Individuals, trustees and personal representatives
In summary the following CGT rate changes have been enacted:
- there is a special 10% rate that can only apply to gains with respect to which a valid ER claim has been made;
- for non ER disposals occurring on or after 23 June 2010:
- trustees and personal representatives are subject to tax at the fixed rate of 28%
- individuals are subject to a standard 28% rate of CGT, for gains realised on disposals effected on or after 23 June 2010, with a potential 18% rate applying to all or part of the gains where the individual does not pay tax on any income at the higher rate or dividend upper rate.
An increase in the ER lifetime allowance to £5 million was also announced from 23 June 2010.
As a result of the rate change being mid-year there are special transitional provisions for 2010/11. These are discussed in detail on pages six to ten. Broadly:
- capital gains treated as accruing to the taxpayer between 6 April 2010 and 22 June 2010 (inclusive) are not included in determining whether the 18% rate applies to all or part of the capital gains;
- where an individual returns to the UK in 2010/11 and is caught by the TCGA 1992 s 10A (temporary nonresidents) provisions the gains treated as accruing to him/her are deemed to have accrued prior to 23 June 2010 such that the fixed 18% rate applies (F (No 2) A 2010, Sch 1, para 19);
- remittance basis users:
- remittance basis gains are treated as accruing on the day that the gain is remitted to the UK meaning that a gain that was remitted prior to 23 June 2010 will be taxed at the fixed 18% rate and a gain accruing after that date will be taxed under the new regime;
- where the ITA 2007 s 809I provisions apply for 2010/11 (the individual is a long-term UK resident who has made the remittance basis claim, paid the remittance basis charge and remitted nominated income or gains prior to remitting all remittance basis foreign income for tax years 2008/09 onwards) the foreign chargeable gains deemed to have been remitted in the year will be treated as remitted prior to 23 June 2010 such that the fixed 18% tax rate will apply;
- for 2010/11 gains attributed to the settlor of an offshore trust under the CGT settlor charge provisions will be deemed to have accrued prior to 23 June 2010 and so subject to the fixed 18% tax rate regardless of when in the tax year the disposal was effected;
- for 2010/11 gains attributed to a beneficiary of an offshore trust under one of the CGT beneficiary charge provisions will be:
- subject to tax at the fixed 18% if they are matched to a capital payment made prior to 23 June 2010; and
- taxed under the provisions of the new regime if made after that date:
- for remittance basis users to lock in the fixed 18% rate the capital payment must have been remitted prior to 23 June 2010.
The change in the way that ER is granted (with the introduction of the special 10% rate rather than relief being through the mechanism of a reduction in the qualifying ER capital gain) has also resulted in changes to the rules with respect to ER and qualifying corporate bonds and ER and EIS CGT deferral relief. The changes, which are not beneficial to the taxpayer, are discussed in detail from page 11 onwards.
Apart from the change to ER the Finance (No 2) Act 2010 provisions do not impact on the actual computation of chargeable gains (there has been no return to the taper relief regime and no relief was introduced for inflationary gains). As such many of the features of the regime resulting from the Finance Act 2008 changes are still in place.
The old and the new regimes
For those taxed on the arising basis the old regime will apply where gains arise directly to individuals, trustees or personal representatives and the date of disposal is prior to 23 June 2010, namely:
- fixed 18% rate;
- ER lifetime aggregate limit of £2 million between 6 April 2010 and 22 June 2010 (inclusive).
Disposals after 23 June are subject to the new regime:
- 10% ER rate, the 28% tax rate and 18% where gains are within the individual's basic rate tax band (explained on page 3);
- ER lifetime aggregate limit of £5 million.
See pages 4 to 5 for an analysis of the situation where the individual is a remittance basis user.
Note that given the importance of being able to show when in the tax year a transaction occurred good record keeping will be essential. The retention of documentary evidence to prove when a disposal took place (or when a capital payment was made in the case of an offshore trust) will be vital in the event of an HMRC challenge.
Set off of losses and the CGT annual exemption
For 2010/11 and subsequent tax years a the new legislative provision provides that where gains are subject to CGT at different rates the following may be deducted from those gains in the most beneficial manner for the taxpayer:
- allowable capital losses; and
- the CGT annual exemption.
This provision is subject to any other provisions in the CGT legislation which restrict the use of losses such as:
- the clogged losses anti-avoidance legislation; and
- the losses order of set off for a remittance basis user who has made the TCGA 1992 s 16ZA capital losses election.
