described the introduction of the two memoranda between the tax authorities and the venture capital sector:

A previous memorandum of understanding had been produced in 1987 by the Inland Revenue and the British Private Equity and Venture Capital Association, which made it clear that carried interest would continue to be taxed to capital gains, not income. During the 2003 Finance Bill debate on this issue … concern was expressed, particularly by the former Member for Arundel and South Downs [Howard Flight MP], that changes being introduced to schedule 22, covering the whole range of employment-related securities, might have a negative impact on the capital gains tax treatment of venture capital. As a result of those debates, the memorandum of understanding that had been agreed in 1987 was re-examined and a new one, again agreed between the Revenue and the British Private Equity and Venture Capital Association was published. It provided guidance to the industry, but, importantly, did not affect the operation of the law in the Finance Act 2003. That memorandum of understanding confirms that returns received through carried interest should, in law, in the circumstances that it sets out—in plain vanilla form, which is a technical tax term that means “in a simple and straightforward way”—be taxed as capital gains. No concessions were made to the private equity industry at

13 HC 388 March 2008 p136 14 Competing views were also given in letters on this issue in the Financial Times: see, for example, “Letter:

Attacks on financial services will please continental competitors”, 28 June 2007 & “Burden of proof is on private equity”, 22 June 2007.

15 HC 567 2006-07 paras 85,88

6

the time, but the memorandum of understanding clearly set out how the underlying legislation applied in the case of carried interest. It set that out in a way that would apply to any taxpayer who received such employment-related securities.16

Neither of these two memoranda appear to have been discussed in the House when they were agreed.17

As Mr Balls noted in his speech, the Revenue’s decision to pursue a new memorandum was mentioned during scrutiny of the Finance Bill 2003. When selected clauses of the Bill were debated by the Committee of the Whole House, Jonathan Djanogly MP mentioned the concerns of the private equity sector, in relation to the proposed new anti-avoidance provisions regarding employee share rewards and options (now contained in schedule 22 of the Finance Act 2003):

Significantly for the private equity industry, which seems to be extremely concerned by these proposals, it would appear that the receipt of a carried interest in a venture capital or limited partnership would fall within the new rules. However, that needs clarification, as it is not clear whether the security interest that the employer acquires is the limited partnership interest itself, as with a unit in a collective scheme, because there is no definition of unit in the legislation, or whether the shares and securities that the partnership acquires in its investee companies count as the employee's securities, and whether, if the latter is the case, they acquire that interest qua partner or qua employee, deriving from their initial acquisition of a carried interest qua employee.18

In response to this point the then Paymaster General, Dawn Primarolo, said:

There was a question … about interaction with enterprise SMEs. We are not attacking genuine share schemes that give employees a real stake ... The hon. Member for Huntingdon raised that with regard to its interaction with other areas of the tax system, and stressed that we should ensure that there were no adverse effects that would damage provisions elsewhere in the system. I agree. We will discuss the impact of the new rules, particularly in the context of venture capital, with the British Venture Capital Association. We will be mindful across the piece to ensure that there is no inadvertent knock-on effect.19

When these provisions were scrutinised at the Committee stage, Howard Flight proposed two amendments “to ensure that venture capital partnerships are outside the scope of the Bill.”20

In the event Mr Flight withdrew both amendments following a description from Ms Primarolo of the ongoing discussions the authorities were having with the BVCA:

I am sure that hon. Members appreciate that the venture capital arrangements have adopted new and complex forms in recent years. It is necessary to understand those in order properly to consider the tax consequences. The current agreement with the British Venture Capital Association, in so far as it relates to share scheme issues,

16 HC Deb 25 June 2007 c 104 17 Each was the subject of a short PQ when published: HC Deb 10 November 1987 c 148W; HC Deb 8

September 2003 c 107W. 18 HC Deb 14 May 2003 c 370. This measure was announced in a press notice following the 2003 Budget

(Inland Revenue press notice 53/03, Finance Bill 2003: Tackling avoidance on equity remuneration and creating a fairer system, 16 April 2003).

19 HC Deb 14 May 2003 c 375 20 SC Deb 22 May 2003 c 250. At the time Mr Flight was Member for Arundel and South Downs.

7

sets out the consequences of the current rules governing shares subject to restrictions and conditions for employees in companies backed by venture capital. The current rules will remain in force until shortly after Royal Assent. As I said in the Committee of the whole House, we will discuss the impact of the new rules on venture capital with the BVCA, and do so with the utmost speed. I understand that Inland Revenue officials have already written to the BVCA inviting it to discussions. Adopting the amendment without fully exploring all the issues with that association would be premature and could lead to an unsatisfactory outcome for all concerned.21

As it transpired the Report stage of the Bill was on 1 July 2003, and it was not until some days later – on 25 July – that the department published details of the two memoranda, on its website:

“Management buy-outs, earn-outs & carried interest The legislation in Schedule 22, Finance Act 2003 is designed to deliver the policy of subjecting to tax, and national insurance contributions, value obtained as a result of acquiring securities by reason of employment. The legislation is designed to ensure that value from capital growth is not caught. However, in complex arrangements, such as those described in these memoranda, the divide between capital growth and value obtained as an employee is not easily identifiable. These memoranda have been drawn up to give some clarity in this area for the majority of straightforward cases. Where the circumstances of any particular case are different then the tax consequences will need to be considered in the light of the particular facts.”22

Going back to the debate on private equity and taper relief in summer 2007, in early July Alistair Darling gave his first press interview as Chancellor of the Exchequer, and on this issue he was quoted as saying, “I think we should be very, very wary indeed of a knee-jerk reaction or a reaction to a day’s headlines into making a tax change that could result in unintended consequences and undesirable consequences.”23

B. Pre Budget Report October 2007

There was considerable speculation that the Government would announce changes to these rules in the Pre-Budget Report (PBR).24

In his Pre-Budget statement on 9 October Alistair Darling, said:

The capital gains tax regime here has continued to encourage investment and enterprise. I now propose reforms to make the system more straightforward and sustainable; to ensure that it sets consistent incentives for investment and enterprise; and to ensure that it remains internationally competitive ... I can tell the House that the changes that I propose to capital gains tax also, taken together with the tax loopholes that I am closing, will ensure that those working in private equity pay a

21 SC Deb 22 May 2003 cc 256-7. A piece on the 2003 memorandum which appeared in the Financial Times at

the time (“Resolution reached over tricky tax regime”, Financial Times, 4 August 2003). 22 http://www.hmrc.gov.uk/shareschemes/news/archive.htm. More detail on this agreement and its operation is

given in the Government’s response to the Treasury Committee’s report on private equity (Second special report, 10 December 2007 HC 145 2007-08 pp1-3).

23 “Darling ease buy-out fears”, Financial Times, 4 July 2007. Mr Darling was appointed Chancellor on 28 June 2007.

24 “Brown pledges to plug tax loopholes used by private equity firms”, Guardian, 27 September 2007

8

fairer share. So from April next year I will withdraw the capital gains tax taper relief and in its place there will be just one rate of 18 per cent.—one of the most competitive single rates of any major economy.25

The Government's case for removing taper relief was set out in the PBR as follows:

The Government is committed to ensuring that the UK has an internationally competitive capital gains tax (CGT) system that promotes flexibility and competition, and responds to the changing needs of investors. Building on the Government’s ongoing programme of tax reform, the Government announces a major reform of the taxation of individuals’ capital gains. This will put the CGT regime on a more sustainable footing and help investors plan for the long term. For disposals on or after 6 April 2008 there will be a single CGT rate of 18 per cent, resulting in a more straightforward system for taxpayers. As part of this new system the annual exempt amount (currently £9,200) will remain in place, but taper relief and indexation allowance will be withdrawn. HMRC have today published further details of the reform package, and will immediately begin discussion on implementation with interested parties.26

The second of these tax reliefs – the indexation allowance – was introduced to reduce the taxable gain on the sale of an investment bought between 31 March 1982 and 5 April 1998. This was achieved by increasing the base cost of the asset/investment in line with inflation over the holding period. The allowance was replaced by taper relief after April 1998. Assets acquired between 1982 and 1998 would therefore have the taxable gain reduced by both the allowance and taper relief. Details on how this reform would be implemented were set out in one of the Budget Notes published by HM Revenue & Customs at the time; an extended extract is given below:

