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Control issues

Chris Salih predicts how the proposed capital gains tax increase will play out in the sector

The Conservative-Liberal Democrat coalition may be set to shake up investment in the UK as a hike in capital gains tax looms on the horizon.

As part of an emergency Budget on Tuesday, June 22, there is expected to be a significant increase in CGT, potentially to bring it in line with the 40 per cent and 50 per cent income tax levels.

The coalition states there is agreement on “taxing non-business capital gains at rates similar to those applied to income”. It says there will be “generous exemptions” for entrepreneurial business activities.

The Government has not clarified whether the rise would take effect from the Budget date or from next April.

As an example, if you were to take a £20,000 investment gain, there is currently a £10,100 allowance, leaving a £9,900 gain taxed at 18 per cent, meaning a final return of £8,118. Under a 40 per cent tax rate, that return would be adjusted to £5,940.

The LibDem manifesto proposed dramatically reducing the CGT annual allowance from £10,100 to £2,000, and some industry experts fear the allowance could be reduced in the emergency Budget.

Candidmoney.co.uk founder Justin Modray says: “It is a blow to wealthier investors as it brings CGT in line with income tax and increases the importance of Isa and pension wrappers – though pension wrappers could also come under attack if there is an abolition of higher-rate tax relief.”

Modray says growth funds such as emerging markets will suffer, given their higher potential for capital growth, as will smaller companies. Split-cap and zero-dividend preference shares investors may also feel the pressure.

F&C director and head of corporate affairs Jason Hollands says closing the differential rates between CGT and income tax will prompt a flurry of investors to consider crystallising gains made on long-term holdings ahead of the Budget.

He says: “One strategy open to them will be to bed and Isa these holdings, ie, sell them and repurchase within an Isa so that they use current annual CGT exemptions and incur any additional tax liability at the 18 per cent rate while future returns will be ringfenced from the taxman altogether.”

Hargreaves Lansdown investment manager Ben Yearsley says Isa and Sipp investing will be boosted: “Pensions were written off when it was thought higher-rate relief would be scrapped. But because we still get tax-free growth in there, and add to that a possible change in annuitisation rules, they should get a benefit from proposed CGT changes. It also makes EIS and VCT more attractive. What it does not do is incentivise long-term investment outside tax wrappers.”

Fidelity has also called for the Government to consider re-introducing indexation in some form with its planned CGT rise.

Fidelity International UK managing director Gary Shaughnessy says going back to a marginal income tax rate without a re-introduction of the indexation allowance will disincentivise future investment in the UK.

The coalition has not said if it will introduce an inflation-based indexation allowance, which was in place before Labour changed the tax system.
Individuals traditionally paid CGT at their highest rate of income in that tax year. However, from April 6, 1998, taper relief was introduced, reducing the amount of gain that was subject to CGT, depending on whether the asset was classed as business or non-business and the length of period it was owned. Taper relief provided reductions of 75 and 40 per cent for business and non-business assets respectively. Taper relief replaced indexation allowance for individuals, which can still be claimed for assets held prior to April 6, 1998, from day of purchase until that date, but was itself abolished on April 5, 2008.

This was then adjusted to 18 per cent CGT for all without indexation, partly to tackle private equity firms making profits on gener-ous relief of taper assets. The loss of indexation was unnoticed, offset by low inflation and a lower tax rate.

If an individual invested £100,000 in a second property in 1985 and sold it 25 years later to fund retirement, that property would be worth £490,617, according to Nationwide House Price index. Under the current 18 per cent CGT rate, an investor would face a tax bill of £68, 493. Under the 40 per cent rate with indexation it would rise to £96,258 while with no indexation, the bill would rise to £152,207.

Shaughnessy says: “The potential impact is very large relative to the initial investment made. For many, this tax hit is likely to arise at the time they are liquid-ating assets to pay for their retirement.”

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