Differential tax rates for individuals: the standard rules
Where a claim is made, qualifying ER gains are subject to tax at the special 10% rate regardless of whether the taxpayer is a basic, higher or additional rate taxpayer. It may be that a disposal realises a gain which, either on its own or when aggregated with prior qualifying ER gains on which the individual has claimed ER, will be in excess of the individual's lifetime limit. In such a case only the part within the lifetime limit will qualify as an ER gain and be subject to the special 10% rate. Any excess gain will be taxed in the same way as for non ER gains.
Where gains realised are non ER gains one has to establish whether the 18% or 28% tax rate applies or whether part of the gains is subject to tax at 18% with the remainder being taxed at 28%.
The 28% rate will always apply to non ER capital gains where any part of the taxpayer's income is taxable at either the higher rate or the dividend upper rate. It is where there is no income taxable at the higher rate or the dividend upper rate that the 18% rate may be in point. Where the amount on which the individual is chargeable to capital gains tax (that is the aggregate gains after deduction of losses and the CGT annual exemption) exceeds the unused part of the individual's basic rate band he or she will pay CGT:
- at 18% on the gains within the basic rate band; and
- at the rate of 28% on the excess.
The level of the basic rate band is determined by the legislation. This provides that for 2010/11 the standard basic rate limit is set at £37,400 and that it is increased in some circumstances. The circumstances given are where there are:
- grossed up gift aid payments (ITA 2007, s 414(2)); and
- grossed up personal pension contributions coming within FA 2004 s 192 (4).
It will, therefore, be necessary to determine whether an individual has made such payments and if so establish the amounts and aggregate these with the standard limit to determine the figure to use for the individual in computing the unused basic rate band amount.
The unused part of the basic rate band is the amount by which the individual's basic rate band (defined above) exceeds the individual's taxable income. The individual's taxable income is the aggregate of the various components of his or her income after this aggregate figure has been reduced by any personal allowance due to him or her (including any age related element), blind person's allowance (where appropriate) and any permissible deductions (such as trading losses) attaching to specific components of his or her taxable income. Note that there are a number of specific provisions which adjust the income figure downwards where particular provisions apply such as where deemed gains from contracts for life assurance are included within the individual's income and top slicing relief applies.
In carrying out the calculation to determine whether there is unused basic rate band any ER gains in the tax year must be taken into account and treated as forming the lowest part on which the individual is chargeable to CGT. In simple terms ER gains are taken as using up the basic rate band in priority to non ER gains. Qualifying ER gains are likely to be material, and so where an ER claim is made in a tax year it is unlikely that non ER gains will fall within the basic rate band. Accordingly, where a valid ER claim is made for a qualifying gain chargeable in the tax year any non ER gains chargeable in that tax year (including those which would qualify for ER but for the taxpayer having utilised his lifetime allowance) are likely to be taxed at 28%.
Specific transitional provisions specify that for 2010/11 when determining whether there is any unused basic rate band one ignores gains accruing prior to 23 June 2010. This means that establishing whether the individual has any unused basic rate band (such that all or part of the gains accruing in the tax year are taxed at 18%):
- for individuals taxed on the arising basis in 2010/11 gains realised prior to 23 June 2010 are ignored; and
- for individuals taxed on the remittance basis in 2010/11 one ignores:
- UK gains realised prior to 23 June 2010; and
- remittance basis foreign chargeable gains remitted prior to 23 June 2010.
Note that there are no such disregard provisions with respect to income for the period between 6 April 2010 and 22 June 2010 so all income for the tax year must be taken into account.
The CGT rate for trustees
Trustees (whether the trust is an interest in possession settlement or an accumulation/discretionary trust) are subject to a fixed 28% tax rate with respect to disposals effected on or after 23 June 2010. The fixed 18% rate applies to disposals effected between 6 April and 22 June 2010 (inclusive).
Note that the specific trusts for vulnerable beneficiaries' provisions are unaltered. For CGT purposes where the election has been made, broadly, the trustees are liable for the CGT, but their liability is reduced to the amount of capital gains tax the vulnerable person would have paid if the gains had accrued directly.
Trustees may be able to access the special 10% ER rate but it should be remembered that the qualifying conditions are strict. ER will only be available where there is a qualifying disposal of trust business assets and a qualifying life tenant who has unused ER lifetime allowance and he or she is willing to allow this to be used in relation to the trust gain.
Trusts and sub-fund elections
The trustees of a settlement may elect that a fund or other specified portion of the settlement property (referred to as the 'sub-fund') should be treated as a separate settlement ('the sub-fund settlement') for both income tax and capital gains tax purposes.
