Alistair Darling, the Chancellor of the Exchequer, has given with one hand and taken with the other in his moves to simplify capital gains tax (CGT) in this week’s PreBudget Report. The good news is that he has reduced the top rate from 40 per cent to a flat rate of 18 per cent. The bad news is that he has abolished two valuable tax reliefs, which could substantially reduce any CGT bill.

The first, indexation relief, reduces an investor’s gain by the annual rate of inflation for the years between 1982 and 1998. The second, taper relief, cuts the percentage of the gain that is taxable, depending on the length of time the investment is held and what type of investment it is. For nonbusiness assets – such as shares, funds and property held by private investors – taper relief progressively reduces a higher-rate taxpayer’s effective tax rate from 40 per cent to 24 per cent over ten years (20 per cent to 12 per cent for basic-rate taxpayers). For business assets – such as companies built up by individual entrepreneurs and shares held by employees in their own company – the effective CGT rate is reduced after two years to 10 per cent (5 per cent for basic-rate taxpayers).

So the winners from the CGT shakeout, which takes effect in April, will largely be those who benefit from the cut in the headline rate from 40 per cent to 18 per cent, but who do not suffer too badly from the removal of the existing tax reliefs.

The losers will be those who enjoyed the generous tax reliefs available to holders of business assets, for whom the new 18 per cent flat rate will be a tax increase. They may want to consider selling their holdings before the new regime is introduced.

THE WINNERS

Owners of shares and funds who have built up enough capital gains to pay CGT. Instead of paying anything up to 40 per cent CGT they will, from April, pay a maximum of 18 per cent. They will tend to be fairly wealthy investors because each year everyone can shelter up to £7,000 in an Isa, where any capital gains build up tax-free, and they can also benefit from the annual CGT exemption, currently £9,200, which means that tax does not start to bite until annual gains have exceeded that figure.

Although most shareholders will be potential winners, long-term investors with holdings dating back more than ten years could lose out. Existing taper relief and indexation relief may mean that they can already reduce their effective rate of tax to less than the 18 per cent, which will apply from April. Buy-to-let investors and owners of second homes are in a similar position to equity investors and could enjoy a cut in their tax rate from 40 per cent to 18 per cent when they sell their properties. The exceptions will, again, be those who have held their properties for long enough to benefit heavily from existing taper relief and indexation relief.

THE LOSERS

Private equity bosses who, as investors owning shares in a private company, were entitled to benefit from taper relief on business assets, which allowed them to cut their CGT rate from 40 per cent to 10 per cent once they had held the shares for two years. Under the new rules they are going to be paying CGT at 18 per cent. Investors in shares on the Alternative Investment Market (AIM) – their holdings were also classed as business assets, allowing them to pay only 10 per cent tax on gains realised after two years. This will rise to 18 per cent. Employees in save-as-you-earn share schemes, budding entrepreneurs and others who hold shares in their own companies. Provided that they held the shares for at least two years, any profit made on their sale was taxed at 10 per cent. From April the figure will be 18 per cent. Greg Limb, of KPMG, the accountant, says: “This seems at odds with the Government’s stated aim of encouraging entrepreneurship and investment.” Some basic-rate taxpayers who hold shares or funds – under existing rules taper relief could reduce their effective CGT rate from a 20 per cent starting level to 12 per cent, which is lower than the new flat rate. Mike Warburton, of Grant Thornton, the accountant, says: “This could apply to lower-earning spouses who divide up assets such as shares, or to thrifty but modestly-paid people who have built up a nest egg over time.”

CASE STUDY: Tax bill halved

Lindsey Carruthers, pictured with her children Laura, 14, and James, 11, is, along with her husband George, a winner in the Chancellor’s overhaul of the rules governing capital gains tax (CGT).

The couple own a buy-to-let property, worth about £250,000, situated next door to their home in Castleton, a village in the Derbyshire Peak District. The Carruthers, who are both higher-rate taxpayers, have owned the property for three years, during which time it has grown in value by about £50,000.

If they wanted to sell the property now, they would face a taxable gain of £40,800, after deducting the annual CGT exemption of £9,200. Under the current CGT rules, they would benefit from a very modest element of taper relief, bringing down their effective tax rate from 40 per cent to 38 per cent, leaving them with a bill of £15,504.

Under the new rules, their gain of £40,800, after deducting the CGT exemption, will be taxed at a rate of 18 per cent, resulting in a charge of only £7,344 – a reduction of more than 50 per cent.

Ups and downs

Mr A is a higher-rate taxpayer who has banked a gain of £20,000 on some shares he had held for two years. After deducting the current annual CGT exemption of £9,200 he is left with a taxable gain of £10,800. Under the current rules he would not be entitled to any taper relief, which kicks in only after three years, nor to indexation relief, which covers only assets bought before April 1998.

So his gain of £10,800 would be taxed at the full CGT rate of 40 per cent, resulting in a bill of £4,320. Under the new rules, he would be taxed at 18 per cent on the £10,800, giving a much reduced bill of £1,944.

Mrs B is sitting on a gain of £20,000 she made two years ago as a result of participating in her IT company’s save-as-you-earn share scheme. Under the present rules, the shares count as a business asset so, as a higher-rate taxpayer, she can reduce her effective CGT rate from 40 per cent to 10 per cent.

This means that after deducting the CGT exemption of £9,200, she would pay £1,080 in CGT if she cashed in her shares now. Under the new rules, taper relief will be abolished and she will have to pay CGT at 18 per cent, resulting in a higher bill of £1,944.