Threat of rise in Capital Gains Tax

June 1st 2010

There will be ‘generous exemptions’ for entrepreneurs as under the old regime reformed by Alistair Darling in 2008.  Before 2008 CGT was charged at the taxpayer’s marginal rate of income tax – which most agree makes sense – and businesses were given tax concessions which meant they paid only 10% CGT on profits of up to £1 million.  The CGT increase was widely expected – whoever won the election – and will be used to fund a significant increase in personal tax allowances to be implemented in April 2011 – although not necessarily an immediate full increase to £10,000 proposed by the Lib Dems in their manifesto. 

So what should investors be doing?  If you were thinking of realising assets like a buy-to-let property – which will take some time to sell – now is the time to go ahead.  Spring is the ideal time to put property on the market and with interest rates at an all-time low and lending criteria easing (buy to let mortgages at up to 80% loan to value are now coming back) there should be healthy demand for properties as a result of considerable pent up demand and a shortage of properties for sale. 

For sellers it will be a case of ‘first up best dressed’ with early sellers probably getting the best prices as there is bound to be a substantial increase in properties coming to the market.  Also, in the owner-occupier market, sellers and buyers are likely to even things out.   But higher CGT will certainly impact on buy-to-let as the possibility of higher rates of tax could deter investors. 

Many buy-to-let investors are relying on capital gains to make buy-to-let worthwhile as they are currently generating no income from their investments after they have paid interest charges.  They will make even less, or be forced into subsidising interest charges out of other income, once interest rates start to rise.  If capital gains are subsequently taxed at up to 50%, this would act as a powerful disincentive to invest.  Second homes are a more difficult call as many owners will want to keep their holiday home.  But it could precipitate sales amongst those coming up to retirement who were going to downsize anyway.

Buyers, in particular first time buyers, might do better to wait until the increase in property for sale brings prices down – or at the very least stabilises rising prices which is what most mortgage lenders and the Royal Institution of Chartered Surveyors were predicting before any CGT increases. 

The market was already moving anyway with the National Association of Estate Agents reporting the biggest jump in sellers since August last year, while there was also an increase in the number of potential buyers.  The NAEA said estate agents had an average of 62 properties on its books during April, up from 60 in March and the third consecutive monthly increase. There was also a small increase in buyers, rising to 278 per branch from 274 in March.  At the moment it is still a sellers' market – but that could change rapidly with the prospect of CGT at 40% or more.

Selling more liquid assets like bonds, shares and mutual funds, which can be executed instantly, can wait until the most opportune moment – which may in fact be sooner rather than later.  The stock market clearly liked the news of the coalition and was up a few points in early trading but was broadly neutral.   

Share prices are more likely to be impacted by the turmoil in Europe or a worldwide sovereign debt crisis, so now could be a good time to take some profits and perhaps stay out of the market until it becomes clearer whether the EU rescue for Greece, and the other Club Med economies which are under pressure, is working and we can see where share prices are going.  Don’t forget the old adage, ‘sell in May and go away.’  Emerging markets – the BRIC countries – might remain immune to what is happening in Europe.  But don’t bank on it.

It could, in any case, be a mistake to sell shares and bonds in a hurry, before we see the detail of changes in CGT for non-business assets.  The new government could go for a root and branch reform, taxing short term gains at income tax rates but giving relief for purely inflationary gains to long term holders of assets.   This would be welcomed by investors – but would create problems for accountants and stockbrokers if it involved a return to indexation which is a nightmare to implement.   A possible compromise might be to retain the flat rate of 18% (which is in line with CGT rates in much of the EU) for gains on assets held for, say, five years or more.

If the coalition goes for a full reform of the CGT, any increases might be delayed until April of next year while the details are worked out.  Investors are advised not to act hurriedly until more detail is known. 

If you would like to speak to one of our advisers, please call 0113 287 8200 or e-mail advice@prosperis.co.uk