Capital taxes

CGT rates of tax

Capital gains continue to be treated as the top slice of income. For 2003/04, rates continue to be aligned with those applying to savings income. Tapered gains are charged at 10% where gains plus total income do not exceed £1,960; 20% between £1,961 and £30,500; and 40% on any balance.

Share options

As expected the government has introduced measures to reverse the decision in the case of Mansworth v Jelley. Following the case, individuals with unapproved share options and Enterprise Management Incentives were able to reduce any capital gains arising on ultimate sale of the shares. The court held that for CGT purposes, the acquisition cost of the shares was deemed to be their market value at the time the option was exercised plus any amount charged to income tax on the exercise. This had the effect of reducing capital gains or turning capital gains into losses. Furthermore, in the right circumstances it was possible to get tax relief twice on sums that the taxpayer had never actually expended! As expected, the rules are being amended to prevent any further ‘windfalls’ and to restore the position to what it was generally thought to be before the case. The new rule takes effect for options exercised on or after 10 April 2003. The brief example above right shows the effect of the changes.

The case and Budget announcements do not generally affect shares acquired through approved Save As You Earn schemes or approved Company Share Option Plans.

Example

An employee was granted an unapproved option to acquire shares in his employer company at their market value of £10 per share. The option was exercised when the shares were worth £25 per share and then later sold for £28 per share.

Following Mansworth v Jelley
Taxable as income at exercise = £15 per share
CGT base cost of shares = £40 per share*
Capital loss on sale = £12 per share
* Market value at exercise (£25) plus taxable as income at exercise (£15).

Following Budget day announcements
Taxable as income at exercise = £15 per share
CGT base cost of shares = £25 per share
Capital gain on sale = £3 per share

Reporting requirements for capital gains

For tax returns from 2003/04 onwards, there will be fewer situations where the capital gains pages of the return need to be filled in. The pages will not need to be completed where the total gains after taper relief do not exceed the annual exemption unless either:

• the proceeds exceed four times that amount or
• there are allowable capital losses in the year.

Taper relief: definition of business asset

The definition of a business asset for taper relief purposes has been further relaxed although the changes will not take effect until 6 April 2004. Currently, the rules determining whether assets other than shares or securities qualify as business assets for taper relief purposes generally require that the owner of the asset uses it for trading purposes. The exception is where an investment property is let to an unquoted trading company. The proposed changes will mean that assets used for trading purposes will qualify as business assets irrespective of whether the owner is involved in carrying on the trade concerned.

Comment

These changes will be welcomed although the delay in their introduction will not. They will remove the current anomaly whereby an investment property let to an unquoted trading company constitutes a business asset but if let to a partnership (in which the owner is not a partner) it does not.

Other CGT changes

• The rules relating to capital gains and losses on disposal of second-hand life insurance policies have been tightened up.
• Legislation has been introduced to counter avoidance schemes known as ‘flip flops’ which sought to avoid a CGT charge when payments were made from offshore trusts to UK beneficiaries.
• The rules governing the deduction of capital losses realised on an ‘earn-out’ have been relaxed. An earn-out is an arrangement on the sale of shares or securities where part of the sale proceeds are deferred and dependant on the success of the business in the meantime.

Inheritance tax (IHT) threshold

The IHT nil rate band is increased in line with inflation to £255,000 with effect from 6 April 2003.

Comment

The prospect of a wholescale reform of IHT which was widely predicted when the Labour Party came to power in 1997 seems increasingly unlikely. However the failure of the increases in the nil rate band to keep pace with rising house values does nothing to help the individuals who find themselves potentially within the IHT net as a result.