The election is deemed to split the sub-fund off from the principal settlement such that for tax purposes the settlements are treated as two separate trusts (although under trust law there is still the one settlement). Such an election may be helpful where there is a range of beneficiaries (for example a generational family trust). The election crystallises a deemed disposal, of the settled property which will constitute the sub-fund, by the trustees of the main trust with the deemed proceeds being the market value of the property and its acquisition at market value by the trustees of the sub-fund.
The sub-fund election is irrevocable and specific terms have to be met (for example the sub-fund and the principal settlement cannot have common beneficiaries) in order for the election to be valid. The deemed CGT disposal is treated as having been made at the start of the date on which the sub-fund election is treated as having been made.
Provided it is made in time a valid sub-fund election is treated as taking effect from the date shown on the sub-fund election form (note that the specified date cannot be later than the date on which the election ismade). For example for an election to take effect from 6 April 2010 it must be made by 31 January 2013 (that is by the first anniversary of the 31 January following the end of the 2010/11 tax year).
The ability to back date the time from which the sub-fund election is deemed to have effect such that a deemed gain prior to 23 June 2010 can be achieved provides a means for the fixed 18% CGT rate to be locked in for pregnant trust gains. It should be noted though that one can only backdate where the specified conditions were met on the date one wants the election to be effective from and at all times between then and when the election is made. Where the necessary conditions were met backdating to crystallise prior to 23 June 2010 will accelerate the payment of CGT (assuming that an actual disposal of the assets later in 2010/11 was not contemplated).
If it can be done then depending on cash flow within the settlement and whether the assets pregnant with gains would ever be sold (it being counter-productive to transfer to a sub-fund assets pregnant with gain that will never be sold) it may be worthwhile for trustees to consider making a sub-fund election and backdating the effective date to prior to 23 June 2010. Before any action is taken specialist advice should be taken and the situation considered in the round.
Remittance basis users
Foreign chargeable gains and the mid-year rate increase
Remittance basis users only pay tax on foreign chargeable gains when the gain is remitted to the UK. The legislation specifies that such gains are deemed to accrue in the tax year of remittance. As such a specific provision is required to deal with a change mid way through the tax year. The rule specifies that the fixed 18% rate will be applicable where property representing or derived from the foreign chargeable gains was remitted to the UK prior to 23 June 2010 (F (No 2) A 2010, para, 20(1)). This means that the fact that the disposal occurred prior to 23 June is insufficient to lock in the 18% fixed CGT rate. In determining the CGT rate applicable to remittance basis foreign chargeable gains accruing in 2010/11 the remittance date itself is the key.
In summary for 2010/11 where entrepreneurs' relief is not in point:
- ALL remittance basis users pay tax at the fixed 18% rate on:
- gains on UK situs assets disposed of prior to 23 June 2010; and
- foreign chargeable gains remitted prior to 23 June 2010.
- Remittance basis users not paying the RBC pay tax at 18%/28% depending on whether they have unused basic rate band on:
- gains on UK situs assets disposed of after 22 June 2010; and
- foreign chargeable gains remitted after 22 June 2010.
The potential issues with respect to individuals paying the remittance basis charge are discussed on page 6.
Possible planning point
It may be that the CGT changes will make the arising basis attractive for foreign domiciliaries for 2010/11. This could be the case where:
- the individual has insufficient clean capital and funds taxed on the arising basis and needs to remit remittance basis foreign income or gains to the UK in the short to medium term; and
- for the quantum of remittance required the remittance basis foreign income available to remit will be taxable at a rate in excess of 18% (that is there is not a sufficient source of foreign income with significant tax credits);
- between 6 April 2010 and 22 June 2010 (inclusive) one or more of the following happened:
- the UK resident foreign domiciliary made disposals of foreign chargeable assets such that significant gains were realised but as at the start of 23 June 2010 either (i) the proceeds or property derived from the proceeds was not remitted to the UK; or (i) there were material unremitted amounts;
- the UK resident foreign domiciliary is a participator in an offshore company such that he or she is caught by the CGT ant-avoidance rules attributing gains to him or her in line with the holding in the company and the company realised gains prior to 22 June but as at the start of 23 June 2010 either (i) the proceeds or property derived from the proceeds was not remitted to the UK; or (i) there were material unremitted amounts; and/or
- the UK resident foreign domiciliary received one or more capital payments from an offshore trust (such that the beneficiary CGT charge anti-avoidance provisions apply) but as at the start of 23 June 2010 either (i) the proceeds or property derived from the proceeds was not remitted to the UK; or (i) there were material unremitted amounts;
- the pre 23 June capital proceeds will be remitted to the UK in 2010/11 or have been or can be isolated to avoid being tainted with remittance basis income or gains for subsequent tax years.
