Hundreds of thousands of ordinary investors have been warned they have just three weeks to take action or face higher tax on their profits, as the government pushes ahead with its capital-gains-tax reforms.

Chancellor Alistair Darling confirmed last week that he will sweep away the complex CGT system and replace it with one flat rate of 18 per cent on April 6 – and offered no new concessions.

Investors in the Alternative Investment Market (AIM) and other unlisted shares, as well as farmland and holiday lets could see an 80 per cent jump in the tax they pay.

People who have invested in the companies for which they work via share schemes also face a sharp rise in their tax bill.

Rose-tinted specs fail to offer hope

The obvious justification for Mr Darling’s relatively upbeat scenario is that the outlook is fraught with uncertainty

Background

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• Need to know: Budget 2008

The Chancellor delivers a modest Budget

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So do basic-rate taxpayers with nonbusiness assets, which include second homes, buy-to-lets and shares listed on the main market – they will see CGT rise from a minimum of 12 per cent to 18 per cent. Most higher-rate payers with nonbusiness assets, including landlords, will benefit, as their lowest rate of CGT will drop from 24 per cent to 18 per cent.

However, long-term investors with assets purchased before 1998 could be thousands of pounds worse off because of the removal of “indexation relief” – an allowance that cuts the amount of tax paid to reflect the eroding impact of inflation.

Investors don’t need to lose out, though, if they act quickly. Directors at some of Britain’s leading companies have been selling their shares ahead of the tax changes to benefit from the 10 per cent rate that applies to their profits before the rule change.

Ken Clarke, the former Conservative chancellor, said this month he had sold £88,000 worth of shares in cigarette maker British American Tobacco, where he is the deputy chairman. Sir John Craven, the chairman of miner Lonmin, sold shares worth £2.17m, giving him an estimated tax saving of more than £170,000. He admitted that his decision to sell was tied to the tax increase.

As ordinary investors follow their lead, analysts fear a sell-off in AIM shares in the run-up to the April 5 overhaul.

Brewin Dolphin, a wealth manager, said that as many as half of the ordinary investors in some AIM companies may look to offload their holdings in the coming weeks. The FTSE AIM All-Share index has fallen 10 per cent over the past year.

We offer tips on getting round the rules.

Bed your shares

If you are sitting on large gains on which you would pay tax of less than 18 per cent, it could be worth selling your funds or shares to benefit from the lower CGT rate now, and then buying them back.

The rules say that you must not buy the same shares and funds within 30 days. If you do, the sale doesn’t count as a disposal for CGT purposes and you are no better off.

However, you are allowed to “bed and Isa” them. You sell the shares and buy them back straightaway using cash in an investment Isa. You’ll pay tax on the gains made so far but at a lower rate than you will pay after April 5 – and any future growth will be tax free. If you’ve used your Isa allowance, another option is to sell the shares and buy them back through a self-invested personal pension. This is known as a bed and Sipp.

Husbands and wives can simply buy back the same funds or shares. Selling the shares means you use your annual exemption for CGT of £9,200, which cannot be carried forward. Provided your gain is no higher than this you’ll have no tax to pay.

Exploit trusts

Some stocks will be difficult to sell in the three-week window, particularly unquoted shares of private firms and those on AIM.

One solution is to sell them into a trust, set up on your behalf. This is deemed to be a sale under the CGT rules so you trigger a tax charge on the gains you have made so far.

Watch out for trust charges, though. The assets could be subject to an extra 20 per cent tax if they are worth more than the inheritance-tax (IHT) threshold of £300,000, as well as 6 per cent charges every decade.

There are other complications. David Kilshaw at KPMG, an accountant, said: “Make sure you have enough cash to pay the CGT bill you have created by making the transfer.”

Bank indexation relief

Investors with assets purchased before 1998 benefit from indexation allowance, which was brought in to take account of high inflation. It is, however, being abolished as part of the CGT reform. Long-term investors in property and shares could therefore be substantially worse off from April 5.

Suppose you bought shares worth £50,000 in 1982 and sold them today for £200,000. You would have a profit of £150,000, but when the indexation allowance is applied you are treated as if you had bought the shares for £102,000. This reduces the taxable gain to £98,000.

Taper relief – another allowance that will disappear – means that a higher-rate taxpayer would pay 24 per cent on the £98,000 gain, or £23,520 if he or she sold before April 5, ignoring annual allowances.

The tax bill would jump to £27,000 if the sale took place after that date as indexation and taper relief are removed and replaced by a flat 18 per cent tax rate on the full £150,000 gain.

You can lock in the benefits of indexation by passing your assets, including property, to your spouse tax-free.

In the above example, as long as the transfer took place before April 5, the value of the assets when your spouse received them would be £50,000 plus the indexation allowance – in other words, he or she would be assumed to have acquired them for £102,000. If your spouse sold the shares for £200,000 in May, the taxable gain would be £98,000. He or she would pay tax on this at the 18 per cent rate, a bill of £17,640 against £27,000 if no action was taken.

Be enterprising

Not everyone is going to be worse off. High-er-rate taxpayers with nonbusiness assets such as second homes, buy-to-lets and shares listed on the main market will see the minimum rate they pay drop from 24 per cent to 18 per cent.

If you need to sell now, or have sold over the past three years, you can benefit from the lower rate by rolling profits into an enterprise investment scheme. You will be liable for CGT when the EIS shares are sold, but at the rate that was in place at that time.

EISs also qualify for income-tax relief at 20 per cent on investments up to £400,000 (rising to £500,000 on April 6, see story right). EIS shares may also become exempt from IHT after two years. The schemes are high risk as they invest in small unquoted firms.

Entrepreneur relief

Business owners – those with a stake of more than 5 per cent in the company they work for – will continue to pay only 10 per cent tax on gains up to £1m. The concession also benefits business angels and other investors who take a minimum 5 per cent stake.

It is understood about 90 per cent of the 80,000 businesses expected to be sold in the coming year will fall under the £1m allowance.

WINNER: Shake-up brings boost to retirement income

Tom Coupe, 32, pictured with his wife Maria, 40, will save thousands as a result of the new capital-gains tax rules.

Tom, a mortgage broker, has a buy-to-let property in Nottingham, where the couple also live. Since he bought it in 2003 for just under £90,000, he has made about £40,000 in profit.

Because he is a higher-rate taxpayer, even if he had held the property for 10 years he would have paid tax at 24 per cent under the current rules.

The new rules mean that from April 6 he will pay tax at just 18 per cent. On a £40,000 gain that’s a £2,400 saving, assuming he has used up his annual allowance.

He said: ‘I’m not intending to sell any time soon as I’m hoping to use the proceeds of my property to boost my pension.

‘By then the change to the tax rate should make a huge difference to my retirement income.’

WINNER: Evasive action defers a tax bill

John Hinnigan almost lost out due to the capital-gains tax changes, but by taking evasive action he has ensured he will come out on top.

Hinnigan, 61, from Acton Bridge, Cheshire, sold an investment he had in the Jupiter Eastern European Opportunities fund in December, netting a profit of £20,000.

Because he’d owned it for only three years and is a higher-rate taxpayer he is liable to pay 40 per cent on the gain.

However, the retired chief executive won’t have to pay anything for several years.

He reinvested the gain in Veritape, a software firm that qualifies for the Enterprise Investment Scheme, allowing him to defer his tax bill.

When he does have to pay the tax he owes it will be at the lower 18 per cent rate, introduced next month.

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