How private investors got caught in the political crossfire
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When it comes to managing the economy you can be pretty certain that if you plug one hole in the dam, the water will come seeping out of another.
And so, at his first attempt, Alastair Darling has succeeded in tackling one supposed flaw in the tax system – and causing all sorts of unintended consequences elsewhere.
The summary removal of all taper relief and the introduction of a flat 18% rate of tax on all capital gains appear to have been designed purely to land a financial blow on the chin of the private equity industry. I am certainly not against this, although frankly I doubt whether the prospect of paying 18% tax instead of 10% on their multi million pound gains will cause too much suffering here.
But these measures, along with changes to the Inheritance Tax Regime, have knock-on effects for private investors.
These are not all bad, so let’s start with the good news. The new Inheritance Regime, which will allow parents to leave £600,000 tax-free to their children without having to do any kind of financial planning has to be welcomed. And a reduction in capital gains tax from a top rate of 40% to 18% is good news too.
I am also pleased that investors will no longer be rewarded for inactivity. Under taper relief, the longer you held shares, the less tax you were liable to pay. This nonsense was introduced by Gordon Brown, who failed to appreciate that taking a long-term view of a company’s prospects and holding its shares for a long time are not one and the same thing. Investors should be encouraged to take a long term view – but they should not be rewarded through the tax system for being mentally idle.
I am far from certain that Darling understands this any more than Brown but, by luck or by judgment, this is a change for the better. Now, though, we come to the bad news.
First of all we now have a situation that I have never seen before where income is taxed at a higher rate than capital gains. The standard rate of income tax is 22%, rising to 40%. But capital gains tax will be levied at just 18%. This is clearly an incentive for investors to go for capital growth in preference to income.
This is quite the opposite of what most experienced private investors have done and what, for that matter, is considered to be the best way of building a retirement income. The new rules may tempt some companies to pay out less in dividends, while promising shareholders that retention of cash in the business will enhance capital growth – a very dubious argument.
It may also encourage some savers to buy non-income producing assets – works of art, for instance – in preference to property or shares that do generate income. This is bad news for the economy, which needs savers to put their cash to work in productive assets.
But the biggest nonsense concerns ISAs. Once again, in his report called (you’ve guessed it!) ‘Fairness and Opportunity For All,’ Darling celebrates these tax-efficient savings vehicles. But in the same report, his tax changes have undermined their advantages.
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For shares held within an ISA it was, before 2004, possible to reclaim the tax withheld on dividend payments. Gordon Brown did away with this advantage in 2004, leaving as the main attraction of ISAs their shelter from capital gains tax. Now with the latter suddenly more than halved from 40% to 18%, the value of this benefit is much reduced, and will in some cases now be insufficient to offset the costs of maintaining the ISA.
But the real bugbear for investors has been the inability to hold AIM-listed shares in an ISA. This was justified partly on the illogical basis that AIM shares are too risky for long-term personal savings funds, and partly because AIM shares were treated as business assets and therefore already offered enhanced tax relief.
Neither of these arguments can now be applied. In order to escape the costs of a quotation on the Main List of the Stock Exchange, a number of mature, well-established and low risk companies have chosen to relegate themselves to AIM. And after yesterday’s announcement AIM shares no longer carry tax advantages over other shares.
All investments are equal...
Instead, Darling has established a new principle. The same rate of CGT now applies to all investments. There is no taper relief. Therefore all investments are apparently considered equally worthy. This surely means that there can no longer be any excuse for excluding AIM shares from ISAs.
Finally the new rules call into question the exemption from IHT of AIM shares, if held for two years. Again this was apparently predicated on a view that investment into AIM shares was so bold that it was worth the reward of IHT exemption – although in practice the AIM shares bought to fulfill this purpose were at the very low risk end of the AIM spectrum. If AIM shares are now no longer worthy of accelerated taper relief, why should they receive favorable treatment under IHT rules?
With the more generous IHT thresholds some investors may find that, in order to be able to pass more of their wealth on to their children, they have in fact bought AIM shares unnecessarily. If so they may now be tempted to sell, as may other AIM investors in order to pay the 10% tax rate that will apply up to April 6th, and not the 18% that will apply thereafter.
In short, and by no means for the first time, the goalposts that affect private investors have been shifted in order that the Chancellor of the day can score a few political points.
Money spent on careful tax planning will be found to have been wasted. Portfolios of Main List and AIM shares, carefully constructed to mitigate tax and to balance the need for income and growth, will suddenly become efficient than before. Financial advisers and private client fund managers will cream off fees as once again they reorganize the affairs of their clients. And again the new arrangements will only hold good until the next time the Government changes the rules.
It’s a mess. It’s a muddle. The private investor has been caught in the political crossfire once again. Oh dear.
This article is taken from Tom Bulford's free daily email ‘Penny Sleuth’. For more information please click here
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