Partial retreat on capital gains, but implications still profound

Britain's Chancellor of the Exchequer has today announced that he has revised his proposed reforms of Capital Gains Tax.

In his pre-Budget Report, issued in the wake of a hugely popular Tory policy announcement to raise the capital gains threshold to a million pounds, Alistair Darling stated he planned to sweep away indexation, tapering relief and variable CGT with a new single 18% tax rate.

"The Chancellor's plan raised serious issues for investors in private and AIM-listed companies since the replacement of the accelerated taper-relief currently available to investors in unlisted companies would mean that instead of paying an anticipated 10% tax rate on disposal after three years, this would soar to 18%. The measure would particularly hit owner entrepreneurs," explained Jason Hollands of F&C Investments.

However, today Mr. Darling announced that while he will press ahead with a flat 18% CGT rate, he will introduce a new entrepreneurs' tax relief allowance. The new lifetime allowance will deliver a 10% tax rate for capital gains of up to £1 million. To qualify for the allowance the investor will have to have a material shareholding of at least 5% of the voting rights of the company as well as being an employee or director.

"This means that ordinary investors in qualifying AIM shares and unlisted companies who are not employees or directors will be worse off. Currently they can enjoy a 10% capital gains tax rate after as little as three years. Now they will pay 18%," said Hollands.

"Since the relief is only available to sizeable shareholders of trading companies, it could also be very bad news for many British workers who have small shareholdings in large or medium sized companies and who will no longer benefit from taper relief."

Hollands' points out that the confirmation that the government is set to introduce a differential tax rate for capital gains tax compared to income tax will have "all sorts of consequences for investors, shrewd financial planners and product providers" .
"For both top rate and basic rate taxpayers, there will be significant advantages to receiving returns in the form of capital distributions rather than as income through dividends or interest payments," he said.

"Within F&C's product range we believe that there are several investments that will stand out as having considerable tax advantages.

"First, zero dividend preference shares have a clear advantage as all return is in the form of a capital gain. A good way to access this market in a diversified portfolio is through the F&C Progressive Growth Fund which targets the high quality end of this market."

"Second, the F&C BLUE Fund is an ultra cautious portfolio of circa 80% short dated debt instruments with some exposure to equities and a derivative overlay that is designed to provide returns in the form of steady capital growth. By taking regular capital distributions from the BLUE Fund, investors will find it very tax advantageous against savings accounts and cautious yield generating investments."

"Third, for investment trust fans the B shares of Investors Capital Trust are uniquely designed to distribute capital returns to an equivalent level of the trust's more traditional dividend yielding A shares. These B shares should also prove attractive tools for financial planners assisting higher rate tax payers."