All change for capital gains
The new Chancellor's Emergency Budget on 22 June produced two suprises. Not only was the increase in the rate lower than expected but the rate changed from the next day.
That means coping with a split rate in a single tax year.
- For gains arising up to and including 22 June 2010, the rate of CGT is 18%.
- For gains arising on or after 23 June 2010 the rate remains at 18% only for those whose total taxable income and gains are less than the upper limit of the income tax basic rate. For gains, including parts of gains, above that limit, the rate is 28%.
Many people who normally pay tax at only the basic rate may find they are liable to the higher capital gains tax rate on all or part of their capital gains. Fortunately, gains arising before 23 June 2010 are not taken into account in determining the rate (or rates) at which gains arising on or after 23 June will be charged. In addition, taxpayers will be able to deduct losses and the annual exempt amount in the way which minimises the tax payable.
What will be taxable in 2010/11?
The tax treatment for the 2010/11 tax year depends upon the date a capital gain is treated as arising. If there is a contract for a sale, this will normally be when the contract is signed, unless it is conditional.
However, the Finance Bill proposes solutions for a number of special cases where gains from earlier years may become taxable in 2010/11 or where gains are attributed to a person for a tax year, rather than on a specific date. For example:
- Those returning from living abroad during 2010/11, who have been non-UK resident for less than five complete tax years, may become taxable, on the day of their return to the UK, on all capital gains made in their absence. All such gains taxable in 2010/11 will be treated as arising before 23 June, regardless of the date of return to the UK.
- For settlors who are taxed on the gains made by offshore trusts, the gains arising in 2010/11 will be treated as arising before 23 June, regardless of the actual date of the trustees' gain.
- Beneficiaries of offshore trusts pay tax on gains made by the trust when they receive a capital payment or benefit. It is the date of the capital payment that will determine when the gain arises for 2010/11; gains made long before 22 June may be taxed as if they arose later. On the other hand, gains made after 22 June could be treated as arising earlier if they are matched with an earlier capital payment. The difference could be substantial, with an effective rate of tax of up to 28.8% for gains treated as arising before 23 June and an effective rate of up to 44.8% thereafter.
- For those taxed on the remittance basis, foreign capital gains will be deemed to accrue only when they are remitted to the UK. Which means that gains made in earlier years, but not remitted to the UK until 2010/11, may be deemed to accrue after 22 June at the higher CGT rate.
- Those paying the remittance basis charge (RBC) must nominate foreign income or gains to be the subject of the charge. If such income or gains are actually remitted to the UK, special rules are applied and the foreign gains of those who are taxed under these special rules in 2010/11 will be deemed to arise before 23 June.
Effects on entrepreneurs' relief
Disposals of business assets qualifying for entrepreneurs' relief may also give rise to complications, as may gains previously deferred under the Enterprise Investment Scheme (EIS). In summary:
- The rate of CGT for gains qualifying for entrepreneurs' relief remains at 10%.
- However, from 23 June 2010 the lifetime limit will be increased from £2 million to £5 million.
- The previous 4/9 reduction applied to qualifying gains, to achieve the effective rate of 10%, will cease from 23 June 2010 and a new 10% rate will apply.
Where qualifying gains above the previous £2 million limit are made before 23 June 2010, no additional relief will be allowed. If further qualifying gains are made after 22 June 2010, relief can be claimed on an additional £3 million (or £4 million where the £1 million limit applied). This marks a distinct change from the previous Government's proposal which would have increased entrepreneur's relief to £2m but did not allow anyone who had already used the former £1m limit to obtain further relief.
And in more detail...
- Gains qualifying for entrepreneurs' relief are set against any unused basic rate band before non-qualifying gains in determining the rate of CGT to be applied on any other gains arising after 22 June 2010.
- On a company re-organisation after 22 June involving the acquisition of loan notes that are Qualifying Corporate Bonds, it will now be possible to disapply the normal deferral rules, by election, so that a claim for entrepreneurs' relief can be made.
This option will not be available for loan notes that are not Qualifying Corporate Bonds, so that entrepreneurs' relief could be lost if the new loan notes do not qualify for the relief.
Under the rules currently drafted there is no clear mechanism to ensure that, if an offshore trust makes a gain that qualifies for entrepreneurs' relief, any beneficiary to whom the gain is attributed will benefit from the 10% tax rate. This is a result of the technical change in the way the relief is given.
Enterprise Investment Scheme - deferred gains
- Gains deferred under the Enterprise Investment Scheme will be taxable at the CGT rates applicable at the time the deferral ends. Under the rules currently drafted, the technical change in the way entrepreneur's relief is given will mean that it will not be possible for individuals with gains qualifying for entrepreneurs' relief, to defer the tax liability by investing in an EIS company and still obtain the benefit of entrepreneurs' relief on the original gain when the EIS shares are sold. Instead, an individual must choose between paying tax at 10% on the original gain or deferring the gain to a later year but paying tax at 18% or 28%.
The split rate of capital gains tax in the 2010/11 tax year will inevitably produce complications. But there are, even now, opportunities to take advantage of the lower 18% rate in certain circumstances and, for those who have previously used their qualifying gains entitlement, to make further use of entrepreneurs' relief. If you wish to discuss your capital gains tax position, please contact your usual Littlejohn tax advisor or email senior tax consultant Barry Luscombe on 020 7516 2204 or email bluscombe@littlejohnllp.com
