Commercial property and CGT – planning for the increase

Planning for a CGT increase

Capital Gains Tax is going up. Whether you own commercial property directly or shares in a property company, these are worrying times. The government will reveal full details in the emergency budget on 22 June but everything suggests a new CGT rate for top earners of up to 40% or even 50%. That’s more than double the current rate of 18% which, by historic standards, is exceptionally low for property owners and investors. This note explores what planning can be done now to beat the increase.

When will the new rules apply?

Any changes are likely to take effect either on budget day or on 6thApril 2011. Even a retrospective change is possible although unlikely. Whilst the lack of certainty makes planning difficult, we still believe it is sensible to assume a budget day increase on 22 June and plan for that. If you take action now, the potential tax savings could be very significant compared to the cost of doing nothing.

Will there be special rules for entrepreneurs and investors in small businesses?

The government has announced that there will be “generous exemptions for entrepreneurial business activities…”. The problem is no-one knows what that means or how generous any new exemptions or reliefs will be. The old Business Assets Taper Relief gave a CGT rate of just 10% and was widely available. When Taper Relief was abolished in 2008 and replaced with a new fixed 18% CGT rate, Entrepreneurs’ Relief was introduced to preserve the 10% rate for gains up to £1m (later £2m). However, Entrepreneurs’ Relief is far more restrictive than Business Assets Taper Relief, since it won’t apply to a property investment business. It also requires a shareholder to own at least 5% of the business and be an employee or director.

Our view is that any new reliefs are more likely to mirror the tighter rules for Entrepreneurs’ Relief and be restricted to larger shareholders working in a property trading or development company.

What planning can be done now?

The key to any planning is to dispose of your property or shares now. You will then lock in the current rate of 18% before higher CGT rates apply. If a sale is already in progress then you should try to complete, and certainly exchange contracts, before the budget. But for most people, a sale to a 3rd party before 22 June will be impractical. In that case you can still trigger a pre-budget disposal for tax purposes by transferring the property to a connected party such as a family trust. There is nothing to stop you benefiting from the trust and you can even be a trustee so that you still keep control.

What are the advantages?

A disposal to a family trust is taxed like an actual sale at today’s market value. That means you pay tax at just 18% on all gains to date. If those historic gains are large, the tax saving could be very significant compared to paying tax at up to 40% or even 50%. Locking in today’s tax rates is particularly attractive if you expect to sell in the next few years. In that case only future gains would be taxed at the new higher rates.

What are the disadvantages?

A disposal to a family trust means the tax will ordinarily be payable on 31st January 2012 even though the property or shares might not have been sold by then. However, you can usually pay the tax in ten annual instalments.

Another potential downside is the risk of having to pay tax on current gains which may never actually be fully realised. The tax liability remains even if the property or shares subsequently fall in value or are never sold.

What if there is no sale on the horizon or the value falls?

Fortunately there is a solution. It still involves a disposal to a family trust to lock in today’s lower CGT rates. However, the disposal is structured in such a way that if circumstances change, there is a mechanism to unwind the disposal and avoid the CGT charge.

Who should consider pre-budget planning?

Planning for an imminent increase in CGT is relevant for the following:-

• Individuals (or trustees) who own investment properties
• Property company directors and employees
• Property company investors
• Those currently selling, but where contracts will not be exchanged before 22 June.

For further information on possible CGT planning before the emergency budget on 22 June, please contact Andrew Goldstone on 020 7440 7205 or Jonathan Legg on 020 7440 7092.