Section 4 of Taxation of Chargeable Gains Act 1992 (TCGA) provides that an individual is currently chargeable to CGT at the rates for income tax on savings income (10 per cent, 20 per cent or 40 per cent in the tax year 2007-08), treating his or her net chargeable gains (after deduction of allowable losses, taper relief, any other relevant reliefs, and the AEA) as the top slice of his or her income. Most trustees and personal representatives are chargeable at the rate applicable to trusts (40 per cent for 2007-08). For the tax year 2008-09 there will be a single rate of capital gains tax set at 18 per cent. The rate will apply to individuals, trustees and personal representatives. The 18 per cent rate of CGT does not affect the income tax rates. The main taper relief provisions are in section 2A of and Schedule A1 to TCGA. Taper relief came into effect for disposals on or after 6 April 1998. The relief may reduce the amount of the gain chargeable to capital gains tax (and hence reduce the effective rate of tax payable on the gain). The amount of relief available depends on the length of time an asset has been held since that date, and whether the asset is classified as a business or non-business asset for taper relief purposes. Currently maximum business assets taper relief is available if the business asset has been held

25 HC Deb October 2007 cc170-1 26 Cm 7227 October 2007 para 5.79

9

for 2 years, and the maximum non-business asset taper relief is available if the non-business asset is held for 10 years. For disposals on or after 6 April 2008 and held over gains coming into charge on or after 6 April 2008 taper relief will no longer be available (even if assets were held before this date) and the chargeable gain will be liable to tax at the new rate of 18 per cent (subject to the deduction of allowable losses, any other reliefs and the AEA). The indexation allowance rules are in sections 53 to 57 of TCGA. Indexation was introduced as a mandatory relief with effect from 31 March 1982. It was frozen for CGT purposes at 6 April 1998 for assets held at that time. Currently where an asset was held at 6 April 1998 and is disposed of after that date the gain on the disposal may be eligible for indexation and taper relief. For disposals on or after 6 April 2008 indexation allowance will no longer be available in computing the gain arising. This change will only affect assets that were acquired before 6 April 1998. The ‘kink test’ rules are in section 35 of TCGA and only affect assets that were held on 31 March 1982. This has the effect that the gain (or loss) on the disposal of an asset held on 31 March 1982 is the lower of two amounts: the gain (or loss) calculated by reference to the original acquisition cost of the asset (and any other allowable expenditure on it), and the gain (or loss) based on treating the value of the asset on 31 March 1982 as the total allowable expenditure up to that date. It is possible to elect for the actual 31 March 1982 market value to be used without considering the kink test. The abolition of the kink test will mean all assets held on 31 March 1982 will be deemed to have had a cost equivalent to their market value on that date. Halving relief will also be abolished. This relief, the rules for which are in Schedule 4 to TCGA, reduces the amount of a chargeable gain which, because of the previous operation of certain reliefs, effectively includes a deferred gain that relates to a period before 31 March 1982. The abolition of taper relief, indexation allowance, the kink test and halving relief will apply to disposals on or after 6 April 2008.27

It was estimated that these reforms would raise £350m in 2008-09, rising to £750m in 2009-10 and £900m in 2010-11.28

As noted above, it is estimated that taper relief cost the Exchequer £6.3 billion in 2006-07. Indexation allowance costs an estimated £300 annually.29 The reasons for the apparent disparity in these estimates was provided by the Treasury in March 2008: “the proposals announced at the Pre-Budget Report include a number of changes other than the withdrawal of taper relief—in particular a change to the headline rate of charge. The figures published in the Pre-Budget report also include an adjustment for expected changes in taxpayer behaviour. This explains why the figures presented in the Pre-Budget Report are not the same as the published cost of taper relief.30

27 Pre-Budget Notice PBR 17, 19 October 2007 paras 5-11 28 Cm 7227 October 2007 p164 29 Treasury Committee, Second report, 26 November 2007 HC 54-II 2007-08 para 58 30 Seventh special report, 25 March 2008 HC 429 2007-08 p8

10

The proposals were controversial, particularly in the business community.31

Writing online, the BBC’s business editor, Robert Peston admitted that he was “shocked” by the announcement:

Taper relief meant that those who hold on to assets for longer payer a lower rate of capital gains tax when they sell the relevant assets. In other words, whether you build a business up over 30 years and then dispose of all or part of it, or whether you buy a bunch of shares at 9am and then sell them at a fat profit at 10am, you’ll now pay exactly the same 18% rate of tax. And, what’s even more extraordinary, Darling cut the tax payable by most speculators by more than half while increasing the tax payable by genuine wealth creators by 80%. This is the equivalent of the Treasury saying “let’s turn the UK into a hedge-fund paradise, where the biggest rewards go to those who search out the easiest short-term profits”. It’s a really odd signal for the government to send out. And those who’ll be punished by the tax change also include hundreds of thousands of individuals in Save as You Earn company share schemes. They currently pay 5% or 10% tax when they sell the shares they accumulate (depending on the marginal rate of income tax they pay). But that’ll rise to 18%. It effectively sounds the death knell for such schemes, which have been a great boon in aligning the interests of employees with their employers. All that being said, many will say hooray that Darling should wish to simplify the capital gains tax system. I can see why he thinks that having a single 18% rate, with no tapers and no discrimination between any kind of investment, should be attractive. Such simplicity is incredibly attractive and desirable. But it is being acquired at a steep cost for what may turn out to be millions of employers and employees – the entrepreneurs and employee shareholders – whose determination and morale are vital to all our economic futures.32

As Mr Peston acknowledged, some commentators welcomed these proposals. Following the PBR, Stuart Adam at the Institute for Fiscal Studies commented, "moving to a flat-rate capital gains tax regime by abolishing taper relief and indexation allowances is a major and welcome simplification. It reduces the tax advantage of those who hold assets for a long period, but the treatment of capital gains remains significantly more favourable than ordinary income for higher-rate taxpayers, and indeed that distortion has increased where assets are held only for short periods.”33

In a lecture to the Institute of Chartered Accountants, Mike Truman, editor of the journal Taxation, suggested that “the changes to CGT are the sort of bold measures which we need in order to get simplicity [in the tax system]”:

In a country with a highly developed market for capital such as ours, small businesses should only find it hard to attract investment because investors make rational decisions based on the real risks, whereas business owners complain about lack of investment based on their own flawed perceptions of how much their business is worth, a process which can be seen in all its gory detail each week on BBC2 in Dragons’ Den …

31 “Business anger at tax crackdown”, Financial Times, 10 October 2007; “Blow for small business is boon for

wealthy as private equity loophole closed”, Times, 10 October 2007 32 “Mother of all U-turns”, Peston’s Picks: Robert Peston BBC Business Editor Blog, 11 October 2007 http://www.bbc.co.uk/blogs/thereporters/robertpeston/2007/10/mother_of_all_uturns.html 33 IFS press notice, Some initial thoughts on PBR / CSR 2007, 9 October 2007

11

[With regard to the CGT reforms] … why are we particularly encouraging small businesses when the market is perfectly capable of doing that itself? Why do we give taper relief which encourages those who hold onto their assets, when it might be more economically efficient if they sold them and reinvested in something else? Professor Willem Buiter, in a letter to the Financial Times last month, said that taper relief had no more justification on the grounds of fairness or efficiency than would tape worm relief.34

Writing on the AccountingWeb site one practitioner noted that there would be losers from the change, but they “are losers precisely because the complexity introduced in the system was intended to favour retention of assets and investment in business … a simple tax system cannot incentivise one group as against another: that requires complexity.”35

The Chartered Institute of Taxation issued a press notice giving a “guarded welcome” to this “significant simplification”, but was critical of the absence of “transitional provisions and the CIOT anticipates significant market distortions over the next 6-12 months as some transactions are brought forward and others may be delayed.”36 It was also reported that the private equity sector were relieved; the Financial Times quoted Ian Armitage, chairman of HG Capital, as saying, “it all depends on the detail. But subject to my understanding of a flat rate of 18 per cent, I think that is pretty good.”37

Nevertheless the consensus in the business community was that the proposals would be very damaging. For example, a few days after the Budget the four leading business lobby groups wrote to the Chancellor urging him to “suspend your decision”; an extract is reproduced below:

Your announcement came as a bolt out of the blue. Despite the statement that this decision was driven by the need to simplify the tax system, none of our organisations has ever raised ending taper relief as a desirable step. Neither did the Treasury signal at any point that such a change was in prospect. The impact of the decision will be felt throughout the economy. The net effect will be to set back the growth of the economy over coming years, by discouraging longer-term investment and risk-taking. Owners of small enterprises, who have toiled over years to build up an asset, are now faced with selling up before April or facing a substantial dent to their investment. The 1.7 million ordinary employees who are in company share schemes could also face an 80% increase in their tax bill and a serious disincentive to taking up and retaining share options in the future. Business angels and venture capital funds say they too will be discouraged from taking risk and investing for the long game. Many of those affected have already made investment decisions. The retroactive nature of this move has undermined their reasonable expectations.

