Inland Revenue 16
17 March 1998
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CAPITAL GAINS TAX REFORM
A number of fundamental changes to the structure of capital
gains tax are proposed by the Chancellor in today's Budget.
The reform will help investment through encouraging
longer-term holding of assets by reducing the effective rate
of CGT on longer-held assets. It will stimulate
entrepreneurial activity by rewarding longer-term investment
in businesses. Gains on business assets that have been held
for 10 years or more will be taxed at a rate equivalent to 10
per cent or less.
The changes will lead to simplification of the CGT system by
progressively removing indexation, a major complicating
feature.
For those affected (individuals, trustees and personal
representatives) the proposals will:
withdraw indexation for periods after April 1998 (details
below);
reduce the amount of a chargeable gain according to the
period for which the asset has been held, with a greater
reduction for business assets than for others (details
below);
phase out retirement relief over a 5-year period (details
in press release Inland Revenue 17);
encourage the channelling of more equity capital into
smaller, higher risk companies by combining the best
parts of the Enterprise Investment Scheme and CGT
reinvestment relief (see press release Inland Revenue
13);
rationalise the charging structure for the gains of
trustees and personal representatives of deceased
persons (see press release Inland Revenue 18);
uprate the Annual Exempt Amount by statutory indexation
to a figure of 6,800 pounds (see press release Inland
Revenue 19).
Companies are not affected by these proposals, (but see press
release Inland Revenue 22, which announces a further review
of how their capital gains are taxed).
In the medium term the changes will be broadly revenue
neutral. In the longer term, the exchequer effect will
depend to a considerable extent upon movements in future
asset prices, any behavioural changes by investors and other
factors.
DETAILS
1. For those within the charge to capital gains tax
(individuals, trustees and personal representatives, but not
companies), indexation will be replaced by a taper which
reduces the amount of the chargeable gain the longer an asset
has been held. The effective rate of tax for longer-held
assets, particularly business assets, will be reduced. This
is part of the Government's initiative to encourage
longer-term investment and encourage entrepreneurship.
Indexation
2. For gains realised on or after 6 April, indexation
allowance will be given for periods up to April 1998, but not
thereafter. So for an asset held at 6 April 1998 and
disposed of after that date, indexation allowance will be
computed for the period from the date of acquisition (or the
date the expenditure was incurred) to April 1998, but not for
the period from April 1998 to the date of disposal. For
assets acquired on or after 1 April 1998 no indexation
allowance will be allowable in computing the chargeable gain.
Tapering chargeable gains
3. Indexation will be replaced by a taper. The taper will
reduce the amount of the chargeable gain according to how
long the asset has been held for periods after 5 April 1998.
The taper will be more generous for business assets (as
defined in paragraph 10 below) than for non-business assets.
The form of the taper will be:
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Gains on business assets
Number of complete Percentage Equivalent tax
years after of gain rates for higher
5.4.98 for chargeable rate / basic rate
which asset held taxpayer
0 100 40 / 23.00
1 92.5 37 / 21.27
2 85 34 / 19.55
3 77.5 31 / 17.82
4 70 28 / 16.10
5 62.5 25 / 14.37
6 55 22 / 12.65
7 47.5 19 / 10.92
8 40 16 / 9.20
9 32.5 13 / 7.47
10 or more 25 10 / 5.75
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Gains on non-business assets
Number of complete Percentage Equivalent tax
years after of gain rates for higher
5.4.98 for chargeable rate / basic rate
which asset held taxpayer
0 100 40 / 23.00
1 100 40 / 23.00
2 100 40 / 23.00
3 95 38 / 21.85
4 90 36 / 20.70
5 85 34 / 19.55
6 80 32 / 18.40
7 75 30 / 17.25
8 70 28 / 16.10
9 65 26 / 14.95
10 or more 60 24 / 13.80
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4. Assets which were acquired before today will qualify for
an addition of 1 year to the period for which they are
treated as held after 5 April 1998. This addition will be
the same for all assets, whenever they were actually acquired.
So, for example, an asset purchased on 1 January 1998 and
disposed of on 1 July 2000 will be treated for the purposes
of the taper as if it had been held for 3 years (two complete
years after 5 April 1998 plus one additional year).
5. For new assets, the point where the taper will compensate
for the loss of indexation depends on the rates of asset
growth and inflation. For example, with real asset growth
rates of 6 per cent and inflation of 2.5 per cent, a similar
tax liability will arise once business assets have been held
for about four years and once non-business assets have been
held for around seven years. With real asset growth of 3 per
cent and inflation of 2.5 per cent, a similar liability
would arise after about six and a half years for business
assets and after about ten years for non-business assets.