Where all the above applies being taxed on the arising basis for 2010/11 may be the better option as the fact remittances occurred after 23 June 2010 would be irrelevant and the 18% CGT rate would be locked in on the gains. To be certain it will be necessary to consider the level of unremitted foreign income and gains for 2010/11 and whether there will be any short to medium term need to remit these funds. Where there is significant unremitted foreign income and gains and no need to make further remittances it may be that the remittance basis is still the better option even though the higher 28% CGT rate will apply to the remittance of foreign chargeable gains. Note that at this stage it may be possible to rearrange an individual's affairs to minimise foreign income and gains for the period to 5 April 2011.
Where an individual has significant unremitted foreign chargeable gains as the start of 23 June 2010 it will be necessary to review his of her affairs in the round to determine the correct action to take. In some cases as well as considering the 2010/11 position it may make sense to not make a remittance basis claim for 2009/10 or even to amend a remittance basis claim already made for 2008/09. Specialist advice should be sought.
Paying the remittance basis charge (RBC) for a tax year
Long term remittance basis users who do not qualify for the automatic remittance basis have to pay the RBC to access the remittance basis (see ITA 2007 s 809C and s 809H).
It was stated in the 22 June 2010 HMRC Q&As on the changes that an individual paying the RBC in order to access the remittance basis for a specific tax year is deemed to have utilised their entire basic rate tax band for that year. This would mean that they will have to pay CGT at 28% on all UK gains realised as a result of chargeable disposals effected after 22 June 2010 and all remittance basis gains remitted after that date. It is not certain that the current legislation achieves this. There is no specific deeming provision and it is not clear that the interaction between the new CGT legislation and the remittance basis charge provisions achieve the reported result.
Specific transitional provisions for 2010/11
Remittance basis users paying the RBC: where ITA 2007 s 809I has been triggered
The provisions surrounding the remittance basis charge are complex and include making a nomination of foreign income and/or foreign chargeable gains arising or accruing in the relevant tax year. Individuals paying the RBC are potentially subject to penal rules at ITA 2007 s 809I. These provisions are in point where an individual remits property representing or derived from nominated income and/or gains prior to remitting all remittance basis foreign income or gains arising or accruing since 6 April 2008. Whilst they do not change the quantum of the taxable remittances the s 809I provisions will if triggered result in taxable remittances made to the UK by the individual being re-characterised for tax purposes in accordance with the provisions at ITA 2007 s 809J. As the rules work on a whole tax year basis transitional rules were required as a result of the rate change mid way through the tax year. Where the individual is subject to tax on remittances under the terms of the specific ITA 2007 s 809I legislation F (No 2) A 2010 contains a specific provision deeming all foreign chargeable gains realised in 2010/11 to have accrued prior to 23 June 2010 and, therefore subject to tax at the fixed 18% rate. Specialist advice will usually ensure that individuals avoid triggering s 809I so, whilst necessary, this specific transitional provision should not generally be relevant.
Temporary non residents' anti-avoidance provisions (TCGA 1992 s 10A)
TCGA 1992 s 10A can apply where the period of non residence does not span at least five complete tax years. With certain exemptions, such as for assets acquired during the non resident period, the section subjects an individual to CGT on the gains realised in the period of temporary non residence.
Where an individual returns to the UK and is subject to CGT as a result of the temporary non-residence antiavoidance provisions the TCGA 1992 s 10A gains brought into charge are said to be with respect to the tax year of return rather than being deemed to accrue on a specific date. Without a specific provision it would, therefore, not be possible to determine which tax rate should apply where an individual caught by these provisions returned to the UK in 2010/11. The provision that addresses this issue states that gains treated as accruing under TCGA 1992 s 10A in the tax year 2010/11 should be treated as accruing prior to 23 June 2010.
It should be noted that TCGA 1992 s 10A only applies to gains accruing in the intervening period that is the tax years between the year of departure and the year of return. Where the transitional provision is in point 2010/11 will be the tax year of return. As such gains in that year will be taxed in accordance with normal principles as explained on pages one to three. It will only be gains in the intervening tax years of temporary non-residence that are subject to TCGA 1992 s 10A and will be deemed to have accrued prior to 23 June 2010.
In planning terms it would make sense from a CGT perspective for the date of return to be in 2010/11 rather than 2011/12 where: an individual:
- will be caught by TCGA 1992 s 10A either way;
- has realised gains, which will be caught by TCGA 1992 s 10A in the intervening tax years of nonresidence; and
- in practical terms can return in 2010/11 or in 2011/12.
