The decision to abolish indexation relief on corporate capital gains will have a major impact on many advisers and their clients
Important changes can often become apparent several weeks after an event, when the fuss has died down and you can put them into perspective.
This is particularly true of the recent Budget, which provided threats and opportunities for advisers and their clients that were not necessarily clear at the time.
Take Chancellor Philip Hammond’s decision to abolish the indexation relief on corporate capital gains, for example. It will have a major impact on anyone holding an asset like property or equities in a UK company. That is most adviser businesses and a fair number of their clients, and increasingly those with buy-to-let property.
It will also have a huge effect on the future returns of UK life policies: single premium investment bonds, endowments and whole of life policies.
So, what happened?
The Autumn Budget announcement was that indexation relief for companies will be abolished with effect from 1 January 2018. Hitherto, the base values of corporate investments have been revalued in line with increases in inflation, as measured by the retail prices index.
For example, if a company has owned an asset, such as a share or a property, since, say, 2002, the base value will be revalued in line with inflation. So a £10,000 investment bought in 2002 will be uplifted by the percentage rise in RPI since then. The RPI has increased a little over 53 per cent in the last 15 years – raising the base value for the gain to about £15,300. If the value of the investment has increased to, say, £19,000, the taxable gain would be only £3,700.
If equity capital gains average about 4 per cent a year and inflation runs at around 3 per cent a year, indexation relief takes about three quarters of the capital gains out of tax. Sometimes it is more and sometimes it is less. The point is that a high proportion of the gain is covered by indexation relief and is therefore free of tax.
Individual investors and trusts were in much the same position until capital gains tax indexation relief was abolished nearly a decade ago. But the relief was retained for corporate gains. Now the corporate indexation relief will continue up to 1 January but, after that, it will be frozen and there will be no further uplift.
Hammond called the indexation relief for companies “an anomaly” and perhaps it is one. But there have been good reasons for keeping it. The main justification is that corporate gains are highly likely to be taxed again before they reach the individual owners of companies, or indeed policyholders in UK life policies.
A shareholder in a company containing a property or other investment will see the company pay corporation tax (currently at 20 per cent) on the gain. Then, if the shareholders are to benefit personally from the asset, the proceeds will need to be distributed and be taxed as a dividend or in some circumstances as a capital gain; for example, if there is a share buy-back or the company is put into liquidation.
Buy-to-let investors who have been putting their properties into companies to avoid the new restrictions on interest relief might now want to review their strategy in the light of this further attack on their chosen investment.
The other people adversely affected by the abolition of indexation relief on corporate assets are policyholders in UK insurance companies. The change will affect the future returns of many UK life policies, at least to the extent they are linked to returns on property and equities.
So that will include most people who own single premium investment bonds with equity or property funds, mixed funds or, in some cases, with profit funds. A lot of with profit funds are effectively invested for the most part in government and corporate bonds, so they will not be greatly affected. But the rest will.
Most people with endowments and whole of life policies will also experience a hit to their future investment returns – a further blow to those who are still hoping to avoid a shortfall on their eventual mortgage repayment when their endowments mature.
How big the impact will be is hard to gauge, because the taxation of life companies is spectacularly complicated and arcane. But very roughly, if inflation is running at 3 per cent as we assumed earlier, then the future lost relief might be worth about 20 per cent of this – perhaps cumulatively about 0.6 percent a year in very crude terms.
That is probably enough to swing the balance of the argument away from UK life policies to offshore plans for new investments, which is in any event the trend already. It might even be worth switching out of existing bonds now in some cases, depending on individual circumstances. Not great news.
Danby Bloch is chairman of Helm Godfrey and consultant at Platforum