Tax changes mean that entrepreneurs, business owners, employees and other investors will face higher taxes when they sell shares. Oh dear!
I'm feeling extra-specially grumpy with the Chancellor, Alistair Darling, following his Pre-Budget Report on Tuesday. As usual, the Chancellor fiddled with various tax rates and allowances.
What has really upset me is his changes to Capital Gains Tax (CGT), which we revealed in Winners And Losers From The CGT Changes. Overall, Mr Darling's changes to CGT will net him an extra £750m to £900m a year -- money which would otherwise have gone to British investors.
What the Chancellor has done is to introduce a flat rate of tax for CGT of 18%, to take effect on 6 April 2008. At present, investors in shares, property and other assets pay CGT on realised profits at their highest marginal rate of tax. These tax rates are: 0% for non-taxpayers, 20% for basic-rate taxpayers and 40% for higher-rate taxpayers.
However, most investors don't pay CGT at all, thanks to a tax-free CGT allowance, which is £9,200 in the 2007/08 tax year. So, by moving to a flat rate of 18% on taxable capital gains, almost everyone will be better off, right? Wrong, because Mr Darling has killed off taper relief, which makes things much worse for several groups of investors!
Taper relief allows investors to reduce their CGT exposure by holding onto their shares for longer, as per the following table:
Taper relief for Capital Gains Tax
No. of years held | Relief for non-business assets (%) | Relief for business assets (%) |
|---|---|---|
1 | 0 | 50 |
2 | 0 | 75 |
3 | 5 | 75 |
4 | 10 | 75 |
5 | 15 | 75 |
6 | 20 | 75 |
7 | 25 | 75 |
8 | 30 | 75 |
9 | 35 | 75 |
10+ | 40 | 75 |
So, if I buy an asset and keep it for at least two full years, then my CGT bill starts to fall. Even better, if the asset qualifies for `business property relief', then my tax bill falls by three-quarters after just two years. This valuable concession allows small-business owners and employees who invest in their firms to pay much lower rates of CGT. Indeed, with the maximum 75% taper relief, CGT at 40% becomes a much more manageable 10%.
One group to lose out from these changes is the 3.5 million or so employees who buy shares in their employer via discounted, tax-efficient schemes such as Save As You Earn (SAYE) or Share Incentive Plans (SIPs). (Note that shares accrued via SIPs attract CGT from day one if they're removed from the SIP prematurely, or from the date they're removed if it's after the qualifying period is up.) I'm a huge fan of SAYE and SIPs, which can produce good returns at low risk, as I explained in Your Boss Could Make You A Millionaire.
Under the current CGT regime, basic-rate taxpayers liable for CGT on gains made from employee share schemes would pay a rate of 5% after holding the shares for two or more years. For higher-rate taxpayers, the minimum CGT would be 10%. Alas, from next tax year, CGT at 18% will be applied to all profits above the annual CGT allowance. Thus, basic-rate taxpayers investing in their businesses could see their CGT bill leap from 5% to 18%, which is a rise of 260%!
Furthermore, investors in AIM companies -- those listed on the Alternative Investment Market, the London Stock Exchange's junior market -- also face similar problems. After holding a share for two years, AIM investors see their CGT bills fall by 75%, as AIM shares benefit from business property relief. Thus, changes to CGT will make investing in smaller business, unquoted shares and start-up firms far less attractive. So much for creating a vibrant `enterprise economy'!
On the other hand, people who invest in other listed shares and property should be better off. For example, as a higher-rate taxpayer, I am liable for CGT at 40% if I hold a share for less than two years before selling it at a profit. Under the new regime with its 18% tax rate, I stand to save thousands of pounds a year.
Long-term property investors will also be better off, especially those who have owned buy-to-let properties for ten years or more. These investors could see their CGT rate fall from, say, 24%, down to 18%, which is a reduction of a quarter. So, buy-to-let barons may be better off waiting until the 2008/09 tax year before selling!
However, my wife, who invests heavily in the shares of her multinational employer, will see the CGT bill on her employee shares leap by four-fifths (80%), from 10% to 18%. Hence, I will encourage her to sell as many shares as she can before 6 April 2008, in order to avoid higher CGT in future. As you can see, there are winners and losers from these CGT alterations, even within individual families!
So, the Chancellor is to be congratulated for replacing the tiresomely complex system for CGT with a simple, flat tax. However, at a stroke, he's made risky, short-term speculation more appealing, while making sensible, long-term investment less attractive. Therefore, I present Mr Darling with a "Fool Villain" award for taking away the tax benefits of long-term investing.
More: How I Started Investing - With Ease! | The Case For Shares | Five Top Ways To Avoid Tax