34 Mike Truman, 2007 Hardman Memorial Lecture Tax Faculty of the ICAEW, 15 November 2007. Mr Truman

is referring to Professor Buiter’s letter, “Simplifying tax regime with common rate on all capital income”, which appeared in the paper on 18 October 2007.

35 “Do you want a simpler tax system?”, AccountingWeb.co.uk, 10 October 2007 36 CIOT press notice, CIOT comments on the CGT changes, 10 October 2007 37 “Sigh of relief from private equity titans”, Financial Times, 10 October 2007

12

Our members were already deeply concerned by the move in the last Budget to raise small business corporation tax over each of the next three years.38 Combined with this week’s decision on Capital Gains Tax they feel that the government’s ten-year effort to create a pro-enterprise agenda has been put into reverse gear. On behalf of our combined memberships we urge you to pause, suspend your decision and enter into urgent and detailed discussion with the key business organisations to resolve this situation. We will work with you towards a better solution that meets the government’s objectives, however we do need to understand what those objectives are.39

Speaking for the Conservatives the shadow Chancellor George Osborne argued that scrapping taper relief was “economically the wrong thing to do and … a political disaster.”40

In an editorial the Financial Times argued that Mr Darling had “offered no rationale or philosophical basis for the [18%] rate he chose or the reversal of his predecessor’s policy”:

Removing the special rate for business assets, however, will only graze buy-out executives. They will now pay 18 per cent on their carried interest, instead of the 10 per cent that was sometimes achievable, but their cleaners, who earn £7,500 per annum, will still incur a marginal rate of 22 per cent. The main effects of the CGT change, however, will come from the increased gap between income and capital gains tax rates. Accountants are no doubt dreaming up new and exciting ways to turn income into capital gains - thereby cutting the maximum tax payable from 40 to 18 per cent - even now. That makes the Treasury's estimates that the reform will raise £900m by 2010-11 dubious: the potential changes in behaviour are so complex that this is guesswork. Revenue will be lost from capital gains on second homes and investment properties, where the combined effect of the CGT and inheritance tax changes41

is a big cut in property taxation. Slashing already light taxes on real estate risks pumping Britain's extreme property prices even higher - although that may have its political attractions.

What is most striking, though, is that Mr Darling offered no rationale or philosophical basis for the rate he chose or the reversal of his predecessor's policy. A simpler tax system is welcome - but it needs to be a logical tax system as well.42

Following this, there was a lot of press speculation that the Government was making plans to amend these proposals. On 31 October the Times reported that the Chancellor would "soften the blow by giving £100,000 in tax relief for small businessmen who sell up and retire."43

After the PBR, Treasury officials and the Chancellor appeared before the Treasury Select Committee. At an evidence session on 17 October Andrew Love asked Mr Mark Neale,

38 [In Budget 2007 the Government announced the small companies rate of corporation tax would rise from 19%

to 22% over the period 2007-08 to 2009-10 (HC 342 March 2007 para 3.23)] 39 British Chambers of Commerce, Federation of Small Businesses, Confederation of British Industry, Institute

of Directors, “Open Letter to Chancellor of the Exchequer”, 15 October 2007 40 “Tories look to exploit Brown’s ‘own goal’”, Financial Times, 16 November 2007 41 [A reference to the announcement in the PBR of a new transferable IHT allowance for married couples; for

details see, HMRC Pre Budget Report Note PBR16, 9 October 2007.] 42 “Editorial: Confused about capital gains tax”, Financial Times, 11 October 2007 43 “£100,000 tax relief as Brown gives way”, Times, 31 October 2007

13

Managing Director, Budget, Tax and Welfare at HMT, about what impact the introduction of taper relief in 1998 had had. Mr Neale’s reply is instructive:

We have looked at this very carefully. Our conclusion is that the introduction of taper relief did have a positive impact in signalling a new hospitality to entrepreneurship. This very often happens when one introduces an incentive into the tax system. It has a positive impact at the outset and one finds that it comes under pressure as others seek to take advantage of it and structure deals or their affairs to be within it rather than without it. That is why we are now taking this step both to simplify the tax and to put it on a long-term basis.44

When the Chancellor appeared before the Committee on 25 October, Michael Fallon put it to him that “your defence of simplification would surely be more credible if you had not introduced the taper relief in the first place”; Mr Darling said:

We introduced [taper relief] … because the prevailing rate was 40% up until we formed the Government in 1997 and in addition to that, mainly because of the economic turbulence of the 1980s and 1990s, one of the big problems that people complained about was instability and the whole culture was very short-termist. We introduced that regime, it was the right thing to do, I was in the Treasury at the time when it was introduced right at the start ... The economic climate against which people now plan is completely different from what it was 10 years ago but I think it is also right to ask ourselves at each and every stage whether or not the tax system is the right one. Nothing we do precludes changes at any time in the future on any tax.

Mr Fallon went on to ask the Chancellor if he was “prepared to rethink the taper relief”; Mr Darling replied:

I think the prize of simplification, the gains that you get from that are very, very important … the more complexity you add back into the system the more you will get back to where you started from. I fully accept when people talk about simplifications it is sometimes in the abstract rather than in the particular, I do think it is something that is well worth pursuing.45

In their final report, the Committee were strongly critical of the Government's decision to withdraw taper relief "without adequate notice.” The Committee went on to say:

This will particularly penalise those planning to sell their businesses and retire within the next two years. We therefore recommend that the Government, in its response to this Report, set out how it proposes to mitigate the effects of the withdrawal of taper relief, particularly for those already within the two-year qualifying period and with especial reference to small businesses. Such a statement should assist with the discussions on the details of the capital gains tax reforms that the Government has said it is prepared to have with interested parties.46

44 Second report: The 2007 Pre-Budget Report, 26 November 2007 HC 54-II 2007-08 Ev34 Q222 45 HC 54-II 2007-08 Ev46 Qs340-1 46 HC 54 2007-08 para 56

14

C. Announcement of entrepreneur’s relief – January 2008

In a speech to the CBI's annual conference on 27 November, the Chancellor stated that he was considering changes to his proposed reform of CGT (emphasis added):

I know that my proposals to introduce a single rate of capital gains tax have been controversial. That was inevitable. We are working with the CBI and other business organisations to listen to what you have to say. I expect to publish final proposals in the next three weeks. But many have long called for a simplified tax system and have long complained about the complexity of the tax system. And we have to recognise that one person's tax exemption is another's complexity - simplification is not the easy option. But it is the right one wherever it is possible. Let me say this on the principle: capital gains like any other profits ultimately come from the strength of the economy. So I believe it is right and fair that they pay their share in tax as a contribution to the economy's future strength. But because we want to reward investment, we are right to now tax gains at a lower rate than income - and the new single rate is among the most competitive in the world, is less than half the top rate for income, and is also less than half what it was ten years ago. It is also right to make the system more straightforward and sustainable, with a tax that is easier comply with.47

As it transpired the Chancellor announced on 13 December that the proposals he had received “cover a wide range of approaches, and in some cases are quite complex” and that as a result he thought “it desirable to have further discussions with those groups before I finalise my proposals. It is not now going to be possible to conclude that process until the new year.”48

Unsurprisingly the delay was widely criticised.49

The IFS published a detailed analysis of CGT and the impact of abolishing taper relief in its Green Budget in January, arguing that, “owners of business assets are understandably upset to see the withdrawal of a tax break from which they had expected to benefit, but it is not clear in many cases that the proposed regime is less favourable than when they bought the asset in the first place. The government could have offered transitional relief, but this would have re-complicated the system and created problems of its own.” The Institute was particularly critical of the policy-making process: “To the fiscal purist, the lack of consultation prior to this announcement, the strong incentive to sell assets before the announced changes are supposed to be implemented in April 2008, and the subsequent period of uncertainty about how they will in fact be implemented fail every test for sensible tax reform”:

In evidence to the Treasury Select Committee’s inquiry into the Pre-Budget Report, Chancellor Darling claimed that taper relief had been a good idea when it was introduced, but that it was no longer needed. He argued that in the 1990s, there had been a climate of excessive short-term speculation that needed to be countered by incentives for long-term asset holding, but that this climate of short-termism had now changed. This is unconvincing. It is doubtful that ‘excessive’ speculation was ever

47 HM Treasury press notice 134/07, Speech by the Chancellor of the Exchequer, the Rt Hon Alistair Darling

MP, to the CBI Annual Conference, Business Design Centre, London, 27 November 2007 48 HC Deb 13 December 2007 c461 49 “Outrage at capital gains tax ‘dithering’”, & “Editorial: Departmental drift at the Treasury”, Financial Times, 14

& 20 December 2007

15

adequate justification for introducing taper relief; it is more doubtful that this aspect of the economic climate has changed much over the past 10 years; and it is still more doubtful that any of this justifies the problems associated with introducing a tax break and then removing it again. Business lobby groups, tax professionals and the Treasury Select Committee have all expressed concern about the lack of consultation before the announcement of the CGT reform in the Pre-Budget Report. It is difficult to think of good reasons not to consult on major reforms to the structure of a perennially awkward tax. One reason might have been if the government had wanted to implement the reforms with no notice so as to avoid a rush to sell assets before the new regime came into effect, and feared that consultation would not remain confidential. But the government clearly did not want the reform to come as a surprise: rightly or wrongly (as discussed in the previous section), the government deliberately gave some months’ advance warning to allow taxpayers to arrange their affairs, so there could have been little additional harm done even if the details of a consultation had leaked out.