6. The taper will be applied to the net gains that are
chargeable after the deduction of any losses that are
suffered in the same tax year and of any losses that are
carried forward from earlier years. The Annual Exempt Amount
will then be deducted from the tapered gains. The allocation
of losses to gains for this purpose will be on the basis that
produces the lowest tax charge.
7. In certain special situations taper relief will operate
as follows in respect of holding periods after 5 April 1998:
where there has been a transfer of an asset between
spouses, the taper relief on a subsequent disposal will
be based on the combined period of holding by both
spouses;
for other no gain/no loss transfers and for gifts
hold-over relief, the taper will operate by reference to
the holding period only of the new holder;
where gains have been relieved under a provision which
reduces the cost of a replacement asset (such as
roll-over relief for business assets), the taper will
operate by reference to the holding period of the new
asset; and where a relief defers the gain on a disposal
until a later occasion (such as the relief on
reinvestment in a Venture Capital Trust), the taper will
operate by reference to the holding period of the asset
on which the deferred gain arose.
Treatment of shares and other securities
8. Acquisitions of shares and other securities are presently
"pooled", i.e. the individual acquisitions lose their
identity in the pool, which is treated as a single asset with
an overall average cost per share. The introduction of the
taper means that pooling will have to cease for acquisitions
on or after 6 April 1998. This is necessary so that the time
of each acquisition can be recorded and retained and each
treated separately from other acquisitions. New rules for
identifying shares disposed of with those acquired will apply.
Disposals after 5 April 1998 will be identified with
acquisitions in the following order:
- same day acquisitions (under the existing rule);
- acquisitions within the following 30 days (see press
release Inland Revenue 21);
- previous acquisitions after 5 April 1998, identifying the
most recent acquisition first (a LIFO basis);
- any shares comprised in the pool at 5 April 1998;
- any shares held at 5 April 1982;
- any shares acquired before 6 April 1965.
If the above identification rules fail to exhaust the shares
disposed of, they are to be identified with subsequent
acquisitions.
9. The share pooling rules for companies are unaffected by
these changes.
Definition of business assets
10. A business asset will be defined broadly as:
an asset used for the purposes of a trade carried on by the
individual (either alone or in partnership) or by a
qualifying company of that individual;
an asset held for the purposes of a qualifying office or
employment to which that individual was required to devote
substantially the whole of his time;
shares in a qualifying company held by the individual.
A company will be a qualifying company if it is a trading
company or a holding company of a trading group, and the
individual holds shares which entitle him to exercise at
least:
- 5 per cent of the voting rights in that company and the
individual is a full-time working officer or employee of
that company, or
- 25 per cent of the voting rights in that company.
The rules for business assets will be extended to assets held
by trustees and personal representatives.
11. Where an asset has been used partly as a business asset
and partly as a non-business asset throughout its period of
ownership, or the last 10 years of its period of ownership,
whichever is the shorter, the gain on the disposal of the
asset will be apportioned pro rata. Part of the gain will
qualify for the business asset taper over the whole period of
ownership and the other part for the non-business asset taper
over the whole period of ownership.
12. There will be rules to address possible exploitation of
the taper provisions. There will be a special rule for
assets held by trustees where the settled property originates
from a company.
NOTES FOR EDITORS
1. Capital gains tax is payable on gains realised by
individuals, trustees and personal representatives of
deceased persons. Companies pay corporation tax on their
capital gains. Broadly, a capital gain is the excess of the
sale proceeds of an asset over its acquisition cost, less a
deduction for indexation allowance reflecting inflation.
Only gains accruing over periods since March 1982 are taxed
but, subject to this, short-term gains are taxed in the same
way as long-term gains.
2. The indexation allowance is computed by uprating the cost
of an asset by the change in the Retail Prices Index during
the period of ownership of the asset. The calculation of the
allowance is a major complicating feature of the present CGT
system and its eventual withdrawal, together with the
withdrawal of retirement relief (see press release Inland
Revenue 17), will lead to significant simplification.
3. The present structure of CGT treats long-term gains and
short-term gains in the same way and, with the exception of
some special reliefs, does not generally distinguish between
business and non-business assets. The structural changes now
proposed are consistent with the Government's desire to
encourage long-term investment, particularly entrepreneurial
investment.
4. Comments were invited on the reform of CGT in the
Chancellor's Budget speech of 2 July 1997, followed by an
Inland Revenue Press Release of 29 July 1997. Some 170
responses were received, displaying a wide range of opinion.
