We ended our previous blog with:
If tax concessions are taken from one area they will seek others. Expect to see changes brought in concurrently to limit ISA contributions and increase the rates of Capital Gains Tax to investments outside of ISAs. The subject for next time.
So as promised here is my take on the increase in Capital Gains Tax and the decrease/capping of an individuals ISA allowance.
Currently there is no CGT on ISA or Pension investments, we expect that to remain the same. This blog is really only of interest if you hold excess investments in a General Account outside of your ISAs & Pensions. If you do not have a General Account there is no need to read on, unless you are interested. The rest of you can get back to what you were doing before this blog interrupted you.
Increase in Capital Gains Tax
We have left this blog quite late, with the Autumn Budget just 48 hours away now, but we have been waiting to see if any clearer information surrounding tax rates would be “leaked”.
Investment capital gains have always been taxed at a lower rate than earned and unearned income. That differential is about to become closer, or indeed fully closed, with maybe even a doubling of the rate of tax. Basic rate tax-payers currently are charged 10% on the gain achieved from holding investments (higher for property gains) Our worst expectations are that this could be increased to 20%. For higher rate tax-payers, their current 20% rate could be raised to 40%.
Why would this be unfair?
In a word inflation. For example let’s say an individual with a £100,000 General Account made a gain of 7.5% in the year, giving a gain of £7500. Let’s also assume there is no CGT allowance available – perhaps also a true assumption post budget. At the current rate of tax for a basic rate tax-payer the tax would be 10% – £750. But could that individual, a year later, have bought £7500’s worth of more goods and services? More stuff? Well no, not if inflation had risen over the year by 2.5% – £2500. After factoring in inflation, “in real terms” the increase in worth is just £5,000 (£7500- £2500) , so a £750 tax bill would already equate to a real rate of 15% anyway (£750/£5000). CGT is also a tax on inflation. Much of our inflation has been created by the fiscal irresponsibility of successive UK (and other Global) Governments. If tax rates were doubled, a basic rate tax-payer would retain just £6000 of their gain, which when modest inflation is taken into account, would mean the investor still takes 100% of the risk but receives only 70% of the gain.
Fairness will not stop this Labour administration
Neither will pre-election promises. We are immensely proud that over a couple of decades we have managed to encourage clients to save over £33 million into ISAs which are currently outside the grasps of CGT and Income tax. We also expect a radical change here too. The £20,000 allowance we have taken advantage of for years is likely to be reduced, forcing more funds into taxable General Accounts. So too is it likely that an overall cap could be introduced at perhaps £100,000, reducing the future tax-free allowance for some investors to nil.
ISA Action
For those clients with General Accounts and ISA accounts with us, we have tried to ensure allowances have been used already this year before this budget. It would be difficult for Labour to change ISA allowances mid year as product providers would need time to adapt systems. A reduction in the level of allowance is therefore likely to only come into play in the next tax year. They have talked about “simplifying” the system (read reducing allowances). I wouldn’t bet the farm, but reducing all ISA allowances to just £9000 a year (The level of JISAs) could be on the cards.
General Account Action
Pondering this question has kept us busy for weeks. With a guaranteed increase in CGT on the cards, do we realise our profits now at current rates of tax? Surely a no-brainer? After all, we could be subject to double the tax if we do nothing. It looks like a simple question, but it isn’t.
To cut to the chase we have decided to let our profits run on for several reasons. We will not be selling just yet.
CGT currently dies with you.: If we sold across the board and an elderly client then dies, we could be creating an in-life, up to 20%, tax bill for them which wasn’t necessary. However we were torn on this conclusion as it has been suggested CGT becomes chargeable on death, probably with a credit against IHT. If not, that would be double taxation on death (CGT & IHT!)
Seasonality: To crystallise a capital gain, we cannot re-invest back into the same asset for a period of 30 days. 30 days out of the market at the traditionally strongest period of the year would likely cost more in lost growth than the potential tax saving.
Timing: Upon consideration Labour would be foolhardy to make CGT changes from midday Wednesday. It wouldn’t be impossible charging different levels of CGT either side of the middle of a tax year. A mid year step change has happened in the past. However Rachel Thieves has one job – maximise revenue. If suddenly an individuals rate of tax is doubled – many would not consider selling in the short term. If sales are therefore not made, no tax is generated. We believe less tax would be collected in the immediate term, which would prove embarrassing. Better to give investors 6 months notice of the rise because many, many investors would then sell to lock in the lower rates now and avoid a doubling of tax. A huge concentrated result for Government. Selling investments is voluntary, 5p on a litre of fuel from 6.00pm causes queues at the pumps, because everybody has to keep filling their fuel tanks. Filling early saves money. It makes some sense increasing some taxation measures with immediate effect, but deferring others.
(Note to self – buy extra wine and fill up the fuel tank now.)
Discretion: As you know we can buy and sell on your behalf at our discretion to try to maximise your gain, within your risk tolerance and ability to withstand short term losses. We consulted with our compliance experts who confirmed that our discretionary mandate stops short of making the decisions necessary to minimise any individuals tax due. Advising on minimising tax can only be done on an individual basis, and action can only be taken when an individual agrees with us on our recommendations.
We don’t know what we don’t know: Labour have neither confirmed nor denied any action they intend to take in this budget. What we expect to happen in this budget depends on the mainstream media we consume. If you read the Guardian, or watch the BBC, Labour are angels, if you read the Telegraph, this budget is being prescribed over by the devil incarnate. I’m sure neither view is absolutely correct.
What’s next?
We expect to be extremely busy over the coming weeks and months as the reality sets in and we can plot an appropriate course for all of our clients. If action is needed, rest assured we will be personally in touch.
None of the above constitutes financial advice. We only make personal regulated recommendations directly to individual clients.