A second justification for not consulting before announcing the reform might be if the government was so sure that its policy was the right one that no consultation was needed. Yet the government has proclaimed itself willing to reconsider the detail of the reform since announcing it. Having created uncertainty in this way, the government has exacerbated it by missing its self-imposed deadline for publishing its ‘final proposals’ (though there had been no indication at the time of the Pre-Budget Report that the proposals were anything other than final). And there is no guarantee that the ‘final proposals’ that do emerge will be sensible, given that the government is constrained to make some decision before the policy is due to take effect on 6 April and is being lobbied intensively by interested parties. Almost the worst option of all is to announce reforms without consultation and then to make hasty policy in the months between announcement and implementation to try to deal with the response.50

On 24 January Mr Darling gave a statement to the House, confirming that the changes previously announced would come into effect from April 2008, but that a new ‘entrepreneurs relief’ would be introduced at the same time; part of his statement is reproduced below:

Following discussion, I am today announcing the introduction of a new capital gains tax entrepreneurs relief. This will complement the new regime, which I set out in the pre-Budget report last year. The reformed regime and the new entrepreneurs relief will come into effect in April. The relief will provide a special 10 per cent. tax rate for the first £1 million of qualifying gains. Gains made on different occasions will qualify for the 10 per cent. rate up to a cumulative lifetime total of £1 million. However, gains in excess of that will be taxed at 18 per cent. The special 10 per cent. rate will be available on the disposal of all or part of a trading business carried on by an individual either alone or in partnership. It will also be available to individuals disposing of shares in a trading company, provided that the individual is an officer or employee of the company and takes a minimum 5 per cent. stake in the business. The measure will benefit the owners of small businesses when they choose to sell their business, as well as business angels

50 The IFS Green Budget, January 2008 p212, 234

16

and other business investors who take a 5 per cent. or greater stake in the company concerned. As a result of the reforms that I have announced, entrepreneurs and material business investors will keep 90 per cent. of the first £1 million of gains that they make. And they, and everyone else, remain entitled to make gains of up to £9,200 a year without paying any capital gains tax. That annual exemption will rise again in April. We estimate that, next year, around 80,000 business owners and investors will make disposals eligible for the entrepreneurs relief. In approximately 90 per cent. of those cases, we expect the individual’s entire gain to be taxed at the special 10 per cent. rate. In the other cases, people will pay 10 per cent. on the first £1 million of gains and the standard 18 per cent. rate on the excess. The proposal remains in line with the Government’s objective of keeping the tax system as simple as possible. It is very much in accordance with representations from small business. I estimate that the proposal will cost around £200 million a year. Her Majesty’s Revenue and Customs is today issuing further information about the scope of the new relief, along with draft legislation and supporting materials related to the capital gains tax proposals announced in the pre-Budget report. Those documents have been deposited in the Libraries of both Houses and are available on the HMRC website. As with all other aspects of the tax regime, I am determined that we do as much as possible to encourage entrepreneurship in this country and, in future Budgets, I will seek to do more. I will therefore keep the £1 million lifetime limit for the entrepreneurs’ relief under review.51

As the Chancellor noted, the department published draft legislation and a series of FAQs on its website on the new relief. This guidance underlined the point that the £1 million limit would not be retrospective: “entrepreneurs' relief must be claimed. Until a claim is made the £1 million lifetime allowance remains untouched. Claims can be made for disposals on or after 6 April 2008 providing the gains qualify for the relief.” The conditions for the new relief would be based broadly on the CGT 'retirement relief', that had been phased out between 1998 and 2003; in particular, the new relief would 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). A more detailed explanation of the new relief, taken from this guidance, is reproduced over the next two pages:

Capital Gains Tax: Relief on Disposal of a Business (Entrepreneurs’ Relief) The new relief announced today will reduce gains liable to CGT (at the single 18 per cent rate) by 4/9ths, resulting in an effective 10 per cent rate (5/9ths × 18 per cent). 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).

51 HC Deb 24 January 2008 cc1627-8

17

The conditions for the new relief will be based broadly on the CGT 'retirement relief' (at sections 163 and 164 and Schedule 6 Taxation of Chargeable Gains Act 1992) that 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. 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) that 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. 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 per cent of the ordinary share capital of the company and that holding enables the individual to exercise at least 5 per cent 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. 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. 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.) 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.52

52 HMRC, Capital Gains Tax: Relief on Disposal of a Business (Entrepreneurs’ Relief), 24 January 2008. At: http://www.hmrc.gov.uk/cgt/disposal.htm

18

In general the business lobby appeared to have been pleased at this concession, though the Government was still strongly criticised for the way it had approached reform.53 The director-general of the CBI, Richard Lambert, said, “this is superficially quite clever and on the surface might seem like a relief after three months of uncertainty, but even the smallest business owner will lose taper relief and indexation and be worse off than before October.”54 The national chairman of the Federation of Small Businesses, John Wright, said, “we welcome these plans, but the way in which the whole issue has been handled has seriously eroded small businesses’ trust in the Government.”55 Both the Institute of Chartered Accountants (ICAEW) and the Chartered Institute of Taxation argued that any changes to CGT should be deferred until April 2009 so that, in the words of the ICAEW, “individuals can make appropriate arrangements before the new regime comes in and [the Chancellor] can consult properly on its implementation rather than rushing it.”56

The Chancellor ruled out any delay in implementation when before the Treasury Committee on 19 March:

Some people said, ”Look, put the thing off” but a lot more were saying, ”Whatever you do, we would like to know what the position is.” When you think about it, if you have somebody in business who wants to make plans, if we had said we would not make our mind up until March 2009 I do not think that would have been desirable. I am not saying this is a universally held view but most people believe, if you cannot decide what to do, you should just get on and implement it.57

Unsurprisingly the IFS was critical of this change, arguing that it would “seriously complicate the admirably simple system proposed in the PBR”:

Unlike retirement relief, entrepreneurs’ relief does not have a minimum age requirement or give a higher rate of relief for longer-held assets. This reform therefore avoids reintroducing an explicit incentive for people to hold on to assets for longer than they would on commercial grounds alone. However, the design of the relief in fact entails several similar distortions:

• It gives self-employed individuals and partnerships a large incentive not to sell any assets of the business until they are ready to stop doing business altogether, regardless of whether the assets could be more profitably used by others and whether the proceeds of a sale could be more profitably used in other ways.

• The need to meet the qualifying conditions for the relief for at least a year is also a distortion, but the owner-managed businesses that qualify for relief are not the kind of assets typically traded in relatively short time horizons, and a qualifying period (or some alternative measure) is probably necessary to counter tax avoidance. Even with the one year qualifying period, the incentive to roll existing assets into a business environment in order to shelter previously accrued gains from tax will put pressure on any anti-avoidance rules designed to counter this.