Specialist advice should be taken and all the tax and non tax consequences considered before a decision is made.
The offshore settlor interested trust CGT charge (TCGA 1992 s 86)
The settlor charge provisions can only apply where the settlor:
- is alive throughout the tax year;
- is UK domiciled (this means the provision CANNOT apply to a foreign domiciliary regardless of what basis he or she is taxed on for the relevant tax year);
- is either UK resident and/or ordinarily UK resident;
- is deemed to have an interest in the settlement by virtue of one or more of the following defined persons having the potential to benefit from the settlement property:
- the settlor;
- a close family member (close family member being: a spouse/civil partner of the settlor; child of the settlor or his/her spouse/civil partner; spouse/civil partner of such a child; grandchild of the settlor or his/her spouse/civil partner; spouse/civil partner of such a grandchild); or
- a company controlled by the settlor or one or more of the settlor's close family members; or a
- company associated with a company or one or more of the settlor's close family members.
Transitional rules may protect some older trusts from the settlor charge provisions. Where applicable the settlor charge has priority over the beneficiary charge and works by attributing net trust gains for the tax year to the UK resident domiciled settlor. As the gains are attributed to the settlor on a tax year basis it was unclear how the legislation would work with a mid-year tax increase. The provision that addresses this issue states that where the net gains for the year are attributed to the settlor under the TCGA 1992 s 86 legislation such gains are deemed to have accrued prior to 23 June 2010 and should, therefore, be taxed at the fixed 18% rate. This means that the 18% rate applies regardless of when in 2010/11 the disposal is effected and there is, therefore, a window of opportunity between now and 5 April 2011 where gains can be crystallised to take advantage of the 18% tax rate. It also means that if possible trustees of such trusts should refrain from making disposals which will result in losses in this period as the losses will be more valuable in 2011/12.
Given the planning opportunities it is recommended that specialist advice is taken,
The CGT beneficiary charge anti-avoidance legislation
Where there is an offshore trust and the settlor CGT charge provisions are not triggered the beneficiary charge CGT provisions will apply. The provisions are complex. Broadly, there are complicated matching rules which attribute gains to capital payments made to beneficiaries. This results in a tax charge (and a potential supplementary charge where gains are not matched to capital payments in the year of disposal or the following year) for beneficiaries who are UK resident and/or ordinarily resident. Special rules apply to foreign domiciliaries.
The highest effective tax rate when the supplementary charge was included was 28.8% between 6 April 2008 and 22 June 2010 (inclusive) when the CGT rate was a fixed 18%. With the increase to 28% the highest effective tax rate increases to 44.8%.
The matching process is on a tax year basis with gains being said to accrue with respect to the tax year in which the matching event occurs. Specific provisions are, therefore, necessary to determine which tax rate(s) should apply. The relevant transitional provisions are as follows:
- the basic rule is that where there is a matching event in 2010/11 (that is a capital payment is matched to gains realised in 2010/11 or prior tax years):
- the fixed 18% rule will apply where the capital payment was made prior to 23 June 2010; and
- the new rules will apply where the capital payment was made after 22 June 2010;
- remittance basis users must have remitted the capital payment prior to 23 June 2010 to benefit from the fixed 18% rate.
We understand that HMRC's view is that the provision for apportioning gains between beneficiaries (that is attributing gains to capital payments proportionately taking into account the total capital payment figure for the tax year) should also be used in situations where one has to consider capital payments made to the same beneficiary either side of the mid-year rate change.
Where there are continuous capital payments (such as the benefit from an interest free loan or where the trustees allow a beneficiary free use of trust property) determining the precise date of the capital payment can be challenging. In the absence of evidence to the contrary (such as specific entries in the minutes of trustees' meetings or other details of the trustees' decision-making processes) the Courts (Billingham (Inspector of Taxes) v Cooper; Edwards (Inspector of Taxes) v Fisher EWCA Civ 1041) have determined that timeapportionment on a daily basis is the fairest course. As such if there is no evidence to the contrary where there are continuous payments one must time apportion the benefit into the pre 23 June 2010 amount and the post 22 June 2010 amount and apply the rules accordingly. Where there is evidence to the contrary that will determine the capital payment date.
Possible planning opportunities and pitfalls
There are potential planning opportunities where there are capital payments prior to 23 June 2010 which have not been matched in whole or part to gains. There are also potential issues where capital payments are made between 23 June and 5 April. As such trustees should seek specialist advice to ensure that they act in the most tax efficient manner possible.
