Memorandum by the Association of Tax Technicians
(ATT)
CAPITAL GAINS TAX—ENTREPRENEURS' RELIEF
The Association of Taxation Technicians (ATT)
is delighted to have the opportunity to present its evidence on
this topic to the Sub-Committee for their consideration.
GENERAL OBSERVATIONS
A simple tax system which is fair to all taxpayers
is a Holy Grail which has long been sought by politicians, administrators
and taxpayers and, like the Holy Grail itself, it does not exist.
There can be a simple system which will not be fair or a fair
system which will not be simple. A balance has to be struck because
over-simplification leads to unfairness.
The Chancellor's desire to simplify capital
gains tax (CGT) amply illustrates this point. There is no doubt
that there is uncertainty and complexity in the capital gains
system; uncertainty because many calculations of liability include
one or more valuations which have ultimately have to be agreed
with HMRC and cannot be predicted with any certainty at the time
of the disposal and complexity because of the various reliefs
and exemptions which may be involved.
It is understandable therefore that CGT might
be seen as a target for simplification; however the complexities
are there for a reason: to give relief in cases thought to be
deserving or to encourage investment in businesses. The effect
of the simplification proposed in the Bill is to increase the
potential effective rate of tax on the business community by 80%
whilst reducing that on the short-term speculator by 55%; a clear
example of simplicity leading to unfairness. It is surprising
that this was not made clear to the Chancellor before the proposals
were announced as part of the Pre-Budget Report.
Quite apart from the issue that "simplifying"
the rate of CGT leads to unfairness, it should be noted that the
proposals in the Bill do not really amount to simplification in
any significant sense—the computation of gains and losses
remains as complex as before, and only the very final step of
deciding which gains are to be taxed at which rate has been changed.
ENTREPRENEURS' RELIEF
It is generally accepted that this relief was
hurriedly devised to preserve the 10% effective rate on businesses
whilst still allowing the abolition of taper relief as originally
proposed. It is largely based on the former retirement relief
which was a feature of CGT since its introduction in 1965 until
it was phased out over the period from 1999 to 2003. (Ironically
this was on the grounds that it was too complex.) It is perhaps
stating the obvious but it does need to be stressed that drafting
legislation "on the hoof" has a potential for inconsistencies
and anomalies. In this case it was perhaps felt the risk was lessened
by simply dusting off legislation used earlier.
If Government policy is to encourage the formation
of and investment in new businesses, then entrepreneurs must be
able to take a long term view in formulating their plans and judging
the likely rewards. In the last 10 years they have seen: the abolition
of retirement relief, which granted a complete, albeit limited,
exemption; the introduction of taper relief which granted a reduced
effective rate of tax but on unlimited gains; and now the introduction
of entrepreneurs' relief, which continues the effective low rate
of tax but now limits that rate to gains of up to £1 million
in a lifetime. What is required now is a period of stability.
Although largely based on retirement relief,
entrepreneurs' relief is a direct replacement for taper relief
as it applied to business assets, and its effects need to be measured
against that latter relief in judging whether it achieves its
aim of maintaining the status quo for businesses.
Focus of the relief
Taper relief was entirely focused upon the individual
business assets. Entrepreneurs' relief, however, restores the
old retirement relief concept of a disposal of the whole or part
of a business. That concept led to a string of court cases which
sought to decide whether the sale of some, but not all, the assets
of a business was a disposal of part of a business. The new relief,
as proposed, will mean that a gain on a single asset sold by a
sole trader will no longer attract an effective 10% tax rate and
could provide scope for further litigation on the question of
what constitutes a part of a business.
No doubt it could be argued that relief for
the sale of a single business asset is available to the sole trader
under TCGA 1992, section 115 (roll-over relief) provided he reinvests
the sales proceeds in new qualifying assets. However this relief
will not apply in all cases; in particular where financial circumstances
mean that the proceeds are required to supplement the working
capital or the business or to repay borrowings. We believe that
entrepreneurs' relief could easily be granted for such sales by
amending the definition of a material disposal of business assets
in the proposed section 169I(2)(a) to refer to assets used for
the purposes of a trade carried on by the individual.
