Robin Hooper examines the opportunities arising from recent changes to capital gains tax
With no sign in sight of a meaningful U-turn from the Chancellor in respect of his proposed changes to Capital Gains Tax (CGT) there is increasing concern among accountants and financial advisers regarding the potential impact of the proposed 'simplification' on their business and private clients.
For a government that has the stated intention of helping business, the changes are odd, to say the least.
By removing the taper relief that has for a decade replaced indexation and helped those holding assets for the longer term to combat the effect on inflation on their gains, the Chancellor is effectively imposing a tax on rising prices. However, the principal impact hits those holding business assets - such as shares in the firm they work for, or which are otherwise treated as business assets for CGT purposes. In their case, the effective tax rate rises from just 10% on assets held for more than two complete years (or 5.5%, currently, for basic rate taxpayers) to 18% from next April. This represents a hike of anything from 80% more, to three times as much as the current level.
Perversely, higher rate taxpayers with non-business assets held for more than 10 years will actually end up paying less tax. This is hardly consistent with the aim of helping business grow. This tax may be simpler, but it is far from more equitable.
Business - and its advisers - must work within the framework presented to it. This has inevitably thrown up short term opportunities for investors holding business assets to consider ways of minimising their liability before the door slams, on the current regime.
The opportunity arises because pension schemes are exempt from CGT and also because it is no longer illegal (thanks, for once, to this government) for an individual or company to move assets into the pension scheme of which the individual is a member. This used to be precluded as "connected person" transactions.
This means pension schemes can either use assets such as commercial property and most shares as an in specie contribution, or by selling the assets to the pension scheme. In fact, it is possible for a combination of contribution and sale to be involved, if the asset value exceeds the annual contribution allowance.
For 2007/8 an individual can contribute his or her entire earnings into a pension scheme, up to £225,000 (beyond this no tax relief is available) and receive tax relief at source of 22%, with up to a further 18% being available via the self assessment system. Employers can contribute in excess of earnings up to the annual allowance, provided that the total remuneration package is justifiable to the local HM Inspector of Taxes. Any employer contributions in excess of the annual allowance incur a massive penalty on the scheme member, of at least 40%.
In effect, this means that if a person currently earns £300,000 a year and owns business assets worth £500,000, these could be moved into his or her pension scheme through a combination of in specie contribution and sale (provided the self invested pension has adequate assets to make the purchase, although borrowings will normally be possible up to half the value of the pension fund). If no other pension contributions are made during the current year, then an in specie contribution of £175,500 (that is £225,000 less 22% basic rate tax relief) can be made. If the employer owned the asset, the contribution would, of course be gross.
The balance of the value (£324,500) could be purchased from the member at market price. Assuming the pension fund was already worth £500,000, it now holds assets worth £675,500. It is also entitled to a tax reclaim of 22% of the contribution it has received, or £49,500, giving the scheme a total value of £724,500. The member now has a lump sum of £324,000 which will be used to pay off the CGT of 10% on the gain (40% higher rate tax, less 75% taper relief for assets held for more than two years). Assuming the asset was acquired for £150,000 three or more years ago, the tax would be £34,800 (allowing for the personal exemption of £9,200).
The lump sum that the member has can be used as the basis for personal contributions in subsequent years, generating up to 40% tax relief on the entire amount and further increasing the value of the pension fund.
It is important, of course, to ensure that the lifetime allowance (set at £1.65 million for 2008/9) is not breached, by the time the member wishes to crystallise benefits.
Apart from protecting the asset against future CGT liabilities, and ensuring that the rental income is also protected from income tax, there is also an immediate saving in CGT - compared with selling the asset after April 2008 - of £27,264 since (assuming no change in personal exemptions) the liability under the new post-April 2008 rules would be £61,344.
There are other advantages, too. The business will, in future, be paying rent to the member's pension scheme, rather than to him or her as an individual. There is therefore no tax to be paid, despite this being a perfectly legitimate business expense. In addition, the rent can be paid on top of the maximum pension contribution (which will be £235,000 for 2008/9 and rising thereafter).
Financial advisers and accountants also need to be aware that there could develop a "false market" within AIM of investors seeking to sell off assets before the new rules come into force. In some respects this could help those wishing to move shares into a pension scheme, because the move could depress share values at a time when they are already reeling from world market conditions. This would make the cost lower, possibly even wiping out much of the gains made and thus reducing the potential CGT liability.
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