Note that for an individual with stockpiled gains which would currently be matched to a capital payment made prior to 23 June 2010 there is a trap as realising further gains in 2010/11 would mean matching to gains in the current year where there is no supplementary charge. The 18% rate would still be secured as the payment would have been prior to 23 June 2010 (bearing in mind that for a remittance basis user to secure this 18% treatment the capital payment must have been remitted prior to 23 June 2010) but the stockpiled gains which would have resulted in a 28.8% effective tax rate would not have been matched leaving them to be matched to a capital payment such that an effective tax rate of 44.8% will apply.
Remittance deeming issues and the CGT beneficiary charge anti-avoidance legislation
The basic rule, that for a remittance basis user to benefit from the 18% tax rate the property representing or derived from the remittance basis foreign chargeable gains must have been remitted to the UK prior to 23 June 2010, has already been explained. The issue in the CGT beneficiary charge context is whether bringing the capital payment to the UK is sufficient where the gains arose on or after 23 June 2010. It is understood currently that HMRC is of the view that where both the capital payment and the remittance are prior to 23 June 2010 the gain is charged at 18% even if the capital gains were realised on a date in 2010/11 which is after 22 June 2010.
The attribution of gains to members of non-resident companies
CGT anti-avoidance provisions attribute gains realised by foreign resident companies (which would be close companies if UK resident) to any UK resident/ordinarily resident qualifying person (broadly a person who, either personally or when their interest is aggregated with connected persons, has an interest in the company which exceeds 10%). Persons to whom the gains are attributed are referred to as participators. Gains are attributed to participators in the tax year in which the disposals are made in proportion to their interest in the company.
Mid-year rate change
The mechanism by which the anti-avoidance legislation works means that a gain is deemed to accrue to qualifying participators at the time that the gain is realised by the company. Unlike the trust anti-avoidance the gains are not deemed to accrue with respect to a tax year as a whole. As such where the legislation applies and the qualifying participator is an individual the same transitional rules as for gains with respect to assets disposed of personally will apply. This means that for an individual chargeable on the arising basis gains realised prior to 23 June will be taxed at the old fixed 18% rate.
Remittance basis users
Where the gains are foreign the analysis is more complex for remittance basis users as they can only be subject to tax on the remittance of the proceeds. Broadly, there are two types of situation where a remittance of the funds representing or derived from the foreign chargeable gains might happen. The first would be where the proceeds were brought to or used in the UK by the company such that there would be a deemed remittance by the individual (as a result of there having been a remittance by a relevant person in connection with the individual of property representing or derived from post 5 April 2008 gains attributed to the individual). The second would be where the funds were brought to or used in the UK after either (i) a distribution or (ii) the liquidation of the company. Other tax consequences would be in point in a situation falling into the second type of situation and specialist advice should have been taken. Regardless, the remittance of the funds representing or derived from the foreign chargeable gain must have occurred prior to 23 June 2010 for the fixed 18% rate to be available to a remittance basis user.
Where there is a trust/company structure, such that the trust's interest (including holdings of connected persons) in the company exceeds 10%, gains realised by the company will be attributed to the trust and then to the settlor/beneficiary in line with the relevant legislation. Since it is realised by a company the gain attributed is computed in accordance with the corporate CGT rules. Once it is attributed to the trust it is, however, treated in the same way as any other gain. This should mean that where the settlor interested trust CGT charge applies all gains will be deemed to have accrued prior to 23 June 2010. Where the beneficiary charge CGT legislation is in point it will be the timing of the capital payment (and for a remittance basis user when that capital payment is remitted) that is crucial.
Changes to entrepreneurs' relief (ER)
The following headline changes take effect from 23 June 2010:
- the 4/9 reduction is replaced by a special 10% rate on qualifying ER gains;
- the aggregate lifetime allowance is increased to £5 million;
An individual who used (or uses) his/her £2m allowance on qualifying disposals effected prior to 23 June 2010 has an additional £3m allowance which can be claimed on disposals effected on or after that date. An individual who will not utilise all (or any) of his/her pre 23 June lifetime allowance on qualifying disposals effected prior to 23 June 2010, will from that date have a lifetime allowance equal to £5m less any relief claimed.
As a result of the new method of favouring ER gains (a special tax rate rather than a reduction in the gain) changes have been made to the ongoing provisions with respect to:
- re-organisations involving the acquisition of qualifying corporate bonds (QCBs); and
- the interaction with enterprise investment scheme (EIS) CGT deferral relief.
