On 9 October 2007 the Chancellor announced, as part of his pre-budget report, that taper relief would be abolished with effect from 6 April 2008, and that, from the same date, a single 18% rate of tax would apply to capital gains realised by individuals. Although a rate of 18% is lower than the marginal rate of capital gains tax, which currently stands at 40%, it is significantly higher than the 10% effective rate of tax associated with full business asset taper relief.
The announcement drew fierce criticism from industry. There has been widespread criticism that no consultation was offered. Amongst other matters, it was suggested that the new regime would have a significant adverse effect on the competitiveness of the UK, affecting small businesses in particular as well as the attractiveness of the UK to private equity, hedge funds, and asset managers generally. The latter point is closely linked, of course, to the fact that workers within these sectors have, since the introduction of taper relief in 1998, been able to receive a significant proportion of their compensation in the form of capital, taxed at 10%.
In response to the pressure, the Chancellor announced that a review of pre-budget proposals in relation to CGT would be taking place. Initially, there was an indication that the results of the review would be available before the end of 2007, but a later announcement confirmed that any modification of the proposed new rules would not be available until early in 2008. This in itself resulted in intensified pressure on the Chancellor to provide some form of transitional rule, or at least to delay the coming into force of the new regime. Given the profound effect that the new rules could have on existing arrangements and structures, it was felt by the business community that an opportunity to restructure prior to implementation should be given.
The new regime
With all this in mind the Chancellor’s announcement late last week, on 24 January, was received by many business circles with disappointment. In summary, the message is as follows:
- The new CGT regime, including the abolition of taper relief and the introduction of the 18% flat rate will, as previously planned, take effect from 6 April 2008;
- No interim regime or transitional rules will be introduced;
- The only exception to the new 18% flat rate will be the newly introduced "entrepreneurs’ relief".
At the time of writing, draft legislation for the implementation of the new relief is not yet available, but the announcement on 24 January provides some details. In summary the relief will provide for the first £1million of lifetime gains on qualifying business assets to be charged to CGT at a rate of 10%. For these purposes qualifying business assets include the assets of an unincorporated business, as well as shares in a trading company, provided the individual making the disposals is or was an officer or employee of the relevant company, owns at least 5% of the ordinary share capital of the company and is entitled to exercise at least 5% of the voting rights.
While owners of small businesses may find the relief beneficial, the relief is unlikely to be of much relevance to the private equity or hedge fund sectors (where it would be unusual for individuals, other than founders, to hold at least 5% of the ordinary share capital). Similarly the relief is likely to be of little relevance to founders of companies who take their company public or who participate in a trade sale, in circumstances where the gain crystallised on an exit is many times far in excess of the £1million lifetime cap. Furthermore, the ubiquitous employee equity plans, which in the last decade have been relying heavily on the availability of business asset taper relief, and the associated 10% effective rate of tax, are unlikely to qualify for the relief, again because most executives are not likely to hold 5% or more of the equity.
In all such cases, as well as many others, the new regime, even taking into account entrepreneurs’ relief, represents a significant hike in tax rates.
The coming months and beyond
Immediate reactions following the pre-budget report suggested that investors sitting on significant pregnant gains eligible, under the current rules, to full business asset taper relief, are contemplating accelerated disposals, pre April 2008 (whether for the sole purpose of triggering a tax charge at the lower rate while this is available, or in the context of an ultimate exit). The Chancellor’s message, in response to public pressure, that the pre-budget announcement was being reviewed, put almost all such planning on hold. We suspect that last week’s announcement, which confirms the thrust of the pre-budget report so far as CGT is concerned, will see a revival of such planning, albeit that investors have now been left with little time before the new rules take effect.
In this context, it is important to note that the tax legislation can give rise to disposals for CGT purposes (and hence the crystallisation of a taxable gain), in a variety of circumstances, not all of which require that ownership or control over the relevant assets (usually shares) is lost. It is therefore possible to contemplate transactions before 6 April 2008 which allow investors to benefit from the lower rate of tax available under the current rules, whilst retaining the relevant assets pending an actual future exit. The cost associated with doing so is that, in the absence of any relief, tax would arise earlier than originally contemplated. Strategies involving such planning are probably most suitable where an actual exit is expected in the near to medium term.
In the longer term, some anecdotal evidence is emerging that private equity and hedge fund firms are beginning to migrate to other jurisdictions, with friendlier tax regimes, in response to the changes announced in the pre-budget report in relation to the UK remittance basis of taxation, and the taxation of non-residents generally. It remains to be seen whether the combined effect of these changes and the new CGT regime will indeed have a noticeable effect on the presence of asset management businesses in the UK.