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Turning the tables

Last week, I looked at the impact of the proposed capital gains tax changes on business owners. For many, the proposed changes will mean an 80 per cent increase in the effective rate of tax if the changes are enacted.

Only two weeks ago, we had reports, supposedly based on leaked information, that the Treasury was prepared to introduce a form of retirement relief, with up to £100,000 of tax-free gains being available subject to the satisfaction of as yet undisclosed conditions. The Treasury constantly expresses its commitment to a simplified system.

Unsurprisingly, and with no little justification, the Confederation of British Industry and the Federation of Small Businesses seem to be of the view that the proposed relief would go Current rules New rules

Gain £50,000 £50,000Taper 15% £7,500£42,500 £50,000Exempt £10,000 £10,000Taxable £32,500 £40,000Tax @ 40% £13,000Tax @ 18% £7,200Net £37,000 £42,800Current rules New rules

Gain £100,000 £100,000Taper relief £40,000Post-taper relief £60,000 £100,000Exempt £10,000 £10,000Taxable £50,000 £90,000Tax @ 40% £20,000Tax @ 18% £16,200Net £80,000 £83,800fairness to the sector.

Let us now have a look at the impact on that hottest of hot potatoes, the CGT changes in connection with investors. First, individuals.

It is proposed that taper relief will be abolished from April 6, 2008 but, for many, the lower 18 per cent flat rate of CGT will deliver a comparative benefit. This will be available for those investing in collectives as opposed to investment bonds. UK life funds, while qualifying for indexation allowance, will not be eligible for the 18 per cent CGT rate because companies pay corporation tax on their capital gains.

However, let us not forget that these changes are relevant only in respect of realised capital gains. They have no impact at fund level and they have no impact on performance driven by income – dividends, interest or rent.

Here are some examples of the different net receipts from capital gains made on collectives under the current and new regime respectively.

These comparisons are to illustrate who could be winners and losers in respect of realised capital gains. They do not compare collectives with investment bonds. I think this is a necessary first step towards making such an important comparison.

First, let us look at higher-rate taxpayers with a 10-year investment term, £100,000 gain and, say, an available annual exemption of £10,000. A comparison of the net return based on the current rules and the proposed rules would look like this (see Table 1).

Different results arise based on different assumptions but the 18 per cent rate applies however long an investment is held for. For example, after five years and based on a £50,000 gain, a higher-rate taxpayer with an available annual exemption of £10,000 would need to think about this comparison (see Table 2).

The margin of difference would be greater if and to the extent that the annual CGT exemption were not available.

It is for smaller gains and longer holding periods that the current rules would be beneficial, even for higher-Current rules New rules

Gain £16,000 £16,000Taper @ 40% £6,400Taxable £9,600 £16,000Exempt £10,000 £10,000Tax @ 40% NilTax @ 18% £1,080Net £16,000 £14,920rate taxpayers with an available annual exemption. For example, take a gain of £16,000 accrued over 10 years and then realised (see Table 3).

The key to this comparison is that the gain is of such a size that the impact of taper relief reduces the chargeable gain to below the annual exemption. When this happens, the lower flat tax rate has no impact. There needs to be sufficient taxable gain for the lower tax rate to operate on.

This is even more so for basic-rate taxpayers as the margin of difference in the current and future rates is only 2 per cent.

Remember as well that all the examples here focus solely on capital gains. Many portfolios will have other drivers of growth, including reinvested dividends and interest. I will consider this next week.

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