Fidelity International is urging the Government to consider the effect of inflation when introducing its planned rise in capital gains tax (CGT).
The company says failing to factor in inflation during the period the investor owned the asset would mean much of the increase in an investor's tax bill would be based on a misleading nominal gain, rather than a real inflation-adjusted profit.
CGT on non-business assets could rise to as much as 50% in line with income tax under new Government plans. Without indexation this would more than double the tax bill for thousands of investors, Fidelity analysis suggests.
Prior to a Labour rule change, indexation meant if an asset merely held its value in real terms, the owner should not have to pay tax when they decided to sell it. If returns were made above inflation then tax was payable.
The Lib-Tory coalition Government has said it will move to tax non-business capital gains at rates similar or close to those applied to income, with generous exemptions for entrepreneurial business activities.
However, it has not said whether it will also reintroduce an inflation-based allowance.
Before Labour changed the tax system, the allowance included a 10% rate to encourage entrepreneurs to reinvest in their business, and pay less tax in exchange for creating wealth and employment.
This was later adjusted to an 18% CGT rate for all, rather than just for business assets, without the benefit of indexation, though a low inflation environment and lower tax rate helped to offset the impact of scrapping indexation.
However, raising CGT without reintroducing indexation could have a significant impact on investors in assets such as second properties, many of whom may have been saving for retirement, says Fidelity.
Fidelity International UK managing director Gary Shaughnessy says: "If the coalition government goes back to a marginal income tax rate without reintroducing the indexation allowance, this could act as a significant disincentive to future investment in this country.
"In the example of an individual who invested in a second property and holds onto the asset for 25 years, the potential impact is very large relative to the initial investment made. For many investors, this tax hit is likely to arise at the time they may be liquidating assets to pay for their retirement.
"If the new government is going to increase CGT it is only fair that they reintroduce indexation so that they are not taxing any illusory gains."
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