OTHER EFFECTS OF CAPITAL GAINS TAX
REFORMS
48. We also discussed the likely impact of the CGT
reforms on groups of taxpayers other than the private equity industry.
Summarising those whom he considered to be the 'winners' and 'losers'
of the changes to CGT, Mr Whiting told us:
The winners do seem to be those with second homes,
other assets that rank for capital gains tax, quoted shareholdings,
providing they are not losing out too much when indexation is
abolished. The losers are clearly those who are seeing their tax
rate climbing, which can include entrepreneurs, small businesses
who also feel a bit blooded with the Arctic Systems agenda, employee
shareholders who in some cases will see their tax rate will go
up from 5% to 18%. There is quite a range of losers … some
of the winners are people generally who will find capital gains
tax easier to understand because I would not discount the advantages
of having a nice, simple flat rate system.[98]
49. The open letter to the Chancellor of the Exchequer
from the BCC, FSB, CBI and IoD addressed what these organisations
perceived to be the impact on the 'losers':
The net effect will be to set back the growth
of the economy over coming years, by discouraging longer-term
investment and risk-taking. Owners of small enterprises, who have
toiled over years to build up an asset, are now faced with selling
up before April or facing a substantial dent to their investment.
The 1.7 million ordinary employees who are in company share schemes
could also face an 80% increase in their tax bill and a serious
disincentive to taking up and retaining share options in the future
… Business angels and venture capital funds say they too
will be discouraged from taking risk and investing for the long
game. Many of those affected have already made investment decisions.
The retroactive nature of this move has undermined their reasonable
expectations.[99]
50. Treasury officials considered the likely effect
on small businesses and entrepreneurs to be minimal:
Capital gains tax is paid in any one year by
only about 250,000 [taxpayers]; it is paid by people who sell
businesses … I do not think you can look at this in terms
of winners and losers because, as I have said, only 250,000 people
dispose of assets and pay capital gains tax in any one year.[100]
When we put it to the Treasury officials that this
would mean 1.25 million people would be affected in the course
of a five-year Parliament, they thought that this would "by
no means necessarily" be the case, "because many of
those people may dispose of assets in successive years".
[101]
51. One group of potential 'losers' identified in
the open letter from the industry bodies was employee shareholders.
Under the current system of taper relief, shares held by employees
in their own company are classified as "business assets"
and, as such, only 25% of the chargeable capital gain is taxable.
IFS ProShare, an organisation established by the Treasury, the
London Stock Exchange and a number of FTSE 100 companies to promote
the benefits of employee share-ownership, commented:
The new rate of 18% applies equally to basic
rate and higher rate taxpayers and to business and non-business
assets. Previously, higher rate taxpayers who held their shares
for at least 2 years would have been subject to 10% CGT (the change
means such shareholders will now be 8% worse off.) Basic rate
taxpayers who held their shares for at least 2 years would have
been subject to 5% CGT (the change means such shareholders will
now be 13% worse off). In contrast, non-employee shareholders
could be up to 22% better off having previously been liable to
a maximum 40% charge. It is somewhat perverse that employees who
have contributed to the success of their employer are now going
to be worse off than under existing legislation whilst non-employee
shareholders who have not done so are to have their CGT liabilities
substantially reduced.[102]
IFS ProShare acknowledged that "the majority
of employees participating in their employers' share plan are
doing so via a SIP (Share Incentive Plan) which shield employees
from any capital gains" and thus probably would not be affected
by the CGT reforms. However, it estimated that a significant number
of the 1.7 million employees on "share as you earn"
schemes would suffer from the changes.[103]
52. In response, Treasury officials explained to
us that:
Our analysis is that there will be very little
impact. The great majority of [employee shareholders] will be
able to take advantage of the continuing exempt amount, which
is £9,200 in 2007-08. They will continue to have the tax
benefits that come with these schemes—income tax and NICs
exemption—and when the assets come out of the scheme they
are CGT-exempt, too. Therefore, our analysis is that very few
people will be affected by it … Very few of them will dispose
of shares that realise gains in excess of the £9,200
exempt amount.[104]
The Chancellor of the Exchequer added that, "in
relation to incentives to encourage shareholders, we already have
a number [of incentives] not just for the tax system but also
in relation to the money that Government spends as well. I do
want to encourage people … It is terribly important that
we do that."[105]
53. We also discussed with witnesses the message
sent by the abolition of taper relief, in terms of investment
and decision-making. Noting that one of the main stated aims of
the introduction of taper relief was to encourage longer-term
investment in unquoted companies, Mr Whiting told us that:
certainly the perception from talking to businesses
small and large is that a relief that was brought in to encourage
entrepreneurship and, indeed, to encourage long-term planning
has gone, so is this a signal that we are not supposed to do it?
