Making the tax system simpler is an admirable aspiration but it does not necessarily make it fair. The recent changes in the capital gains tax rules, or at least in calculating the charge to capital gains tax demonstrate this amply.
As expected and as heralded well in advance by the Coalition, the rates of capital gains tax were increased. Although effectively for basic rate taxpayers the main rate stayed at 18%, for the majority including the basic rate taxpayers deemed to go into the higher rate threshold by dint of their gains will find themselves taxed at 28%. There were a lot of howls about the anticipated increase before it happened. People were afraid that the rate would be increased to 40% or even 50% for the new super-taxpayers, but this has not happened, and was never likely to.
People have short memories of course, and prior to April 2008, the headline capital gains tax rate was usually 40% for investment gains as opposed to business gains. What we had then was taper relief, which could reduce the post 1998 gain charged by 40%, so in fact few people would have suffered a full 40% whack of tax after allowances unless their gains were very short term. Business taper relief reduced the gain by 75% after two years giving an effective rate of 10%.
After April 2008 and up to 22nd June 2010 the main capital gains tax rate was 18%. There was a lifetime “Entrepreneur’s Relief ” on business gains up to £1,000,000. This would be typically in respect of the sale of a business or an interest in a business and again gave an effective 10% tax rate though as mentioned, only on the first million.
Post June 2010 the position is
- Higher rate tax payers will pay 28% tax
- Those who do not breach the higher rate threshold will pay 18%
- The 10% rate for entrepreneurs will be extended to the first £5m of lifetime business gains
- The annual exempt amount for capital gains tax will remain at £10,100 for 2010-11
The main difference between what was the pre-April 2008 regime and the the two subsequent revisions is that there used to be some acknowledgment of the ravages of inflation. Taper relief in the period 1998 to 2008 took account of this if in a rather arbitrary fashion. On assets held prior to 1998 and post 1982 there was indexation allowance based on the retail price index.
The flat rate system Mr. Darling introduced a couple of years ago was wonderful for those who realised investments that they perhaps hadn’t held all that long. A rate of 18% was very acceptable. However, it was not very kind to those who had held assets longer since we must remember that the pound in your pocket in 1982 (if you were alive to have one) would have been worth about 38p by March 2008 and 35p now.
On a short-term gain the post June 2010 flat tax of 28% is still very acceptable. However, suppose one had an asset since 1982 which had cost £100,000 then and had only increased in value by an amount equivalent to the RPI.
In 1982 Mr. X buys a painting by a modern artist for £100,000. Although a lot of art has increased considerably in real value, this artist has rather gone out of fashion. In July 2010 Mr. X sold his painting for £282,000, which coincidentally is close to the increased value as per the RPI. In real terms, Mr. X hasn’t made a bean. Just the same, after deducting his generous £10,100 allowance he has to pay tax of over £48,000 just for keeping an important art work safe for the nation and not even taking into account twenty-eight years of insurance premiums and burglar alarm maintenance.
The Government has announced that it wishes to simplify the tax system, and I applaud that. However, simple doesn’t always mean fair. It is not fair to Mr. X.
Mr. Darling’s simple system was not fair to many employees who bought into share schemes with some expectation that they knew how much tax they would have to pay, but that’s another story.
© Jon Stow 2010