As will be explained below these changes are not favourable to the taxpayer as they mean that if the individual is to benefit from ER it is no longer possible to defer paying tax on the gain.
Re-organisations involving the acquisition of qualifying corporate bonds
Where there is a reorganisation of share capital, a takeover by way of a "paper for paper" exchange or a company reconstruction and certain conditions are met the legislation provides that for CGT purposes no disposal has occurred (TCGA 1992 s 127). This could be a problem if the individual would have been entitled to ER if a disposal had occurred at the time of the reorganisation but does not satisfy the conditions in respect of the new holding. When the original ER legislation was introduced specific legislation (TCGA 1992 s 169Q) allowed the taxpayer to elect for a deemed disposal.
For relevant transactions occurring prior to 23 June 2010 TCGA 1992 s 169R provided for specific and more favourable provisions where qualifying corporate bonds were in point allowing the individual to benefit from both a deferral of the tax liability until the future disposal and a reduction in the taxable gain that would crystallise on the future disposal of the qualifying corporate bonds as a result of ER provided:
- the qualifying ER conditions were met at the time of the re-organisation; and
- an ER claim was made by the specified deadline.
The Finance (No 2) Act 2010 changes to the legislation introduce less favourable provisions for:
- individuals who made (or will make) a valid ER claim for disposals occurring between 6 April 2008 and 22 June 2010 (such that the deferred gain is deemed to be reduced by 4/9) and did not dispose of the qualifying corporate bonds prior to 22 June 2010; and
- individuals making an ER claim where there is a re-organisation after 22 June 2010 and qualifying corporate bonds are received.
Where an ER claim was made prior to 22 June 2010 but the qualifying corporate bonds have not been disposed of prior to 23 June 2010 the post ER gain which comes into charge is likely to be taxed at 28% meaning an overall effective tax rate of 15.6% (that is 28% x 5/9) rather than the 10% effective tax rate(18% x 5/9) which would have applied if the qualifying corporate bonds had been disposed of prior to 23 June 2010.
Where qualifying corporate bonds will be acquired as the result of a re-organisation after 22 June 2010 and the ER conditions are met at the time of the re-organisation the taxpayer has a choice between:
- securing the special 10% tax rate by making an election such that the automatic deferral provisions are disapplied and the gain is brought into charge at the time of the re-organisation; or
- deferring the gain and probably forfeiting entitlement to ER as it is not likely that the ER conditions will be met when the qualifying corporate bonds are disposed of and the deferred gain comes into charge.
The practical consequences of securing ER on a post 22 June 2010 re-organisation are that tax will have to be paid at a time when the taxpayer may not have actually received any cash proceeds as a result of the transaction as the consideration may all have been "paper". As such thought should be given to modifying the consideration to introduce a cash element (remembering that a cash element will trigger an immediate CGT charge) or to structuring the loan note element such that redemption dates are fixed so the necessary funds to meet the CGT liability can be raised in time to meet the payment deadline.
The interaction with enterprise investment scheme (EIS) CGT deferral relief
Prior to 23 June 2010 an individual could make an ER claim and defer the post ER gain under the EIS CGT deferral provisions. This meant that the individual could benefit from ER and defer paying the CGT on the disposal.
With effect from 23 June 2010 the rules have changed. With respect to a gain which potentially can benefit from an ER claim a taxpayer has a choice between:
- making the ER claim:
- he or she will benefit from the special 10% tax rate;
- the tax is not deferred meaning it must be paid by 31 January following the tax year during which the qualifying ER disposal takes place;
- making the EIS CGT deferral claim:
- the gain is deferred;
- when the gain does become chargeable it cannot benefit from the special 10% rate meaning that it will generally be taxed at 28% (as it is unlikely that such an individual will have unused basic rate band).
This means that where the qualifying ER disposal takes place after 22 June 2010 a taxpayer can no longer benefit from ER and defer paying the tax on the qualifying ER gain. Where an ER claim is made the tax at the special 10% rate will always be payable by the standard due date.
The only time ER and EIS CGT deferral relief can be used with respect to the same gain is where the quantum of the gain is such that only a portion of it can benefit from ER. In such cases the gain is in effect taken to be split between an ER gain (the tax on which has to be paid) and a non ER gain (which can be deferred if there is an EIS investment within the qualifying period). This is explained in the example below.
Example where an ER and EIS CGT deferral claim is made with respect to a gain of £9 million
Lucy is a higher rate taxpayer who disposed of her 100% shareholding in Diamond Service Ltd on 19 October 2010 realising a chargeable gain of £9 million. She meets all the requirements such that she qualifies for ER.
