Cicero Policy Briefer

Issue 18, November 2007

CGT: A taxing tax to change

By Jacob Coy

Alistair Darling certainly wasted little time making his mark as Chancellor. In his first major announcement, he combined the usual Pre-Budget Statement with the Comprehensive Spending Review to set forth a raft of policy measures and priorities for the forthcoming Labour Government. Many measures were vintage Labour—commitments to health and education; increased resources to fight terror; and a deep commitment to building a fairer society.

That commitment was almost certain to include measures to dampen some of the uproar in the Labour ranks about the way in which certain individuals were using the existing tax system, particularly those in the private equity industry. This fire had been stoked throughout the spring and summer, especially by the unions in the run-up to the Labour Deputy Leadership election. For its part, the Treasury Select Committee’s enquiry had also shone light upon some of the specific techniques companies and individuals within those companies were using to minimise tax liabilities.

Thus, it came as surprise to few that Darling announced changes to the tax regime. But few could have anticipated just how fundamentally he was prepared to alter the playing field. The central plank was a flat rate of 18p on capital gains—one of the lowest single rates of any major economy. Taper relief and indexation would be swept aside and exceptions would be far and few between.

When considering changes to tax regimes, it’s useful to consider the tradeoffs-the winners and losers following any change. While it is true that the proposed measures do catch the handful of folks in private equity, it’s also true that they potentially affect hundreds of thousands, if not millions, of others-in both good and bad ways. Everyone from small business owners to employees in share ownership schemes to private investors may be exposed to capital gains tax over the course of a year or at different points in their life.

For many in those groups, the gains they make from disposals will not exceed their yearly capital gains allowance, currently at £9,200. Furthermore, for many others, their assets which do make substantial gains are in tax-incentivised wrappers such as pensions or ISAs. But the new regime will sting small businesses and entrepreneurs particularly hard, as in some cases their effective rate of tax has nearly doubled. This is undoubtedly why the Chancellor has made noises about a potential concession for small business owners when they sell to retire (perhaps £100,000 of relief).

In the days that followed the Pre-Budget Report, the public and Government were made aware of other effects. Firstly, the removal of taper relief will have major implications for the attractiveness of buy-to-let properties. There may be more liquidity injected into the housing market as a whole given the reduced need to hold an investment for a period of longer years to attain a more favourable tax rate at disposal. Investment bonds, a major asset class with over £220bn invested, now look somewhat (though not dramatically) less attractive, given that they are taxed as income instead of as capital gains. Major gains on company shares acquired through share schemes will now be lessened through a higher, flat rate of CGT than previously.

But for many, the bigger questions about the changes remain. Is this the end of Labour’s unassailable support for small business and entrepreneurship? Most would agree that the Conservative opposition has been rather ineffective in attacking Labour’s economic record regarding SMEs; it’s fair to say that they have a lot more ammunition with which to bombard Labour now. Secondly, will these changes achieve the Chancellor’s aims of having a system that is more “straightforward and sustainable” and which continues to encourage investment? They may pay as much as or a little more than their cleaners, but will the handful in private equity really pay a fairer share over time?

Only time will tell the answers to these bigger questions. What is clear is that any time one changes the tax regime, there are winners and there are losers. To simplify, many who were the beneficiary of complexity before will find that the newly straightforward system costs them more-and the opposite is almost certainly true as well. Furthermore, it is quite clear that as soon as the Chancellor changes the rules on tax, entire cohorts of professionals dedicated to minimising their tax burden go to work on legally reducing their own and their organisations’ liabilities. That’s not a value judgment by this author, that’s the simply reality of the modern era.

Thus, you may tinker with the flow of income here; divert the stream outlay over yonder; and reduce the incline over time; but if at the end of the day, you are trying to push water uphill, it will still run down.

Jacob Coy can be contacted on +44 (0)20 7665 9535 or click here to email.

Back to main policy briefer