A summary of the comments received and brief reasons why the
Government has decided on the present reforms are set out in
the attached Annex.
5. The reforms are expected to have a negligible cost in
1998-99, to cost 25 million pounds in 1999-2000 and to yield
25 million pounds in 2000-01. For later years, the exchequer
effects will depend to a considerable extent upon movements
in future asset prices, any behavioural changes by investors
and other factors.
6. A regulatory appraisal of these changes will be available
at the time the Finance Bill is published.
INLAND REVENUE PRESS OFFICE
ANNEX
RESULTS OF CONSULTATION
1. The reform of CGT follows consultation on the taxation of
capital gains, as announced in the July 1997 Budget. A total
of 171 replies were received in response to the Inland
Revenue's press release of 29 July 1997 (87/97), of which 75
were from representative bodies and companies and 96 from
individuals. The responses covered many issues and contained
a wide range of views. The Government is grateful for all
the responses received.
2. A minority called for the abolition of capital gains tax.
But other representations pointed out that this would not
provide for a fair tax system, and would also encourage
avoidance through the conversion of income into gains. The
Government believes that capital gains tax should be retained
for these reasons.
3. There was, however, a strong view that the present system
should be simplified. In particular, many respondents were
concerned about the extra complexity and costs caused by
indexation allowance. Some thought that this was not
necessary in a low inflation environment and so should be
abolished, while others suggested replacing it with something
else. The most frequently mentioned replacements were to
rebase acquisition costs or to introduce a taper on the
amount of the chargeable gain.
4. It was commonly suggested that having a taper in place of
indexation would favour long-term investment. Most who
commented on the point thought that this would be a good
thing, although there was also a view that it would not be
desirable to use the tax system to influence behaviour in this
way. Various forms of taper were suggested to reduce the
taxable gain over time, with many wanting it to operate over
a short period and to reduce the gain to zero. These
suggestions did not, however, consider the effects that such a
taper would have on the yield from capital gains tax.
5. The Government's proposals respond to these views by
abolishing indexation for non-corporate taxpayers for periods
after April 1998 and by replacing it with a taper. The taper
should both reward long-term investment and be simpler to
operate than indexation. It will not entail the significant
compliance costs that would be caused by regularly rebasing
the tax to meet the same objective.
6. The proposal for the taper also reflects a general desire
that the system of capital gains taxation should encourage
enterprise. This is achieved by having a more generous taper
for business assets. This taper will reduce the percentage
of the gain that is chargeable to 25 per cent (for assets held
for 10 years or more), which is equivalent to a reduction in
the rate of tax from 40 per cent to 10 per cent for a higher
rate taxpayer.
7. The business assets taper also responds to many of the
representations on retirement relief, which was criticised
for being too narrowly targeted and dependent on the
taxpayer's age. At the same time, some respondents suggested
that it should be abolished as part of the simplification of
capital gains tax. The taper relief will meet these
criticisms by being available to everybody who invests in a
business, and by depending only on the length of time that a
business asset is held. Phasing out retirement relief will
ensure that, while a generous relief continues to be
available on retirement, some tax is paid even on long-term
business gains.
8. Although very few responses dealt with the charging
structure for trusts, the Government considered it was
appropriate to remove the present treatment where different
types of trust are taxed at different rates. The proposal is
to tax all trusts at the rate applicable to trusts which
reflects the various rates that would have applied if the
gains had arisen directly to beneficiaries.
9. Many representative bodies argued for a more generous
treatment of the annual exempt amount (AEA), either through
an increased AEA, carry forward of unused amounts from year
to year, or an exemption based on the amount of disposal
proceeds. Individual respondents were much more evenly split
between those who wanted an increased AEA and those who wanted
it to be reduced or abolished. The Government has decided to
index the AEA this year in line with inflation.
10. Some comments were received on other areas where the
Government is not currently proposing any change. These
include rollover and gifts reliefs, interactions with IHT,
and the indexation of losses.
11. Although most responses concentrated on the treatment of
individuals, some representations were also made about the
capital gains of companies, including the treatment of
capital losses within groups of companies. The Government
wishes to give further consideration to these issues, and to
how the reform package for individuals will affect companies
generally (see press release Inland Revenue 22 for further
details).
12. The consultation exercise was generally welcomed.
However, some representative bodies found it hard to comment
in detail and asked for further consultation as proposals
developed. The Government agrees that more detailed
consultation may be appropriate on certain issues, but felt
that it was not needed for the structural changes that are
proposed in this Budget to encourage enterprise and long-term
investment by individuals.