She can claim ER on £5 million of the claim as this will be her first ER claim. Assume her CGT annual exemption will be used against other capital disposals realised in the tax year.
Should Lucy so choose she can claim ER on the gain meaning that £5 million is subject to tax at the 10% rate with the tax of £500,000 being due by 31 January 2012. Should she make a qualifying EIS investment within the necessary timeframe she could also defer the remaining gain of £4 million.
Where the ER qualifying disposal occurred between 6 April 2008 and 22 June 2010 (inclusive) and EIS CGT deferral relief is in point
Where the original ER qualifying gain on which EIS CGT deferral was (will be) claimed occurred between 6 April 2008 and 23 June 2010 and the deferred gain does not come into charge until after 22 June 2010 an effective overall CGT rate of 15.6% (that is 28% x 5/9) is again likely. This is because the ER provisions will be those under the old rules (that is the gain is reduced by 4/9) and when the gain comes into charge tax at 28% will normally be due (since the probability that there will be available basic rate band is remote).
The FA 2008 transitional rules for pre 6 April 2008 deferred gains
The change to the ER mechanism also required modifications to the treatment of the Finance Act 2008 transitional provisions with respect to gains which arose originally prior to 6 April 2008 and were deferred either as a result of qualifying corporate bonds having being acquired or because valid deferral claims was made under either the EIS or VCT CGT deferral provisions. The transitional provisions meant that ER could be claimed provided a claim for relief was made within a specified deadline of the first relevant disposal. The first relevant disposal being either:
- the time when the whole of the deferred gain becomes chargeable; or
- the first time after 5 April 2008 when part of the deferred gain becomes chargeable.
Making the claim resulted in the 4/9 reduction being applied to the gain such that when all or part of the new asset was disposed of prior to 23 June 2010 the deferred post ER gain came into charge being taxed at 18% resulting in an effective tax rate of 10% on the deferred gain (18% x 5/9).
Where there has been a first relevant disposal prior to 23 June 2010 then either the chance to make the claim will not be taken up meaning ER is not in point or the claim has been or will be made. Where the ER claim is made but only part of the gain comes into charge prior to 23 June 2010 the old rules will be in point meaning the 4/9 ER reduction still applies. There is no provision to modify the legislation such that when the reduced gain comes into charge after 22 June 2010 the higher 28% rate cannot apply to it. Given the affected individual is likely to be a higher rate taxpayer this means that he or she is likely to suffer an effective 15.6% charge (that is 28% x 5/9) on the deferred gain element.
Where the first relevant disposal occurs after 22 June 2010 Finance (No 2) Act 2010 preserves the 10% effective tax rate by modifying the original Finance Act 2008 transitional provisions such that where an ER claim is made by the deadline, provided the necessary conditions are met, the qualifying gain coming back into charge (or, if lower, the portion of it within the individual's unused ER aggregate lifetime allowance) will be taxed at the special 10% rate.
Issues with ER
It should be noted that no changes are being made with respect to widening the qualifying conditions. Given the greater importance that ER will play with a 28% CGT rate this is unfortunate. ER was introduced in whatcan only be described as hurried circumstances. Modelled largely on the old retirement relief provisions but targeted at a different audience the operation of ER is in places unfair and there are a number of technical uncertainties. The definition of qualifying business asset is significantly narrower than the definition of business asset under the old taper relief provisions. As such while the significant increase in the aggregate lifetime limit is welcome it does not shelter all disposals of business assets from the rate increase. For example for individuals to qualify for ER on share disposals it is necessary that in the year up to the disposal:
- the individual was an officer or employee of the company or (if the company was a member of a group of companies) of one or more companies which were members of the trading group; and
- the company must have qualified as the personal company of the individual meaning that the individual:
- is the holder of at least 5% of the ordinary share capital; and
- can exercise at least 5% of the voting rights by virtue of that holding.
- Bullet (First level indent)
Employees/office holders with holdings of less than 5% will not qualify for relief even if for a significant earlier period they did have a holding of 5% or more (their holding may, for example, have been diluted by share options being exercised or by an injection of third-party capital so the business could be expanded). There will also be no relief if the 5% condition is met but the individual leaves the employment or resigns as an office holder and has not disposed of his/her holding beforehand.
The qualifying conditions with respect to trusts can be even more unfair than those with respect to individuals (though for share disposals the qualifying twelve month period is more flexible).
It is hoped that at some point during this current administration there will be a review of how the ER provisions are working and targeted modifications.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.