Should you sell shares now to avoid a big bill in April?

14 October 2007 - Source: http://business.timesonline.co.uk/tol/business/mon

Ordinary investors will be hit by curbs on private equity bosses, from those in employee share plans to owners of farmland

Up to 2m employees with shares in their firms could be unintended victims of Alistair Darling's clampdown on private-equity tax breaks.

The tax on any profits above their annual allowance when they sell their shares could nearly double from 10% to 18% in April, if they are higher-rate payers. The situation for basic-rate payers is even worse - their tax rate could more than triple, from 5% to 18%.

The capital-gains tax (CGT) clampdown will also hit ordinary investors in the Alternative Investment Market (AIM) and other unlisted shares, as well as farmland and even holiday lets.

Stockbrokers predict a wave of selling as investors try to beat the new rules. Roy Maugham of accountant UHY Hacker Young said: "I expect that there will be a rush of AIM and company investors looking to sell before next April to take advantage of the lower rates of taper relief."

However, advisers are urging investors to hang on to shares in good businesses, regardless of their new tax position.

Darling's move was designed to crack down on the bosses of private-equity funds that take firms off the stock market, overhaul them and then sell them on for multi-million pound profits.

Under the old tax regime, they qualified for business asset taper relief, which cut the higher rate of CGT from 40% if the asset had been held for less than 12 months, to 20% for less than two years, and to 10% thereafter - hence the comment that private-equity fund bosses could pay at lower rates than cleaning ladies.

Critics deemed this unfair because the taper relief on the more widespread nonbusiness assets, such as main-market shares, holiday homes and buy-to-lets, was less generous.

The rate fell from 40% if the asset had been owned for less than three years, to a minimum of just 24% after 10 years or more – more than double the rate for business assets.

Darling has overhauled the complex taper-relief regime and introduced one CGT rate of 18% from April, no matter how long you have held an asset or if it is business or nonbusiness.

Private-equity bosses who paid as little as 10% will now pay a flat rate of 18% - but so, too, will millions of ordinary investors. The tax on a £10,000 profit above the CGT allowance - now £9,200 - could leap from as little as £500 to £1,800.

Big companies such as Marks & Spencer, Tesco and Sainsbury are said to be worried by the changes, which will hit thousands of workers in employee share schemes – many of them shop staff on the basic tax rate.

IFS Pro Share, which promotes employee share schemes, said: "Whilst the Treasury may have sound reasons for simplifying CGT, it would appear the consequences for employees saving through share plans had not been fully assessed. These apparently unintended consequences contradict the government’s oft-stated commitment to encouraging long-term saving and to their support for wider share ownership."

Here, we look at who loses out and what they should do.

Company share schemes

About 1.7m workers have a save-as-you-earn scheme, also known as Sharesave, and could be hit by last week’s changes. They do not affect firms with share incentive plans (SIPs).

Under the SAYE scheme, you can pay in up to £250 a month for three, five or seven years, after which you get the option to buy your company’s shares at a 20% discount to the price when you started the scheme.

The previous taper-relief system encouraged you to hold the shares - if a higher-rate taxpayer sold straightaway, they would pay CGT at 40%, but if they held for two years, the rate would be just 10%. Now you would pay 18% in either case - penalising people who want to hang on to shares, even though the schemes were designed to encourage share ownership.

Some analysts point out that the average saved into save-as-you-earn schemes is below the capital-gains tax allowance. However, some people may have much bigger gains. BT, for example, said that someone who saved the maximum £250 a month into its scheme for five years, which is due to mature in August, could net a gain of £16,625 because the option price is just 154p compared with a current price of 314.8p.

This gain would be subject to tax at 18% above £9,200, or £1,336, after April. If the investor could have sold today, they would have paid just £743.

Greg Limb at KPMG, the accountant, said: "The prebudget report held a bizarre twist in that the government has said it will no longer provide a favoura-ble tax regime for employee share holdings.

"From April, they will be 8% worse off when they dispose of their shares than at present whereas an investor who doesn’t work for the business could be up to 22% better off."