I think we would say that business is asking the question.[106]
54. Treasury officials acknowledged that "the
introduction of taper relief did have a positive impact in signalling
a new hospitality to entrepreneurship", but argued that the
simplification agenda signalled by the CGT reforms was more important.[107]
The Chancellor of the Exchequer responded to concerns that a move
towards short-term investment would have potentially deleterious
effects on new businesses and entrepreneurs in the following terms:
We introduced [taper relief] … because the
prevailing rate was 40% up until we formed the Government in 1997
and in addition to that, mainly because of the economic turbulence
of the 1980s and 1990s, one of the big problems that people complained
about was instability and the whole culture was very short-termist.
We introduced that [taper relief] regime, it was the right thing
to do … However, it also makes sense from time to time to
look, as we do, to all tax regimes and say, "What is best
for the future?" … I am very enthusiastic and keen to
encourage people to take the long-term. The economic climate against
which people now plan is completely different from what it was
10 years ago but I think it is also right to ask ourselves at
each and every stage whether or not the tax system is the right
one. Nothing we do precludes changes at any time in the future
on any tax.[108]
55. The Chancellor of the Exchequer repeatedly emphasised
to us that the focus of the changes to the CGT regime was to simplify
the tax system. When ruling out any continuation of taper relief,
even in the short-term, he stated that "by definition any
complexity or qualification you put in a simple concept adds to
its complications".[109]
In terms of what he was prepared to accept for the sake of the
simplification agenda, the Chancellor of the Exchequer explained:
… once you have systems about what is good,
what is bad, what you want to encourage, what you want to discourage
and so on, of necessity you start to introduce a whole series
of complications … When we look at the thing, we know where
the tax taper comes from and where money is not collected. I accept
whenever you change things there will be some people who will
gain and some people who will lose. I think the challenge before
us is to try and get a simpler tax system, which is a prize worth
pursuing.[110]
56. Discussing the private equity industry, in
an interview in July 2007, the Chancellor of the Exchequer stated
he would not make any quick changes to capital gains tax that
"could result in unintended consequences and undesirable
consequences". Despite this, the reform of the capital gains
tax regime announced in the 2007 Pre-Budget Report will affect
small businesses and employee shareholders and could affect longer-term
investment. The Chancellor of the Exchequer's evidence to us suggested
that he regards such unintended consequences as inevitable effects
of the progression towards the goal of simplification of the tax
system. We appreciate the benefits that tax simplification can
bring and its desirability for all taxpayers, particularly small
businesses and entrepreneurs. However, we are concerned about
the possible detrimental effects that the withdrawal of taper
relief could have on small businesses, employee shareholders and
longer-term investment. There is a possibility that the absence
of transitional arrangements might give rise to unfair costs in
cases where a contract was entered into in good faith before the
2007 Pre-Budget Report announcement but where the contract terms
will not be fulfilled until after April 2008. We are particularly
concerned at the proposal to withdraw taper relief without adequate
notice. This will particularly penalise those planning to sell
their businesses and retire within the next two years. We therefore
recommend that the Government, in its response to this Report,
set out how it proposes to mitigate the effects of the withdrawal
of taper relief, particularly for those already within the two-year
qualifying period and with especial reference to small businesses.
Such a statement should assist with the discussions on the details
of the capital gains tax reforms that the Government has said
it is prepared to have with interested parties.
PROJECTED REVENUES FROM THE REFORMS
OF CAPITAL GAINS TAX
57. The 2007 Pre-Budget Report estimated that the
move to a universal 18% rate should generate increased revenue,
as set out in Table 3:
Table 3: Projections of increases in tax
revenue resulting from the capital gains tax reforms
