All for one

As thoughts begin to turn to spring, many higher earners might be wondering if the new financial year may herald a thaw in the burden of capital gains tax.

Sadly, the answer is probably no. The chancellor, George Osborne, has confirmed that the 28 per cent rate is here for the lifetime of this parliament. If we put our faith in the stability of coalition govern-ments, any further change is unlikely to come until May 2015 at the earliest.

For many in the tax and the accounting profession, this period of relative stability will come as something of a relief. The past 12 years have seen three major upheavals in the capital gains tax world, the first two both brought about by the same Labour administration. So how did we get here?

Perhaps surprisingly, capital gains tax has a short history. It was introduced in 1965 by the Wilson government at a flat rate of 30 per cent in an effort to stop individuals avoiding income tax by converting their income into capital. A threshold of £9,500 was set '“ the proximity of these rates to today's might suggest we have come full circle!

Chop and change

Other than the introduction in 1982 of indexation allowance to combat soaring rates of inflation, the tax remained relatively unchanged until 1998. The Finance Act 1998 introduced significant changes. Indexation was abolished and taper relief was introduced in its place. The effect of taper relief was to reduce the amount of gain chargeable to tax according to the length of time the asset had been held.

Business and non-business assets were taxed at different rates, with business assets effectively being taxed at ten per cent if they were held for more than four years (later reduced to two). Non-business assets were effectively taxed at 24 per cent if held for ten years. The purported intention was to reward entrepreneurs for risk taking while simultaneously ensuring that individuals did not have their assets eroded by inflation.

However, within ten years the Labour party's thinking had fundamentally changed. The Finance Act 2008 saw the withdrawal of taper relief and the distinction between business and non-business assets, and imposed instead a flat rate of 18 per cent. This was presented as a tax simplification exercise '“ capital gains tax had become increasingly expensive for the government to collect. But it was also an attempt to assuage public anger at '“ and no doubt capitalise on '“ the substantial profits being made by the private equity industry, who had become adept at structuring returns to be taxed as capital gains at a rate of ten per cent rather than income at a rate of 40 per cent.

Double trouble

Holders of business assets were effectively seeing their rate of capital gains tax almost double from ten per cent to 18 per cent. Great concern was expressed about the negative effect on entrepreneurial activity, particularly for the small business owners.

Entrepreneurs' relief was therefore introduced in an attempt to draw the poison from the wound. This provided for a ten per cent rate on the first £1m of capital gains arising from a qualifying disposal (the £1m being a 'lifetime allowance').

Although undoubtedly well-intentioned, the relief drew significant criticism, particularly because the qualification criteria were narrower than those for the old business assets taper relief and the £1m allowance was seen as too small. The real beneficiaries of 2008 were individuals holding non-business assets long term, particularly the buy-to-let market who saw their lowest rate of tax fall from 24 per cent to 18 per cent.

The most recent changes came with the coalition's Emergency Budget on 22 June 2010. There had been much speculation about raising rates of capital gains tax as a way of helping to tackle the UK's deficit (although, with receipts of about £4bn per year, capital gains tax is certainly not a 'big earner' for the Treasury).

While the Conservative manifesto had been silent, the Liberal Democrats had promised to 'tax capital gains at the same rates as income, so that all the money you make is taxed in the same way'. This could have led to rates reaching 50 per cent, possibly without the benefit of taper relief.

Although this appeared to be an extreme measure, the Lib Dems felt it justified on the basis that certain individuals, particularly in the aforementioned private equity and buy-to-let markets, had paid too little tax for too long. As inevitably happens a compromise was reached, with a new higher rate being introduced of 28 per cent, which is likely to catch most significant gains. This was broadly welcomed by a market fearful of yet more upheaval.

Entrepreneurs' relief was also made more effective with the lifetime allowance increased to £5m. And in many cases that allowance can be multiplied by ensuring that interests in the family business are held more widely by family members.

Unresolved issues

What, therefore, does the future hold for capital gains tax? While the current rate is likely to remain frozen for this parliament, and may not be seen as unduly high in the overall context of UK taxation, several issues remain.

The new rate does not take inflation into account '“ a particular concern given predictions of future inflation. Further, an equitable distinction between business and non-business assets still eludes us, with long-term investors still being penalised.

The recent review of tax reliefs by the Office of Tax Simplification suggests that resolving these problems is not a priority. While the report does highlight some of the difficulties in taxing capital gains (most notable the discrepancy in the treatment of individuals and corporates) it considers another major change, particularly in the area of personal tax, unpalatable. The report concludes that it would 'be sensible to allow [the current rules] to bed in'.

Any wholesale reform is therefore unlikely in the short term. However, the pressure of inflation, and pressure from the business community, may yet lead to a thaw in the burden of capital gains tax.