By Emma Bailey, Partner, Fox Williams LLP
It can hardly have escaped your notice that on 22 June 2010, the Coalition Government introduced a second capital gains tax (“CGT”) rate of 28%. But how will the spilt rate system work in practice, and what are the wider tax planning implications?
CGT rate increase
• The CGT rate chargeable will depend upon the level of taxable income in the relevant tax year — 18% to the extent the gain, plus taxable income, does not exceed the upper limit of the 20% income tax rate band (£37,400 in 2010/11) — 28% thereafter.
• Given the rate change occurs, unusually, midway through a tax year, transitional rules deal with:
o the extent to which pre 23 June gains, and gains qualifying for entrepreneurs relief (see below), affect the applicable tax rate;
o how the annual exempt allowance (unchanged at £10,100) and capital losses can be utilised against pre and post 23 June gains — essentially there is flexibility to use them in the most efficient way to reduce the tax bill.
• In general, pre 23 June gains which have been deferred (for example through the issue of consideration in the form of loan notes, or by investing in EIS/VCT shares (see below)) will potentially be subject to the higher CGT rate (though this may not necessarily be the case where the gain was deferred pre 6 April 2008).
• Certain planning opportunities do exist for reducing the rate of CGT payable, at least for a limited period.
• There has been no change to the requirements for obtaining entrepreneurs relief, which reduces the tax rate to 10%.
• The scope for covering gains with entrepreneurs relief has, however, increased - the limit on lifetime gains which can qualify for the relief has been raised from £2m to £5m.
• But the possibility of benefiting from entrepreneurs relief whilst also deferring any gains arising on a disposal of shares — by, for example, issuing loan notes as consideration for the disposal, or reinvesting the proceeds in shares qualifying for EIS relief (see below) - has been restricted. So there may now be an incentive to crystallise tax on deferred consideration at completion, so as to qualify in full for entrepreneurs relief at that time.
• In this context, it is also worth noting that partnership structures (if otherwise suitable commercially or from a tax perspective) could, in certain circumstances, be more advantageous than a corporate structure in securing entrepreneurs relief.
Tax efficient structuring of returns
• Since the new CGT rate is not aligned to the higher 40/50% income tax rates, there is still an incentive to realise profit, and structure returns, in capital rather than income form — particularly so since the Chancellor of the Exchequer has confirmed that CGT rates will not be increased again during this Parliament whilst there is no current proposal to reduce the 50% income tax rate.
• There continues to be significant scope for entering into tax favoured share and share option arrangements (such as EMI Options — see below) and/or share incentive arrangements for employees which secure CGT treatment - at least pending the Coalition Government’s consultation, planned for the latter half of this year, on the taxation of returns from employment related securities/geared growth shares (and the introduction of further anti-avoidance legislation in relation to trusts (e.g. EBT’s) and other vehicles such as EFRB’s).
• The increase in CGT rates, together with the proposed (albeit about to be revised) restrictions on tax relief on pension contributions, is likely to make accessing the tax reliefs available in the context of investing in Enterprise Investment Scheme (“EIS”)/Venture Capital Trust (“VCT”) shares more attractive. This is particularly so given that certain of the conditions that need to be satisfied for such treatment to be available are also being relaxed, potentially increasing the investee companies for which EIS/VCT investment will be possible.
• A similar relaxation is also being made to the EMI Option rules — thus potentially also expanding the range of companies that could issue tax advantaged EMI Options.
• If there are pre and post 23 June 2010 gains, consider how best to reduce the tax bill.
• Review business/corporate structures to ensure that, if there is a desire to claim entrepreneurs relief in the future, the qualifying criteria are satisfied.
• Consider scope for structuring any returns in capital form and/or in deferring tax on gains on any exit.
Emma Bailey is a Partner in the tax team at Fox Williams LLP. Emma can be contacted on 020 7614 2560, or firstname.lastname@example.org
Join us on