Business assets eligible for relief
A further change from taper relief is that the
owners of properties let to businesses with which they are unconnected
will no longer qualify for the 10% relief. Whilst this was always
the case for retirement relief and, initially at least for taper
relief, Finance Act 2003 relaxed this requirement and permitted
taper for assets used in a business carried on by any individual
or partnership. This was a sensible move; if Government policy
is to encourage the formation of new businesses, it must accept
that those businesses will need premises and will find it difficult
to finance their purchase (especially in the current credit crisis).
We believe that the Government should therefore continue to encourage
property owners to provide premises to businesses by means of
the 10% capital gains tax rate which they have been led to believe
would be levied on a future sale.
Associated disposals
Another instance where "cutting and pasting"
from the former retirement relief legislation brings a significant
change from taper relief is in the situation where a partner or
family company shareholder/director owns, in a personal capacity,
an asset, usually premises, which is used in the business carried
on by that partnership or company. Retirement relief was restricted
where the individual received rent or any other form of consideration
for its use. There was no such restriction under taper relief,
but now there will be again.
Frustrating as such changes may be, the real
point here is that the reintroduction of this restriction brings
with it an element of retrospection. The proposed new section
169P(4)(d) applies the restriction where rent has been paid for
the whole or part of the period for which the asset has been in
use for the purposes of the business, which, of course, would
include any period before 6 April 2008 when the receipt of rent
was unobjectionable. We believe that the restriction should be
removed completely in order to maintain the status quo, or, at
the very least, to prevent retrospection, periods before 6 April
2008 should be ignored.
Personal companies
Relief is available for disposals of shares
in a trading company which is the individual's "personal
company". Stated simply, this is one in which he holds not
less than 5% of the ordinary share capital and voting power. In
addition the individual must be an officer or employee of that
company.
Under taper relief the shares were a business
asset if the company was unlisted, if the individual was an officer
or employee or if he could exercise not less than 5% of the voting
power. These three conditions were options. Thus an employee who
held less than 5% of the voting power would benefit from the relief
as would someone holding more than 5% who was not an employee.
The new requirement that the individual must
both be an employee and hold more than 5% of the voting power
means that from 6 April many people will be faced with an increased
potential capital gains liability. Principally affected will be
those employee-shareholders who have small holdings derived from
share incentive schemes.
It is unfortunate that the definition of "personal
company" for the purposes of entrepreneurs' relief differs
from that already in force for the purposes of roll-over relief
in TCGA 1992, section 157(b). The latter definition only requires
the holding of not less than 5% of the voting power; it does not
require the individual to be an officer or employee. Interestingly,
that roll-over relief definition derives from the earlier retirement
relief definition.
We believe that there should be consistency
in defining common terms in order to avoid misunderstandings and
aid clarity. Preferably, the definition of shares which qualify
for entrepreneurs' relief should be the same as that which has
applied for taper relief—failing that, the definition of
family company should be aligned with the existing definition.
Effect of annual exemption
In most cases, it might be thought that the
overall effect of entrepreneurs' relief is to leave the tax burden
on businesses unchanged from that which would have applied under
taper relief. In the case of modest gains the effect of the annual
exemption, where this is not set against other gains, is actually
to increase the tax burden.
Take the case of a gain of £36,800 in the
last tax year. It would be reduced by three-quarters to £9,200,
which would be equal to the annual exemption and thus no tax would
be payable. That same gain arising in the current tax year would
result in a liability of £1,952 (£36,900 x 5/9ths =
£20,444 less £9,600 = £10,844 @ 18%). In order
to be fully covered by the annual exemption, the gain in future
must be £17,280 or less.