However, financial advisers said you should not necessarily sell your shares straightaway. Elizabeth Woodman of Practical Law said: "There is a lot you can do to avoid tax altogether. You can split your holdings before you sell to use both CGT allowances. You could also reinvest the proceeds in an Isa, or a pension to avoid tax."

AIM shares

Hundreds of thousands of investors buy portfolios of shares listed on AIM because they become exempt from inheritance tax once you have invested in the portfolio for two years.

However, they now face bigger capital-gains bills. If the portfolio manager sells a stock, investors must pay CGT through their tax return – and the rate for a higher-rate taxpayer will now go up from 10% to 18% in April.

Analysts expect AIM to fall sharply next year as investors who have made big gains sell to avoid the higher rate.

Graham Neale of Killik, the stockbroker, said: "People always sell at the end of the tax year to use up their allowance, and it is inevitable that this will be more marked next year. In 2005, for example, the market fell nearly 7% in the month to the end of the tax year."

Holiday lets

People with second homes had been able to take advantage of the lower rate of CGT on business assets – until last week. While your primary family home is exempt, profits made on second properties are taxable. By turning your second home into a furnished holiday let, you qualified for business-asset taper relief and paid the lower 10% CGT rate after two years – though you had to adhere to strict rules.

The property had to be available to the public for at least 140 days a year; lettings had to amount to at least 70 days; it must be fully furnished; it must be let at a market price; and could not be occupied by the same person for more than 31 days in any seven months. That prevented student lets qualifying.

Farmland Farmland could suffer its first fall in value for 10 years because of the budget changes, according to agent Cluttons.

Investors have been snapping up rural land because of the tax perks - one of which was business-asset taper relief. Investors could claim the 10% tax break on any profits from land let or contracted to a farming business.

Long-term farmers will also lose indexation allowance, which means you only pay tax on gains above inflation. It has virtually wiped out the gains on farmland over the past couple of decades.

Take a 500-acre farm with buildings owned in 1982, worth £900,000, and sold in 2008 for £2m. A sale before April would result in a tax charge of just over £12,000, while a sale after this date would lead to a 1,522% increase in tax to over £196,000.

Simon Dixon-Smith of Savills said: "People who were thinking of selling anyway should certainly do so before April."

Enterprise investment

Enterprise investment schemes back small high-risk companies and benefit from tax breaks – not least the ability to roll over gains from other assets to defer CGT. The tax had to be paid when the EIS shares were sold, and they previously qualified for business asset taper relief, but this will no longer be available.

ESCAPE TAX ON STOCKS

Use a spouse's capital-gains tax exemption

If you want to sell assets that have produced strong gains, consider putting half the assets in your spouse's name before you sell, to use his or her CGT allowance. That way, you can realise profits of £18,400 between you without paying tax.

There is nothing to stop you having assets in your spouse's name for income tax purposes, but then switching them back into joint names when you want to sell.

Sell gradually

If you have a particularly big gain, you could sell your holdings gradually so that you use up several years’ allowances to shelter the entire gain from capital gains tax.

Use your Isa allowance

If you know your company share scheme is likely to mature with a big gain, keep your Isa allowance free. If you transfer your shares into an Isa before you sell, they will be free from capital gains tax.

Pay them into a pension

Shares from certain employee share plans can be transferred directly to a pension scheme. In some cases, the tax payable as a result of the share scheme can be cancelled out by the tax relief given on the associated pension contribution.

ENTREPRENEUR HIT BY MEASURES

Roger Kendrick, 52, from Buckinghamshire, started to invest in smaller private firms 10 years ago when he sold his shipping business, but he now faces a higher-tax bill from April.

He sometimes invests in private firms direct, sometimes through private-equity funds and sometimes through network Hotbed, which pools assets from several wealthy investors to take stakes in private firms.

Hotbed members, for example, have provided £5.15m of funding for nursing home group Mimosa.

Kendrick said: "I think the capital-gains tax measures are very damaging to entrepreneurs in this country.

"The taper relief system was designed to encourage investment in smaller firms and was certainly one of the factors that encouraged me to go in, but I now face a bill of 18% rather than 10% on my long-term investments.

"I also have property investments, so I will benefit from a lower rate of tax on those.

"But overall I would say that I am a net loser from the prebudget report," he said.

 

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