Be prepared for capital gains tax change

Landowners have just a few months to prepare for the Chancellor’s “streamlining” of capital gains tax legislation, says Grant Thornton’s Carlton Collister. Be prepared with our detailed guide

Alistair Darling has announced dramatic changes to capital gains tax from 6 April 2008. These includes the loss of indexation, loss of taper relief, the introduction of a flat rate of 18% tax and a new entrepreneurs’ relief. So how will these changes affect you?

The first thing to note is that the changes only apply to individuals, partnerships and trusts. Indexation allowance continues to be available to companies, where taper relief has never been given.

Second, the changes will only affect you if you intend to sell or possibly gift capital assets, such as land or shares. If you are going to hold on to your farm and pass it to the next generation through your will on death, then capital gains tax will not affect you.

So what are the changes?

Loss of indexation

For many farmers, the loss of indexation will have the greatest impact.

Indexation allowance is a relief given to increase the cost of capital assets to reflect the increase in inflation (the retail prices index) and was given to individuals, partnerships and trusts up to April 1998, when it was replaced by taper relief.

The allowance applies from when the asset was acquired or from March 1982 if later, as the cost of assets acquired before March 1982 is generally replaced by their March 1982 value, if higher (from 6 April 2008 the March 1982 value will always be used).

Although indexation allowance ceased to be available from April 1998, it was still available for assets acquired before that date. From April 2008 indexation allowance will be abolished entirely. So why is this so significant for farmers?

In 1982 farmland was at a relatively high value and good arable land might be valued at up to £2000/acre. By April 1998, indexation allowance was at 104.7%, so the cost of the farmland for CGT purposes was increased to £4094/acre. Only if the farmland were sold for more than £4094/acre would a capital gain arise.

Thus, until the past five years or so, much farmland that had been owned for a long time and was sold as farmland (rather than for development or amenity) would not give rise to a capital gain, or a significant capital gain.

Loss of taper relief

Taper relief is a more complicated relief, which has applied since April 1998 and effectively reduces the rate of CGT, depending on how an asset is owned and used. The rules have changed several times since 1998, giving rise to complex computations of the relief available where use of the asset has altered or the rules affecting the asset have changed. The relief also applies to the marginal rate of tax paid, so if you are a basic rate taxpayer, then at least some of your capital gains tax will be payable at 20% before taper relief, whereas a higher rate taxpayer pays capital gains tax at 40% before taper relief.

For example, for land owned and farmed since March 1998, the effective rate of CGT would be 10% for a higher rate taxpayer or 5% for a basic rate taxpayer. If the land has been let to a third party partnership since March 1998, the effective rate of CGT would be about 19% for a higher rate taxpayer.

The winners

Taper relief does not favour non-trading assets, with the minimum effective rate of CGT for a higher rate taxpayer being 24%. Farmers selling cottages that have been let on assured shorthold tenancies or quoted shares after April 2008 will, therefore, usually be better off, as the flat rate of 18% will apply. But this will not be the case if the asset was owned from before April 1998 and the indexation allowance is significant or if tax is paid at the basic rate.

The losers
Taper relief favours trading assets, used either by yourself or others, and shares in unquoted trading companies, so farmers are usually worse off when selling farm assets such as a barn for development or farmland.

Entrepreneurs’ relief

Entrepreneurs’ relief was announced last month as a “sop” to business that had protested hard about the withdrawal of taper relief from 6 April. However, it will be less useful to farmers than taper relief.

The key elements of the entrepreneurs’ relief are:

• The first £1m of gains that qualify for relief will attract an effective rate of CGT of 10%.

• Gains of more than £1m will be charged at the normal rate of 18%.

• The £1m limit will be a cumulative lifetime total.

• The qualifying conditions must be met for a period of one year.

• The relief will apply to gains arising on the disposal of the whole or part of a trading business, or the disposal of shares in a trading company (there are separate tests that apply to share transactions).

Associated disposals, such as the disposal of business premises at the same time as a sale of shares or an interest in a partnership, will also qualify for the relief.

The relief will only apply to disposals on or after 6 April 2008, and previous disposals will not count towards the limit.

For farmers, entrepreneurs’ relief is much more restricted than taper relief. This is because of the lifetime limit of £1m and the requirement that businesses other than companies need:

• A disposal of the whole or part of a trading business (the basic requirement for entrepreneurs’ relief), or

• a simultaneous “associated disposal” of an asset owned personally and used by the trading business, or

• a disposal of business assets within three years of the cessation of a trading business.

This will mean that continuing traders may have to create more complicated structures to benefit from entrepreneurs’ relief. Farmers who remember the complexities of retirement relief will recall some of the arrangements that worked under that regime and may take some comfort from the assertion that the new rules will be simpler (although we should wait for the draft legislation to decide to what extent this is achieved).

Carlton Collister is a senior tax adviser at Grant Thornton. He can be contacted by emailing carlton.k.collister@gtuk.com

Entrepreneurs’ relief – What will qualify

• The sale of a whole farm business
  
• The sale of assets personally owned by a partner who is retiring from a partnership that has had use of those assets
  
• The sale of a separately identifiable enterprise eg, the dairy buildings on a farm going out of milk
  
• What won’t qualify
  
• Let land because it is not considered a trading asset
  
• Parcels of land, houses or buildings used by a business unless considered part of a separately identifiable enterprise

Grey areas

• Because HMRC will not be releasing full details of the relief until the next Finance Act is passed – some time after the March budget – it is difficult to offer definitive guidance for all circumstances. For example, where a business owns more than one farm of the same enterprise type and wants to sell one of its holdings, the business will need to be carefully structured to qualify if it plans to continues trading.