If the intention behind entrepreneurs' relief
is to maintain the status quo for business disposals, this effect
alone suffices to defeat that aim. A gross gain of £50,000
would, if realised on 5 April 2008, have resulted in a tax liability
of £1,320—an effective overall rate of 2.64%. The same
gain realised on 6 April 2008 would, ceteris paribus, result
in a liability of £3,272—an effective overall rate
of 6.54%, more than double.
THE ABOLITION
OF INDEXATION
ALLOWANCE
Along with taper relief, the Bill abolishes
Indexation Allowance (IA) for gains realised after 5 April 2008.
The overall effect of this provision is harder to assess, since
the effect of IA is incredibly variable. Where an asset was owned
on 31 March 1982, the effect of IA is (broadly) to double the
individual's base cost (which, in such cases, is normally the
asset's market value as at 31st March 1982). Where the assets
consist of shares subscribed for at par since 1982 (a very common
instance), IA has virtually no effect since the base cost which
IA increases is usually negligible.
The rules for indexation are quite complex,
since it is necessary to distinguish between assets held at 5
April 1965, assets held at 31 March 1982, assets acquired before
5 April 1985 and assets acquired between then and 5 April 1998.
Calculations can in many cases be cumbersome, with relatively
limited reduction in the tax liability.
Indexation Allowance ceased to accrue (other
than for companies) from 6 April 1998, with the result that the
proposal will not change anything for disposals of assets which
were acquired since that date.
The abolition of Indexation Allowance is certainly
a simplification. Apart from the (relatively few) cases where
it will result in a significant increase in liabilities, it should
be welcomed as a positive step.
CONCLUSIONS
The substitution of a flat rate of 18% in place
of the individual's marginal income tax rate might—at a
stretch—be described as a form of simplification. In fact,
it does nothing more than add yet another tax rate to the many
(10%, 20%, 32.5%, 40%) which already bedevil personal taxation.
The consequence (one hopes unintentional) of
undoing the 10-year-old distinction between business assets and
non-business assets is to increase the tax charge on the former
and to reduce substantially the tax rate on the latter. That this
is an instance of simplification generating unfairness goes without
saying; the possibility that the Government actually wishes to
disadvantage the small business community while benefiting buy-to-let
landlords and short-term speculators defies credibility.
The introduction of entrepreneurs' relief, undeniably
a hurried response to hostile commentary by professional and industry
bodies, attempts to reduce the unfairness which the 18% rate imposes
on the small business community. Unfortunately it does so only
to a very limited extent. The new relief is limited to £1,000,000
of gains over a lifetime (whereas taper relief applied to unlimited
gains). It applies to a much more restricted range of shares than
before (most employee share participation which qualified for
taper relief will fail to qualify for entrepreneurs' relief).
Being based on a "retirement" concept, it excludes many
disposals which were covered by taper relief. It excludes—arguably
retrospectively—many disposals of "associated assets"
which would have qualified for taper relief (ie where a rent has
been charged for commercial property). Disposals where the annual
exemption is available are taxed more highly than was the case
under taper. Overall it is fair to conclude that entrepreneurs'
relief is at best a very partial compensation for the loss of
business asset taper relief.
Because the new relief fails to make use of
existing definitions of assets, but rather imposes a new set of
definitions based in part upon long-defunct legislation, it cannot
be regarded as a simplification. Taxpayers and advisers who had
for 10 years grown accustomed to one set of definitions now have
to cope with a different, more restrictive set. On that basis
it cannot be said to offer any degree of clarification either.
Judging on the basis that a tax system should
seek to optimise the balance between simplicity and fairness,
we are obliged to conclude that, unfortunately, the new provisions
for CGT manage to satisfy neither. The new provisions are no less
complex than those they replace, and treat entrepreneurs and members
of employee share schemes unfairly.
It is hoped that the comments made in this submission
will be helpful to the Sub-Committee, although we shall be pleased
to answer any questions which the members have.
April 2008
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