Autumn Tax Changes

On 9 October Chancellor Alistair Darling, in his autumn statement, made some well publicised changes to Inheritance Tax and Capital Gains Tax.  Are they worth anything, or are they just smoke and mirrors?

Starting with Inheritance Tax, regular readers will know that one of the ongoing problems with this tax (including 10 years of Gordon Brown’s chancellorship) was that if one spouse or civil partner left his or her estate to the other spouse or civil partner, then the nil rate band of the first to die was lost.  Currently the nil rate band is £300,000, and with Inheritance Tax at 40%, that is in effect a tax penalty on marriage and civil partnership of £120,000. 

From 9 October, if spouses or civil partners die leaving their estates to one another, there will be no loss of the nil rate band of the first to die, it will be transferred to the survivor and used on the second death.  Furthermore, the value of the nil rate band of the first to die will increase with the nil rate band of the survivor.

The one novel part of the legislation is that it now provides that any widow or widower currently living whose spouse did not fully use his or her nil rate band, can bring that forward at an enhanced rate.  This only applies where the surviving spouse or civil partner dies on or after 9 October 2007.

The first reaction was to sound the death knell of the nil rate band discretionary trust.   A hasty and misguided reaction.  For those of you who have Wills with nil rate band discretionary trusts in them, my advice is to leave them alone.  If on the first death you no longer want to take advantage of it, then the funds can be appointed by the Trustees to the surviving spouse, and you will automatically enter the new tax regime.  However, those of you with relatively modest estates take care.  If you pass all your estate to your surviving spouse or civil partner, and then he or she has to go to a nursing home, it is likely to be goodbye estate.  If however, you leave the nil rate band trust intact, then it will be safe.

As ever there are no simple answers and it is wise to take proper advice at the time.

The Chancellor then turned his attention to Capital Gains Tax, because he has made a fundamental change to the tax which leaves a number of winners and a number of losers.  The potential losers are those businessman and entrepreneurs who will be selling their companies in a couple of years time.  Under the old regime with taper relief, they could expect to pay Capital Gains Tax at the rate of 10%.  Under the new regime they will pay at 18%, which is an 80% increase.

On the other hand those with ordinary stocks and shares and other investments that were chargeable to Capital Gains Tax at 40%, the rate falls to 18%. 

With Capital Gains Tax there is one rather mean sting in the tail, and that is the abolition of indexation.  Capital Gains Tax was introduced in 1965.  By 1982 most of the gains were in fact inflationary rather than real, and as a consequence rebasing was allowed as at 31 March 1982.  In order then to deal with inflation, the indexation allowance was introduced.  Indexation was scrapped in April 1998 when taper relief was introduced, although the effects of indexation were retained.  Thus, if you acquired an asset in 1984 and sold it in 2006, you had firstly the benefit of the indexation allowance between 1984 and 1998, and then taper relief.  In fact, indexation was a very valuable relief because between 1982 and 1998 the base cost more than doubled in line with inflation.  Unfortunately, Mr. Darling has decided to abolish indexation so that from April of next year, it will no longer be possible to use the indexation allowance to calculate the base cost before capital gains are calculated.

It is clear that the changes to Capital Gains Tax have found favour with some and caused horror to others.  Unlike the changes to Inheritance Tax, the Capital Gains Tax legislation has not yet been drafted and until it is, nobody can be sure what it will say.  Moreover, once it is published it will go through its various stages before entering the statute books in the new tax year, and so it is probably going to be a while before we can absolutely sure, all of which causes the most enormous difficulty in tax planning.

David Endicott
Managing Partner