• The fact that only disposals from 6 April onwards will count towards the £1 million lifetime limit means that people have a strong incentive to realise

53 A short selection of press comment is given at the end of this note. 54 CBI press notice, Darling imposes £700m raid on investors & savers at exactly wrong time for economy - cbi

chief, 24 January 2008 55 FSB press notice, FSB welcomes revisions to capital gains tax plans, 24 January 2008 56 ICAEW press notice, CGT reform – the Chancellor’s latest twist, 24 January 2008 57 Ninth report: The 2008 Budget, 7 April 2008 HC 430 2007-08 Q397 Ev54

19

accrued gains (that are taxed at 10% under the current system) before 6 April if they would otherwise expect to reach the £1 million lifetime limit …

As well as the economic inefficiency caused, it also seems unfair to discriminate in this way against owner-managers who cannot afford to retain profits in their company and against self employed people who choose (or need) to sell business assets before giving up the business altogether. More generally, the justification for applying lower tax rates to people who own their own business than to the rest of the population seems far from clear. These people will no doubt welcome entrepreneurs’ relief, but this tax break appears to come at the cost of some complexity, inefficiency and unfairness.58

Picking up the point made here about incentives, there were reports that owner managers were selling their assets to meet the 6 April deadline.59

In evidence to the Treasury Committee just after the 2008 Budget, John Whiting at PricewaterhouseCoopers, noted:

We have had a variety of clients and a variety of situations wanting to know what was going to happen … and taking action before or after 5 April to make the most of the possible changes or to avoid the tax increase. So it has distorted a certain amount of business decision-making … it has accelerated deals, it has decelerated deals, it has taken people’s minds off perhaps just progressing the business they were doing.60

On this occasion Robert Chote, director of the IFS, went on to add, “the process here is key”:

Clearly there was scope for consultation here. The very fact the Chancellor said there will be time for people to arrange their affairs, implies this was not something which needed to be done at 6 o’clock on the day you announced it for fear of reaction. But then to basically give people time to arrange their affairs and then within a matter of days to cave in to concern from next door and from the CBI and then to throw up uncertainty about what the system will look like, promise clarification before the end of the year, not give it until January, is not a process designed to give a good planning environment for business or indeed for anybody else.61

T

he editor of Taxation, Mike Truman, argued that this concession meant that any benefits in simplifying tax law from abolishing taper relief were now lost:

The main impact, in purely legislative terms, of abolishing taper relief will be the abolition of TCGA 1992, Sch A1, as well as s 2A. That takes up about 16 pages of the Tolley’s Yellow Tax Handbook, if you ignore the legislation which has already been superseded, which should mean that some 8,000 - 9,000 words will be removed. But of course it is not quite that simple. To begin with, it doesn’t go yet. Most tax advisers, when working out capital gains next year, will still be calculating taper relief, because most of the time they will be calculating them for submission on the tax return to 5 April 2008. They will stay in the Yellow Book for some years to come, giving at least the illusion of a failure to simplify.

58 The IFS Green Budget, January 2008 pp236-7 59 “Tax deadline inflates sell-offs”, Financial Times, 1 March 2008; “The clock is ticking on CGT changes”,

Financial Times, 8 March 2008; “HMRC backlog agitates owners eager to sell before rise in capital gains tax”, Times, 14 March 2008

60 Ninth report: The 2008 Budget, 7 April 2008 HC 430 2007-08 Q102 Ev17 61 HC 430 2007-08 Q102 Ev17-18

20

Then we also have to consider the effect of the climb-down on ‘entrepreneur relief’. The details are not yet known, but we have been told that it will be modelled on retirement relief. This in turn is a good illustration of the point I have just made – although no retirement relief has been due for the years 2003-04 onwards, the legislation is still there in the Yellow Book. It takes up about eight pages, so unless the new relief is a significantly simplified version of it, close to half of the potential saving in legislative volume will have been lost.62

Writing in the Financial Times Martin Wolf argued that “the government was right to reform capital gains tax [as] the system of taper relief on business assets was indefensible”, but wrong in introducing “an arbitrary new exemption: entrepreneurs relief”:

Yet why were these CGT reforms even proposed? It was to remove anomalies created by Mr Brown himself in the decision to introduce taper relief when he became chancellor. If Mr Brown had left the capital gains tax regime as it was, this unwinding of unjustified concessions would have been unnecessary. Those who live by the wheeze, die by the wheeze. One of the lessons of the fuss over the CGT reform is that bad tax arrangements create constituencies legitimately interested in their perpetuation.63

D. Budget 2008

In his 2008 Budget speech the Chancellor confirmed that the new CGT regime would be introduced from 6 April 2008;64

details were given in the Budget report:

4.41 A major reform of the capital gains tax (CGT) regime will deliver a system that is more sustainable and straightforward for taxpayers, while remaining internationally competitive. Reform will replace layers of complex legislation built up over many decades with an easy-to-understand personal allowance, a single headline rate of tax and a focused tax relief for entrepreneurs. This remains in line with the Government’s objectives to support business and enterprise and to keep the tax system as simple and as fair as possible. 4.42 As announced at the 2007 Pre-Budget Report, for disposals on or after 6 April 2008, CGT will be set at 18 per cent. In addition, as announced on 24 January 2008, a new entrepreneurs’ relief will also be available on the disposal of a trading business or shares in a trading company, provided the seller is an officer or employee of the company and has a minimum 5 per cent stake in the business. This will reduce the effective tax rate to 10 per cent for up to the first £1 million of gains made over a lifetime. Budget 2008 confirms that the tax-free annual exempt amount for 2008-09 will rise to £9,600, ensuring that individuals with gains below this amount in this year are not brought into tax. The Government will continue to monitor the CGT regime for any signs of avoidance or abuse and will not hesitate to act should such activity come to light. The Government does not see the need for any change to the taxation of life insurance bonds as a result of CGT reform.65

62 “Unnecessary arboricide”, Taxation, 14 February 2008 63 “Brown is wrong even when right”, Financial Times, 22 February 2008 64 HC Deb 12 March 2008 c292 65 HC 388 March 2008 p67; see also, HM Revenue & Customs Budget Note BN48, 12 March 2008

21

At this time HM Revenue & Customs published a series of examples of how the new relief would work in practice – an extract is reproduced below:

1. Miss S sells her trading business in 2008-09 and realises gains of £250,000 on her factory premises and £300,000 on goodwill but a loss of £100,000 on her retail shop giving net 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 Miss S claims entrepreneurs’ relief the gains of £450,000 will be reduced by 4/9ths (so reduced by £200,000, resulting in a chargeable gain of £250,000). Miss S has no allowable losses and no other gains in that year so she deducts the annual exempt amount (AEA) £9,600 giving an amount chargeable to CGT of £240,400. This amount is taxed at 18% giving tax payable of £43,272. 2. Mr W sells his shares in a trading company in 2008-09 and realises a gain of £360,000. He has owned 50% of the ordinary shares of the company, which gave him 50% of the voting rights, for several years, during which time he has been a director of the company. He therefore qualifies for entrepreneurs’ relief on the disposal of his shares. On making a claim, Mr W’s gain is reduced by 4/9ths, resulting in a chargeable gain of £200,000. He has no allowable losses or other chargeable gains, so after deduction of the annual exempt amount (AEA) £9,600 he has an amount chargeable to CGT of £190,400. This amount is taxed at 18%, giving tax payable of £34,272. 3. Mrs L sells her trading business in 2008-09 and realises gains of £1,300,000 (before entrepreneurs’ relief). She has made no other claims for the relief, and the whole of the gains are eligible for relief. She claims entrepreneurs’ relief. The maximum amount of gains on which entrepreneurs’ relief can be claimed is £1 million. So £1 million of Mrs L’s gains is reduced by 4/9ths (to £555,555), and the balance (over the £1 million) of £300,000 is chargeable in full, resulting in net chargeable gains of £855,555. She has no allowable losses or other chargeable gains, so after deduction of the annual exempt amount (AEA) £9,600 she has an amount chargeable to CGT of £845,955. This amount is taxed at 18%, giving tax payable of £152,271.90.66

Writing on the scope of the new relief one practitioner concluded that this was “a modest relief” given that it “cannot be worth more than £80,000 in relation to each individual (18% - 10% x £100,000)”, though it represented “a useful new relief for small businesses.”67

In the PBR in October 2007, it was estimated that this reform would raise £750 million by 2009-10.68 The 2008 Budget report estimated the changes would raise just £300 million by 2009-10; this reflects the cost of entrepreneurs’ relief but also the substantial falls in share prices, as the economic recession took hold. As the Budget report noted, “as most capital gains tax is paid in the final quarter of the financial year following the year in which the gains were realised, the main impact from lower equity prices will not be felt until 2009-10.”69

66 HMRC, Capital gains tax: relief on disposal of a business (entrepreneurs’ relief) – examples, 12 March 2008.

At: http://www.hmrc.gov.uk/budget2008/cgt-entrepreneurs-relief-eg.pdf 67 “Del’s darling”, Taxation, 13 March 2008. For further technical comment see, “Patchwork legislation” & “The

relief column”, Taxation, 27 March & 10 April 2008. 68 Cm 7227 October 2007 p164 69 HC 388 March 2008 p112,189

22

Although the Chancellor’s announcement came as no surprise, there continued to be criticism of the new regime:

The capital gains tax increases confirmed in the Budget have triggered a wave of criticism from entrepreneurs and business groups as ferocious as that sparked by its plans to tax non-domiciled residents more highly. Yet there is little evidence that charging entrepreneurs up to 80 per cent extra when they sell a company will discourage enterprise. At one level, that suggests the row over CGT has been a fuss about nothing. But at another, it is irrelevant that the measure may not influence business decision-making much. Critics say a unified tax rate for business and non-business disposals has sent a darkly negative signal about the government's attitude towards enterprise. The dichotomy is expressed by David Grove, a manufacturing entrepreneur and quoted company boss, who says: "I don't have a problem with CGT of 18 per cent. It is a reasonable rate and will not discourage me." But he adds: "People who (had been paying) 40 per cent tax when selling second homes or stock market investments will now pay the same as someone like me, who creates wealth and employment. That is a very good deal for them." Chris Sanger, of accountants Ernst & Young, believes the increased CGT rate rise, accompanied by the abolition of taper relief, has badly shaken business's trust in government. The change amounts to retrospection, he says, because anyone who set up a company after 2002 will pay more tax than planned. Stuart Adam, of the Institute of Fiscal Studies, a think-tank, agrees, saying: "Much of the anger is the result of the retrospection. The issue here is fairness, rather than the practicalities of setting up a business."70

In their report on the 2008 Budget the Treasury Committee welcomed entrepreneur’s relief “which responds to some of the concerns which we voiced in our Report on last year’s Pre-Budget Report”, although it “does not resolve all the problems created as side-effects by the changes to the capital gains tax regime”:

82. The entrepreneurs’ relief was intended to mitigate the unintended consequences of the abolition of taper relief on small businesses. However, as we noted in our Report on the 2007 Pre-Budget Report, there are other groups who may also be adversely affected by the changes to the CGT regime. Employee shareholders on Save As You Earn schemes were one group mentioned in our Report. The Chancellor of the Exchequer confirmed in evidence that employee shareholders would not be able to take advantage of the entrepreneurs’ relief. The Association of British Insurers (ABI) has claimed that the changes to the CGT regime will have a severe effect on sales of insurance bonds. The ABI claimed that “advisors could no longer safely propose the purchase of insurance bonds … This was due to insurance bonds being put at a real disadvantage, not just due to a problem of consumer perception.” ... When we asked the Chancellor of the Exchequer why he had listened to the concerns of small businesses but ignored other groups potentially affected by the reform of CGT he told us that:

I did not ignore it … whatever solution they came up with, whilst it might have sorted one particular category of life policies, it would have in some cases an

70 “Limited impact of CGT change fails to quell the anger”, Financial Times, 13 March 2008

23

adverse effect on others … When I looked at the amount of sales that were affected and at what was happening in the market generally, I do not think the position was quite as clear-cut. The real clincher is that what we were being asked to do could have run the risk of perhaps—and I only say perhaps—sorting one problem only to discover we opened up another problem. I think it is best to try and avoid doing that.

83. Another aspect of the new CGT regime that was raised with the Committee was the challenge posed by the policing of the new entrepreneurs’ relief. The main innovation of the relief is that it is limited to £1 million over the taxpayer’s lifetime, rather than applying to a particular transaction. Talking about the “lifetime” element of the relief, [John Whiting of PricewaterhouseCoopers] suggested that “the very interesting question … [is] how they are going to keep track of it, because we certainly see a practical problem in keeping track of where you or I in our own individual situations are on the £1 million allowance. Conceptually, it sounds easy, but there is a deal of record-keeping to be followed for this which does create an administrative burden.” When we put this to the Treasury officials and pointed out that this was a considerable increase on the present requirement to hold records for six years, they stated that they did not see any problems with implementing this aspect of the entrepreneurs’ relief:

The million pounds [limit] will be policed by having people who have used any part of the million pounds [keeping] a running tally of how much of the million pounds they have used … The reality in that situation is that both will keep records, the taxpayer and [HMRC] … [if] people who take advantage of the entrepreneur’s relief … do not use up the full million pounds the first time they use it, then they will have to keep a tab of how much of the million pounds they have used.

The Committee suggested that “significant new record-keeping challenges could be posed by the new relief” so the department should give taxpayers “full and early advice”; more widely it recommended that “if the Government is seeking further to simplify taxation for small businesses, it will need to undertake a broader review and consultation which examines the fundamentals of the tax regime.”71 On this last point the Government was non-committal, simply stating that it kept, “all taxes under review and continues work on small business taxation.”72

The reforms were also discussed by the Lords Economic Affairs Committee in their report on the Finance Bill that year.73

Several witnesses from the private sector found it hard to believe that these changes would be long-lasting – for example, Association of Tax Technicians:

In the last ten years they have seen: the abolition of retirement relief, which granted a complete, albeit limited, exemption; the introduction of taper relief which granted a reduced effective rate of tax but on unlimited gains; and now the introduction of entrepreneurs’ relief, which continues the effective low rate of tax but now limits that

71 HC 430 2007-08 pp58-59 72 Tenth special report HC 689 2007-08 16 June 2008 p18 73 Since 2003 the Committee has reported on selected aspects of the Finance Bill from the point of view of

technical issues of tax administration, clarification and simplification rather than rates or incidence of tax.

24

rate to gains of up to £1 million in a lifetime. What is required now is a period of stability.

The Committee went on to conclude that “it will take time for the certainty and predictability which investors need to be restored, given the shock to which the changes gave rise”:

Matters have not been helped by the manner in which the changes were introduced, and the legitimate expectations which— rightly or wrongly—investors believed that they had been denied. It may also not help investment that long term gains are no longer treated better than speculative gains: indeed as inflation picks up they are arguably less well treated … We recommend that the Government/HMT should persist in explaining the reasoning behind, and the advantages of, the changes, with a view to restoring confidence in the system, its sustainability and predictability.74

Provision to set the rate of CGT at the new 18% rate, and introduce entrepreneurs relief, was made by ss 8 & 9 of the Finance Act 2008. During the proceedings of the Bill, the two main Opposition parties were both critical of the Government’s proposals, but for different reasons; speaking for the Conservatives, Philip Hammond said, “the Government need to go back to the drawing board on CGT reform, consult properly and come forward with a comprehensive set of CGT proposals that recognises the need to promote long-term investment and encourage entrepreneurship”:

Only new Labour could devise a business capital tax system that incentivises modest success in lifestyle businesses with entrepreneurs’ relief but penalises the growth of the scalable enterprises that will deliver the prosperity of tomorrow; one that halves the rate of tax on buy-to-let landlords and second homeowners while increasing it by 80 per cent. on serial entrepreneurs and up to 260 per cent. on some employee shareholders; one that rewards short-term, quick-turn investors with CGT rates well below income tax while increasing the effective rate most on the very longest of long-term investors who stand to lose most from the loss of indexation relief on all assets held before 1998.75

Speaking for the Liberal Democrats, Jeremy Browne, argued “our starting point is that capital gains should be taxed at the same rate as income, as was the case under Nigel Lawson when he was the leader of the Thatcherite vanguard in the 1980s”:

This is hardly a particularly left-wing policy; it is entirely in tune with what other Governments have proposed in the past. The danger otherwise is that people with good accountants who are able to convert their income into capital will pay considerably less as a share of tax, and we will effectively create a two-tier system: one for those who are taxed on the money they take home at the rates we will now have to get used to—20p and 40p, with national insurance contributions in line with that—and another for those who enjoy much more favourable rates of taxation, despite having considerably higher earnings … the onus is on both Labour and the Conservatives to make the moral case for a cleaner who earns £10,000 a year paying a higher marginal rate of taxation than the boss of the company whose offices he or she cleans, who takes home £1 million in the form of capital.76

74 HL 117-I 2007-08 12 June 2008 para 86, paras 91-2

75 HC Deb 28 April 2008 c50, c53 76 HC Deb 28 April cc54-6

25

In responding to the debate the then Financial Secretary, Jane Kennedy, argued that the new structure was simpler, fair, competitive, and would promote enterprise:

May I tell the House that the reforms will replace—and this bears repeating—a significant amount of structural complexity built up over many years with a simple system based on a single headline rate and focused relief for entrepreneurs? That is a change well worth having. Entrepreneurs’ relief has been targeted to deliver a special 10 per cent. rate for business and enterprise, which is essentially what businesses have asked for … The Government’s strong view is that that 18 per cent. rate rewards investment and enterprise, which is important for the economy. It ensures that people with gains above the tax-free allowance of around £9,600 contribute to the public purse and it remains internationally competitive.77

