This article appeared in the Yorkshire Post on Saturday 19th January 2008.

Taxing Times: Budget Changes Threaten Investors

Duncan Meredith Tax Consultant

Sweeping changes will be altering Capital Gains Tax (CGT). These changes were announced in October in broad terms, although the details are not yet settled.  The draft legislation was to be published in December but wasn’t.

So, we await the fine print.  However, it appears that there is no intention to back-track on the Government’s part.

The proposed sea change to the CGT rules not only will sweep away the measures introduced in Gordon Brown’s 1998 Budget, they will put CGT back to where it started in 1965, taxing inflationary gains and ignoring the distinction that up to now has encouraged the efforts of trading businesses and their employees.

Possibly worst of all, such a volte-face will leave all taxpayers wondering when the next abrupt change of mind will arise.  Some might think that it is almost impossible to plan because no set of rules can be trusted to endure.  Even completed transactions are haunted by the spectre of retrospective taxation.

The changes will affect everyone who would have a CGT liability if they disposed of assets.  This clearly includes property investors, whether buy-to-let or commercial. 

The distinction in the CGT treatment of residential and commercial land and buildings is likely to disappear.  Whether the investor will be better off has to be considered individually.

The proposed flat rate of 18% is almost double the 10% that owners of commercial property and furnished holiday accommodation were expecting to pay, whereas it is clearly better than the (at best) 24% that residential landlords would be budgeting for.

The basic rules for calculating gains (proceeds less costs of sale, purchase and improvements) will remain.

However, the impact on investors who have owned properties for more than ten years will be negative, as indexation allowance, which “inflation-proofed” original purchase and improvement costs, will be lost.

Those with small gains, typically the small buy-to-let investor, are likely to be affected most, especially as their current tax rate on gains would be only 20% anyway.

Another apparent big change announced in the October Pre-Budget Report is the doubling of the inheritance tax (IHT) nil-rate band for couples.  It seems that this may not be as benevolent as first thought, with likely difficulties in claiming the double relief on the second death.

Also, the basic tenet of IHT planning is to recommend the removal of high-value growth assets out of the first estate to prevent a bigger liability later.

Leaving assets in the second spouse’s estate could attract an expensive charge later, as the growth in value would probably outstrip any increase in the nil-rate band.

IHT must be considered when planning to do anything with existing assets, partly because of the need to consider the long-term and the dangers that can arise when carrying out a transaction for CGT reasons, which could trigger an unwelcome IHT charge.

It is vital to check out your own situation.  There are potential solutions that will preserve the present CGT position, by “banking” indexation allowance and taper relief without causing an immediate tax liability.  It is not possible to generalise on strategies that will be effective.  There are too many variables and it is never a case of “one size fits all.”

As always, structuring transactions at an early stage is recommended to minimise taxes.  It is unfortunate that careful planning already carried out is in danger of being undone.

However, proper consideration of the issues should achieve the optimum position.  Perhaps there will be some good news, to go with the recent fall in interest rates.

Of course, it may be that none of the changes come in, or they are watered down, whatever the draft legislation says.

The point remains that the only way to be sure of your own position is to examine it, so that any problem can be identified and there is a chance of doing something about it before any April 2008 rule changes.

Duncan Meredith is a tax consultant with Garbutt & Elliott, Chartered Accountants and Tax Advisers with offices in Leeds (0113 2739600) and York (01904 464100). www.garbutt-elliott.co.uk