How the Budget will hurt the rich

Tax changes in the Budget spell bad news for investors, landlords and second-home owners...

Yesterday, Chancellor George Osborne set out his first Budget, a mere 47 days after the General Election of 6 May.

This was billed as an ‘emergency’ or ‘austerity’ Budget in which the Chancellor was forced to make some tough decisions on public-sector spending and tax rises. Of course, there are always winners and losers from any Budget – to find out which you are, read The Budget: Winners and Losers.

These are taxing times

One widely expected tax change the Chancellor announced was an increase to Capital Gains Tax (CGT). Investors pay CGT when they sell assets such as shares, property (but not one’s main residence), bonds and so on. In other words, CGT is a tax on the ‘unearned’ profits from selling assets.

However, each of us has a tax-free allowance which enables us to avoid CGT on gains up to a certain threshold. In the 2010/11, this allowance is £10,100, which is high enough to exempt most gains from CGT. In addition, CGT is not paid on gains made inside tax shelters such as ISAs and pensions.

On the other hand, these three groups should worry about CGT:

1. investors with large portfolios of shares held outside of ISAs and pensions;
2. landlords, buy-to-let investors and second-home owners; and
3. entrepreneurs and business owners.

More pain for gains

The bad news for those sitting on hefty capital gains is that the rate of CGT has been increased. What’s more, in order to prevent tax avoidance, this increase took effect at midnight. Thus, any gains made from selling assets on or after 23 June will attract the new rate of CGT.

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Do this goal

The Chancellor has decided to increase CGT to 28%, which is considerably less than the 40% rate initially signalled by the coalition government. However, this higher rate of CGT will apply only to higher-rate taxpayers. Thus, if your income plus any taxable gains comes to less than the £43,875 threshold at which higher-rate tax kicks in, then your gains will be taxed at 18%.

Alas, if you are already a higher-rate taxpayer or your taxable gains (after deducting your £10,100 CGT allowance plus any losses) push you into the higher-rate tax bracket, then you will have to pay CGT at 28% on all gains above the higher-rate threshold.

It could be worse

In my view, this was a lucky escape for investors and property owners. After all, before 6 April 2008, CGT was charged at 40% -- the same rate as income tax -- for gains made by higher-rate taxpayers. The 18% rate introduced in the 2008/09 tax year has been around for a little over two years.

Indeed, for the UK’s highest earners -- those earning over £150,000 -- a CGT rate of 28% is still considerably more attractive than the 50% income tax which they pay on the top slice of their earnings.

What’s more, in April 2008, there were only 3.8 million higher-rate taxpayers from a total of 48 million UK adults. Hence, 92% of Brits won’t be affected by this new higher rate of CGT. In a way, this is a tax carefully aimed at our society’s most well-off individuals.

In short, things could have been a whole lot worse.

Good news for entrepreneurs

Although increasing CGT from 18% to 28% doesn’t seem such a big deal to most of us, one group could be hammered by this change: entrepreneurs and business owners.

Until yesterday, those selling ‘business assets’ could take advantage of a lifetime allowance of £2 million on which CGT of only 10% applies. In order to promote enterprise, this entrepreneurs' relief has been increased to £5 million with effect from today.

In effect, this increase enables all but the very wealthiest business owners to pay CGT at 10%, which is good news for British entrepreneurs.

Unfortunately, to be classed as an entrepreneur, you not only have to be an employee (or former employee) of the company whose shares you own, you also have to own 5% of the company in shares. This means workers in start-ups with share options are unlikely to benefit from this tax relief.

Let’s do the sums

Finally, let’s do the maths, using a worked example based on paying CGT at 18% yesterday and 28% today. My example is based on an investor/landlord who bought an investment property for £100,000 and sells it for £250,000:

As you can see, selling this house yesterday and paying CGT at 18% would have landed this investor with a bill for nearly £25,200. Selling the same property for the same price today would mean paying nearly £39,200 in tax. In other words, the CGT bill has gone up by nearly £14,000 overnight. Ouch.

Becoming a legal tax-dodger

As Capital Gains Tax is so complicated, you can use numerous legal loopholes and allowances to minimise your CGT bill. Last month, I suggested six ways to beat higher CGT, all of which still apply (apart from the first tip to sell before the Budget, of course).

In summary, with the rate of CGT increased -- and possibly set to go higher -- it’s even more vital for investors, landlords and second-property owners to take tax-planning steps. Doing so will maximise their returns and minimise their losses to CGT. What are you waiting for?

PS: Things could get messy this tax year, as someone selling both business and non-business assets could end up paying CGT at 10%, 18% and 28% in 2010/11. Yuk!

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