77 HC Deb 28 April 2008 cc 63-4

26

E. Appendix: selected press comment

1. “Fraught investors left feeling short-changed by delays”, Financial Times, 25 January 2008 2. “Editorial : Darling's retreat in a losing battle”, Financial Times, 25 January 2008 3. “Relief tempered by confusion”, Times, 26 January 2008 4. “Climb down fails to appease”, Financial Times, 26 January 2008 5. “Capital gains tax chaos: will you be better or worse off?”, Sunday Times, 27 January 2008 “Fraught investors left feeling short-changed by delays”, Financial Times, 25 January 2008 More than 70,000 small business owners and investors are likely to pay capital gains tax of just 10 per cent next year under the new entrepreneurs' relief announced by Alistair Darling yesterday. But the much-delayed concession left many investors feeling short-changed and expecting a fraught appraisal of their options over the next two months. Tax advisers said the new rules would leave many owners of larger businesses, farmers and employee shareholders with much bigger tax bills unless they made swift disposals or engaged in sophisticated planning. Paul Aplin, chairman of the tax faculty of the Institute of Chartered Accountants in England and Wales said: "We have had 3 1/2 months of uncertainty. Now there will be nine weeks of frantic activity." The new rules, which will apply to about 80,000 business owners and investors making sales next year, will impose a tax rate of 10 per cent on the first £1m of capital gains, after which gains would be taxed at 18 per cent. In nine in 10 cases the entire gain is likely to be taxed at the 10 per cent rate, the Treasury said yesterday. The relief will apply to businesses and shares in companies, provided the shareholder has been an employee and owned 5 per cent of the shares. It will not apply to investment businesses, such as property letting. The £1m limit will apply over the course of an individual's lifetime. Chris Sanger, of Ernst & Young, said the new relief would, in many cases, remove the need to make sales before April to avoid an 80 per cent tax increase from 10 per cent to 18 per cent. "It will bring a large sense of relief to many of the small business entrepreneurs who have been struggling with the decision about whether to sell early, just to access the lower rate of tax," he said. But he criticised the lifetime nature of the £1m limit which would be "a disincentive to continued serial entrepreneurship". The CBI employers' body said that, in spite of the superficial attractions of the concession, a close examination of the rules would disappoint many investors. The government had not addressed the loss of indexation relief, which substantially reduced the tax bill for long-held assets, it said. Many business angels would not qualify for the entrepreneur's relief unless they were on the board. Even very small business owners would end up paying more tax on sales next year than they would under the existing regime Tax advisers warned there would be many grey areas, as people's circumstances would not necessarily fit the rules. David Kilshaw, of KPMG, said the rules could prove unfair and complicated, requiring entrepreneurs to keep careful records. "HMRC say the relief is to be based on retirement relief. Retirement relief was pensioned off in 2003, partly because its complexity could lead to unfairness." Andrew Hubbard of Tenon said the tight timeframe and the lack of firm legislation would hamper advising clients. "The situation is far from ideal; how can we be sure that there won't be yet more changes before the legislation becomes law?" Who gets the relief . . . or the pain WINNERS *Owner-managers and investors with a 5 per cent stake in a business in which they had worked *Around 90 per cent of the 80,000 sales likely to be eligible next year will have gains that fall entirely within the special 10 per cent rate. LOSERS *Holders of save-as-you- earn schemes, company share option plans and enterprise management incentives are very unlikely to be eligible for the relief *Directors of large publicly quoted companies with share incentive plans are likely to face higher bills *Private equity investors, unless they held 5 per cent and joined the board, will not be eligible for the relief *Long-term holders of assets, who may lose out from the loss of the allowance for inflation *Farmers are particularly hard hit by the loss of indexation allowance and fear they will find it hard to claim the new relief

*

27

“Editorial : Darling's retreat in a losing battle”, Financial Times, 25 January 2008 Gordon Brown's government is suffering from a richness of embarrassments. No sooner had Alistair Darling announced his retreat on capital gains tax reform than Peter Hain resigned from the cabinet after the police were asked to investigate donations to his failed campaign for Labour's deputy leadership. Mr Hain's departure transfixed Westminster yesterday. But Mr Darling's handling of CGT reform, with all its dithering and disappointment, has more lasting impact. The chancellor conceded that there should be a capital gains tax rate of 10 per cent on lifetime gains of up to £1m within the regime announced last October. This is based on a flat rate of 18 per cent and will come into force on April 6. The revised plan has serious flaws. The £1m lifetime limit for the lower rate seems arbitrary. A system with two rates removes some of the attractive simplicity of the original proposal. Having a limit at all brings complexities - how often and on what basis it will rise being just the most obvious. Moreover, the revision fails to address the most damning aspect of the October statement: the whiff of retrospection that hangs over it. The tax rewrite will not apply until the spring, but it undermines decisions business owners have already taken on the basis of the current regime. Entrepreneurs who expected to pay only 10 per cent tax on the sale of business assets built up over time still face the invidious choice of paying more tax or joining a stampede to sell before the April deadline. Of course, governments must be able to vary the tax regime. But individuals have a right to expect that an administration will stick to its own script - especially when that script is seeking to encourage long-termism. The revenue forgone on this climb-down should have been directed at transitional arrangements to ease the shift to the new regime. As to the new rate itself, there is a strong case that 18 per cent is fair. Entrepreneurs go into business mainly because they have ideas and skills. Someone who sets up a business primarily because of the prevailing tax rate is probably in the wrong game. Ministers hoped the retreat would defrost their relations with business. Try again. Even more seriously, their botched handling of this change has also made it harder to have a sensible debate about tax. Any group badly affected by planned reform does not have to argue on merit, but can make its point simply by highlighting the government's capricious behaviour. This is no way to run fiscal policy.

* “Relief tempered by confusion”, Times, 26 January 2008 SMALL businesses and tax experts have given a lukewarm welcome to the Chancellor's U-turn on his shake-up of capital gains tax (CGT). They are pleased that Alistair Darling is introducing a new lower rate of 10 per cent - rather than the proposed flat rate of 18 per cent - on gains made by entrepreneurs. But they are angry that the lower rate, known as entrepreneurial relief, will be restricted to the first £1 million of capital gains. They point out that under the old CGT regime, which Mr Darling is scrapping, all gains on business assets, including companies built up by entrepreneurs, were taxed at 10 per cent once they had been held for two years. And they are concerned that the latest announcement, coming less than three months before April 6, gives businesses little time to arrange their tax affairs before the new regime comes in. Paul Aplin, chairman of the tax faculty of the Institute of Chartered Accountants in England and Wales (ICAEW), says that the clear winners from Mr Darling's announcement are small businesses. "Under the original proposals for an 18 per cent flat rate, someone who sells a business he has built from nothing for £1 million would have paid £180,000 in CGT," Mr Aplin says. "But after Thursday's announcement he will pay 10 per cent on his £1 million gain, leaving him with a bill of only £100,000." Mr Aplin adds that others who will benefit from the Chancellor's latest proposals, such as farmers, will not exactly be uncorking the champagne - they stand to lose a great deal from the abolition of indexation relief and taper relief, which is still going ahead. "A farmer who bought land for £500,000 in 1982 and now wants to sell it for £1 million would, under Mr Darling's October proposals, have paid 18 per cent on £500,000, resulting in a bill of £90,000," Mr Aplin says. "Thursday's changes mean that he will now pay 10 per cent tax on that gain, reducing his bill to £50,000. But under the old regime, which Mr Darling is scrapping, indexation relief would have pretty much wiped out the entire gain, leaving him with little or no CGT to pay." Mike Warburton, senior tax partner at Grant Thornton, the accountant, says: "The introduction of a 10 per cent rate on the first £1 million of gains, which means that not everyone will have to pay the proposed 18 per cent flat rate, is welcome as far as it goes. But it is not as generous as the old regime and there are much tougher restrictions on who can benefit from this entrepreneurial relief. "You have to be a sole trader, a member of a partnership, or a company director or employee who holds at least 5 per cent of the company's shares. This rules out most people who participate in save-as-you-earn company share schemes, so a checkout operator at Sainsbury's would not qualify for the 10 per cent rate." There is also confusion over whether the £1 million figure on which a reduced rate will apply will be a lifetime exemption, which would mean that people would have to keep records indefinitely.

28

George Bull, of Baker Tilly, the accountant, says: "The wording suggests that lifetime means lifetime, which would be an administrative nightmare." Most private equity funds are unlikely to meet the requirements for the new entrepreneurs' relief. However, in some cases where investments are made in small or medium-sized companies, some members of private equity firms may be allocated individual holdings of more than 5 per cent and could qualify for the relief. Mr Warburton says: "It will all depend on the small print."

