The IoD's View

Capital gains tax (CGT) penalises the creation of wealth and inheritance tax (IHT) penalises the passing on of wealth to the next generation. CGT is a substitute for income tax, but it needs to recognise the nature of long-term gains. Inheritance tax should simply be abolished as soon as possible.

Key Points

• CGT is imposed on disposals of most capital assets, including shares, land and buildings and most assets used in businesses. Such assets are typically held for extended periods, for the use that can be made of them or the income that can be derived from them. Over their holding period they can increase considerably in value, at least partly because of inflation. When they are sold, they can generate large tax bills. accumulated annual exemptions for gains go to waste if they are not used in-year. If an asset is held for ten years and then sold, only one annual exemption is available, not the ten which have arisen during the period of ownership. For all of these reasons, it would be inappropriate to tax gains just as if they were income, unless the income tax rate were first reduced significantly.
  
  
• Up to 5 april 2008, gains made by individuals were reduced by taper relief before being taxed at income tax rates. Taper relief depended on the length of ownership of an asset. If a business asset was held for at least two years, only 25% of the gain was taxed. If a non-business asset was held for at least ten years, 60% of the gain was taxed. at the Pre-Budget Report in October 2007, the Government announced that from 6 april 2008, there would be no taper relief and all gains would be taxed at 18%. The IoD lobbied strongly against these proposals as they stood, both in public and in private. as a result, a new entrepreneurs’ relief was announced in January 2008. £1m of gains per person (over a lifetime) arising from the sale of shares in trading companies where the seller has a stake of at least 5% and works in the business, or from the sale of trading businesses, will be scaled down by 4/9 so that the effective rate is 10%. This is an improvement, but the complete package will still significantly increase tax revenue.
  
  
• Companies do not pay CGT, but their gains are included in their profits chargeable to corporation tax. There is no taper relief, but indexation allowance, which takes purely inflationary gains out of charge, is given. The Government announcement of the withdrawal of taper relief and the introduction of an 18% rate did not apply to companies.
  
  
• IHT applies when assets are passed on, either on death or within seven years before death, and on transfers of assets into trusts. It applies to wealth passed on, even though that wealth will often represent income that was taxed when it was made. Thus IHT is a form of double taxation.
  
  
• IHT also deters the accumulation of wealth to fund people’s needs in old age because people recognise that they might die earlier than expected, leaving accumulated wealth to their children. They are naturally reluctant to leave a proportion of their wealth to the state. and as life expectancy increases, many people die as their children approach retirement. a full inheritance could provide a useful boost to the children’s pension provision. If the state takes a bite, then that opportunity to make the children financially independent in retirement is correspondingly reduced.
  
  
• IHT has a 0% band (the nil rate band) of £312,000 of transfers (the 2008/09 figure), and then a 40% rate applies. Transfers are cumulated for seven years – the nil rate band is not an annual allowance. Spouses and civil partners can pass on assets to one another free of tax. They can also pass on unused nil rate bands to one another. So if the first spouse or civil partner to die has not made transfers within the seven years before death, the whole of his or her nil rate band will become available to the survivor, potentially giving him or her two full nil rate bands to set against his or her estate on death.

Q & a

Q. What is the IoD’s view on the CGT changes announced at the Pre-Budget Report in October 2007 and in January 2008?

a. Our main concern is that these changes raise significant extra tax revenue. This comes not just from the withdrawal of taper relief, but also from the withdrawal of indexation allowance that was accumulated from 1982 to 1998. So although the changes represent simplification, it is a very expensive simplification.

Clearly the Government should have consulted on these changes, given that it was decided to announce the changes six months in advance anyway. The Government did however respond to some business concerns by introducing entrepreneurs’ relief. This will help many smaller businesses, although the limit of £1m over a lifetime will be a constraint on some serial entrepreneurs and there will be complexities in identifying which assets qualify for the relief.

Q. Should CGT be abolished?

a. There is a hazy, and permeable, boundary between income and gains. If there were no CGT at all, huge efforts would be made to get income treated as gains. (Substantial efforts are already made by some people.) It is also not clear that all capital gains are so qualitatively different from income that they should not be taxed. There would be a case for not taxing long-term gains, which would be clearly identified by the length of time for which the relevant assets had been held. Indeed, the IoD proposed a taper down to zero after ten years early in 2007. But now that the Government has announced the abolition of taper relief, the more immediate aim must be to get rates of tax down.

Q. Does IHT really matter to the IoD, given that many businesses are exempt from tax by virtue of business property relief?

a. Yes, IHT matters a lot to the IoD. It is true that businesses are often exempt, which avoids any direct need to sell them or break them up in order to pay IHT liabilities. But a typical estate will include a house as well as a business. That can impose a very difficult choice on a family: sell the house or sell the business. allowing unused nil rate bands to be passed on to spouses and civil partners will help: many houses are worth more than the nil rate band, but far fewer houses are worth more than twice the nil rate band.

another reason to be concerned about IHT is that it deters people from building up their savings in order to remain financially independent in retirement, and reduces the extent to which inheritances can be used to boost the retirement savings of heirs. The IoD wants to see pensioners be independent of means-tested benefits, rather than have them be a burden on future taxpayers.