The mixed blessings of capital gains tax

It might look promising at first glance, but on closer inspection there's a lot more to the 10% CGT than meets the eye.

Try this one at your next party when you're stuck for a conversational gambit: "what's the rate of Capital Gains Tax?". This might cause people to move away and look at you strangely, but many will be interested and will probably respond along the lines of "it's 10 per cent now, isn't it?". After all, we have heard a lot about the 10 per cent capital gains tax (CGT) rate, starting with Gordon Brown's Green Budget last November.

Try this one at your next party when you're stuck for a conversational gambit: "what's the rate of Capital Gains Tax?". This might cause people to move away and look at you strangely, but many will be interested and will probably respond along the lines of "it's 10 per cent now, isn't it?". After all, we have heard a lot about the 10 per cent capital gains tax (CGT) rate, starting with Gordon Brown's Green Budget last November.

A 10 per cent rate certainly sounds a lot better than the 40 per cent rate that most people in the CGT net have usually paid. But, like most cut-price offers, there are plenty of conditions and hurdles in the way.

The confusion about the rate of tax that I find when I pose the question I suggested (I do it at seminars rather than parties) is a result of the tapering regime that was introduced from April 1998. Only individuals and trusts get to taper CGT - companies keep a standard, set rate. Instead, companies continue to have an indexation allowance, which compensates for the ravages of inflation. You and I can have indexation up to April 1998 on assets we've held before then, but after that we taper the rate of tax that applies to the gain rather than getting formal inflation protection.

Once you've worked out your capital gain - and that in itself can be quite a saga - then you get to taper the rate that applies. Strictly, you get to taper the amount of the gain and then apply your tax rate - which will be 40% for higher rate payers, 20% for most others and 10% if you have little or no income. It may be that your gain takes you across the threshold of the tax rates, of course - causing yet more complexities!

Taper relief operates according to the number of complete years that you have held the asset. The table below gives the percentages that operate from April this year.

You can see where the 10 per cent rate comes from - taper the gain that you've made to 25 per cent of the original and then apply 40 per cent - and there you are, a modest 10 per cent excision. But the low rate only arrives after four years - and only on "business assets". Non-business assets can only get down to 24 per cent for higher rate taxpayers.

Business v non-business

So, what's a business asset? If you are a sole trader, then the term includes the things you use for the business, as you would expect. As far as shareholdings are concerned, business assets excludes those few shares you have in an average PLC. From 6 April 2000 it covers any shareholding in an unquoted company a 5 per cent or more holding in a quoted company any shares held in your employing company.

All companies must be trading companies. Prior to April this year, the business asset taper was for shareholdings of 25 per cent or more - or 5 per cent or more where you were a full time employee or director. Now, there is no length of work requirement - which conjures up thoughts of taking someone onto the payroll for nominal duties just to turn their shares into business assets! Should you, for instance, do a few Saturdays collecting trolleys in the car park at your local supermarket if you are about to sell a shareholding in that organisation? I suspect the Revenue will challenge artificial arrangements!

Having got this far, instinctively, those selling their unquoted shares will now expect a maximum 10 per cent CGT rate, as will employees selling shares in their employer. But it isn't that easy. The problem is that many shareholdings will indeed rank as business assets - but only for periods from 6 April 2000, with earlier periods as non-business. Toss in the fact that there is a "bonus year" in the tapering where you have held the asset in question since before 17 March 1998 - but now only for non-business asset disposals - and we get into an involved calculation.

Illustration

In late April 2004, A sells his holding of 1 per cent of the shares in X Ltd, an unquoted company, which he had held since 1996, for a gain of £60,000 after indexation. What is then the CGT due? (Ignore the annual exemption.)

There needs to be some careful apportioning. Firstly, the total holding period for tapering is 6 years of which 4 years is business, 2 years non-business - so business gain is £40k, non-business £20k. Each part is then tapered according to the whole period of ownership, so business taper is 25 per cent (ie the maximum taper, reached after 4 years) and non business is 6 years + bonus year to 75 per cent. Therefore, tax due is (assuming a 40 per cent tax rate), £40k x 25 per cent x 40 per cent = £4k: £20k x 75 per cent x 40 per cent = £6k, ie a total of £10,000 or a 16.67 per cent overall tax rate, rather than the 10 per cent rate that A might have expected.

There will be holdings that get a lower tax rate than some which have been held for a longer period. That does not seem to stack up with the Government's desire to encourage longer-term holdings! But the prospect of a 10 per cent tax rate compares favourably with 40 per cent income tax rates.

I do wonder if any of your fellow party guests suggested the rate of CGT could be 16.67 per cent. If they did, perhaps you should suggest they should try a breathalyser before they go - they must have got carried away one way or another!

The writer is a Chartered Tax Adviser with PricewaterhouseCoopers