I make no apologies for returning to the subject of capital gains tax and the new taper relief for individuals. It will serve as a warning of what happens when radical legislation is rushed through without proper consultation. This must be avoided at all costs when companies’ CGT reform is outlined in the Green Budget.
What’s wrong with the taper? Apart, that is, from the fact that we are lumbered for some time with two sets of complicated calculations: frozen indexation to March 1998 and taper thereafter? Plenty. Consider the following.
When taper relief fails
Rollover: unincorporated businesses A and B each invest #100,000 in an identical unit in an industrial estate in 1998. Business A sells its unit after six years for #220,000. It invests the same amount in a similar unit at a different location and claims rollover relief.
Each business then sells its unit in 2008 for #300,000, making an identical gain, before taper, of #200,000. B is taxed on a gain of #50,000 and A on a gain of #140,000.
Why is there such a huge difference, when in cash terms their results are identical?
Business B deducts ten years’ taper of 75% from its gain of #200,000, making #50,000 chargeable. Business A’s gain on the sale of the first unit doesn’t qualify for taper. Under rollover relief, the gain simply goes to reduce the cost of the second unit to #100,000.
The gain on the second unit is therefore #200,000, but qualifies for only four years’ taper of 30%, making #140,000 chargeable. But if each business had sold its unit six years later, each would have had a gain that qualified for ten years’ taper, reducing it to #50,000.
The playing field would have been level again.
This means a business has to take great care in deciding whether to sell one asset and reinvest in another. To do so could be commercial sense but fiscal folly.
This problem is by no means confined to rollover relief: it also exists in holdover and incorporation relief and relief for losses.
Holdover: a major shareholder in an unquoted trading company gives his daughter shares that cost him practically nothing six years ago. Holdover relief is claimed so the father has a nil gain and the daughter a nil cost. After four years, the company is taken over. She gets only four years’ taper on her gain; if the father hadn’t made the gift, he would have had ten.
Pitfalls of incorporation
Incorporation: the business of a partnership that has been going for ten years is up for sale, but the purchasers demand to buy it through shares in a limited company. The business is therefore incorporated and incorporation relief claimed, so that the partners’ gain on the goodwill is nil and their shares have a nil cost (assuming other assets and liabilities balance each other).
The partners’ gain on the sale of their shares doesn’t qualify for taper relief because they haven’t held the shares for any length of time. If they had sold the goodwill direct without going down the incorporation route, they would have reduced the gain by ten year’s taper.
Losses: a company has a loss of #100,000 in year one and gains of #100,000 in each of years two and three. Assume the first gain qualifies for ten years’ taper and the second none. Losses are not tapered but are set against gains before taper.
So the loss is set wholly against the first gain, and potential taper relief of #75,000 goes up in smoke.
If the gains had been made in reverse order, the loss would have been set against the gain that didn’t qualify for taper, so that full taper relief would have been available in year three.
Four ordinary examples, then, where taper relief fails and large sums hang on matters of chance. I cannot understand why such rough justice was allowed to stand in the Finance Act. It is not too late to get it changed in next year’s Budget; let’s hope the Treasury is listening.
The signs are that we won’t have tapering for companies. Let’s at least have proper consultation this time round so that equivalent madness can be avoided in whatever reform companies are in for.
Maurice Parry-Wingfield is a tax consultant with Deloitte & Touche.
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