*

“Climb down fails to appease”, Financial Times, 26 January 2008 Alastair Darling's humiliating climb-down on capital gains tax this week has been criticised as too little, too late for many entrepreneurs who are now either planning to sell their businesses or move operations abroad. The chancellor had decided to press ahead with plans to raise the capital gains tax to 18 per cent and abolish taper relief from April 6, but bowed to pressure from business lobbyists by offering a 10 per cent rate for lifetime gains up to £1m. The new relief will apply to anyone who owns a minimum 5 per cent stake in a trading business and is either an employee, company director or other office holder of the company. The move is expected to cost the government £200m a year, compared with the forecast £900m annual revenue generated from the original CGT reforms. It will help about 80,000 business owners and investors, Darling told MPs when he announced the relief on Thursday. However, business owners and accountants criticised the amendment for failing to provide meaningful compensation for serial entrepreneurs and those operating staff share schemes, which will be hardest hit by the increase in the capital gains tax rate and the removal of taper relief. Several owners of high- growth companies said the changes made them less likely to consider starting another business and more likely to move their operations abroad. Mike Anstey, founder and chief executive of I-Vu, which installs television screens in hair salons for advertising and staff training, says he is more likely to expand his US operation at the expense of his UK business as a result of this week's announcement. "We are not making a knee-jerk reaction, but we may grow in the US significantly more in the next 18 months," he said. I-Vu employs 20 people in the UK and recently raised about Dollars 80m in funding. However, the rise in capital gains tax from 10 to 18 per cent means that I-Vu is more likely to get better returns abroad, Anstey said. "America is proving phenomenal for us," he said. "We are just hitting big money now and have a serious investor behind us who is looking for a return." David Storey, director of the centre for small and medium-sized enterprises at Warwick Business School, said the UK's most productive entrepreneurs are more likely to relocate to countries with lighter tax regimes. "They have the facilities, the commitment and the wherewithall to take that position," he said. Others criticised the chancellor's claim to have simplified capital gains tax. Richard Mannion, a partner at Smith & Williamson, an accountancy firm, said: "This new simplified system looks like it is going to be at least as complicated as the one that went before, but the 10 per cent rate will be much more restricted."

* “Capital gains tax chaos: will you be better or worse off?”, Sunday Times, 27 January 2008 Many investors are expected to rush to sell their assets ahead of a punitive new regime in April. Clare Francis works out if you are a winner or loser. HUNDREDS of thousands of ordinary investors will face higher tax on their profits from April, despite the government's climb-down on capital-gains-tax (CGT) reform last week. Chancellor Alistair Darling announced last October he would sweep away the complex CGT system and replace it with one flat rate of 18%. This prompted howls of protest from business owners who would have faced an 80% increase in their tax bills when they sold their firms. Under the current system, they pay a CGT rate of just 10% once they have owned the business for two years. Last week the chancellor announced a partial climb-down when he unveiled plans for entrepreneurs' relief. Business owners -those with a stake of more than 5% in the company they work for -will pay only 10% tax on gains up to £1m. This is a lifetime limit, so while individuals will be able to claim relief for gains made on multiple occasions, they cannot exceed the £1m barrier. Accountants, however, have criticised the new allowance for not helping ordinary savers. Thousands of people who have invested in the companies for which they work through share schemes could still see a sharp rise in their tax bills, as could investors in stocks listed on the Alternative Investment Market (AIM) who own less than 5%. There are big winners, too. Most higher-rate taxpayers with non-business assets, which include second homes, buy-to-lets and shares listed on the main market, will have their CGT cut from a minimum of 24% to 18%. However, basic-rate taxpayers with non-business assets will see their rate rise from 12% to 18%. Thousands of people who have held off from making decisions while waiting for the chancellor's reforms are now expected to make plans to sell. This could lead to a wave of selling of AIM stocks before April, and buy-to-lets afterwards. We look at the winners and losers.

29

Losers Employee share schemes An estimated 270,000 people who have joined the employee share scheme offered by the firm they work for could lose out. Save-as-you-earn schemes, also known as Sharesave, enable employees to pay up to £250 a month for three, five or seven years, after which they get the option to buy their company's shares at a 20% discount to the trading price at the start of the scheme. Shares held in these schemes are classed as business assets so higher-rate taxpayers could pay only 10% once they have owned the shares for two years, while basic-rate taxpayers would pay only 5%. This means that employees pay a lower rate of CGT on their company's shares than outside investors, who would pay at least 24% if they were in the higher tax bracket. From April, however, there will be no tax benefit for people who join their employer's Sharesave scheme because they will pay 18% -the same as outside investors. Many workers will not have to pay any tax at all because their gains will fall within the annual CGT allowance -now £9,200. However, the changes will hit employees who have paid the maximum into the scheme and have seen their company's share price go through the roof. Mike Warburton at Grant Thornton, an accountancy firm, said: "These are the unintended losers and the government should have done something to address this issue. It has encouraged company Sharesave schemes, but now thousands of ordinary employees, not just the highly paid executives, face much higher tax bills." AIM investors Analysts fear a big sell-off in AIM shares in the run-up to April 5. Brewin Dolphin, a wealth manager, said that as many as half the ordinary investors in some AIM companies may look to offload their holdings in the coming weeks. The FTSE AIM All-Share index has already fallen 8% since the start of the year. Jamie Matheson, executive chairman at Brewin Dolphin, said: "The reprieve for entrepreneurs with their own businesses is, of course, welcome. However, investors who have been encouraged to take the extra risk of supporting small and fledgling companies, including those on AIM, are still faced with the decision of whether to sell before April 5 or face an 80% tax increase." For those sitting on large gains, it could be worth selling their shares now to benefit from the lower CGT rate, and then buying them back. Graham Barber at Rensburg Sheppards, a wealth manager, said: "Investors should make sure they make use of their £9,200 allowance, and in some instances it may be worth crystallising further gains before April 5 -even if they then buy the shares back. There is certainly an opportunity for executives who own shares in their company to sell their holding before the end of the tax year and then buy the shares back within a self-invested personal pension (Sipp)." Long-term investors On top of the change to the rates of capital-gains tax, the so-called indexation allowance will also be abolished from April. This allowance makes the first 105% of gains on an asset bought in 1982 tax free, but this will be wiped out from April. The change will particularly affect farmers. Someone who bought a 500-acre farm in 1982 for £900,000 and sold it this year for £2m would pay £12,000 in CGT if he or she sold before April 5. However, the tax bill would surge to £196,000 if the sale took place after that date. Those who have held shares through company schemes for many years could also be hit, as will many retired people in the basic tax band with assets that they have owned for a long time. John Whiting at Price Waterhouse Coopers, an accountancy firm, said: "I feel it is unnecessary and unfair to penalise people with long-held assets in this way." However, not everyone will be a loser from the abolition of indexation allowance. Higher-rate taxpayers with non-business assets may find the benefit of the lower 18% tax rate outweighs the tax relief they would have otherwise received from indexation. It all depends on the size of the gain. Insurance bonds Investors with money in bonds provided by life insurers will pay more tax than those investing in unit trusts and open-ended investment companies (OEICs). When you cash in an insurance bond, returns are treated as income, rather than a capital gain. Higher-rate taxpayers therefore pay 40%, while those in the lower band pay 20%. Profits from unit trusts and OEICs are liable to CGT, so investors will pay only 18% from April. Winners Property investors The big winners from the CGT reforms will be the estimated 2m second-home owners and buy-to-let investors. Most are higher-rate taxpayers so they will see their tax rate fall by at least six percentage points, and possibly by as much as 22 points, which will knock thousands off their bill. At present, they pay 40% if they have owned their property for less than three years, falling to a minimum of 24% after more than 10 years. Under the new regime, they will have to pay only 18%.

30

People who bought five years ago for the average price of £123,000 and sold now for £200,000 would face a potential CGT bill of £22,500. If they sold after April 5, their tax bill would fall to £12,204 -£10,296 less -assuming they sold the property for the same amount. There are also various tax breaks available to property owners that could even reduce their CGT liability to zero. These include principal-private-residency election, CGT relief and letting relief if you rent out a property that you used to live in. Equity investors Higher-rate taxpayers who have shares (apart from those in firms listed on AIM) and managed funds outside Pep and Isa wrappers will also gain from the new rules, because the flat-rate tax will be less than their current rate. However, basic-rate taxpayers will lose if they have owned their assets for more than five years, because the current taper-relief system means their effective tax rate is less than 18% at present.