CGT

After years of stalling, the Government finally caved in to pressure from the property sector and allowed the conversion to and establishment of Real Estate Investment Trusts from January this year (REITs are an established investment in many other countries).  Unfortunately, the year has not been kind to the sector with a loss in share price of almost 25% so far.  They have also been hit by the Governments proposal to introduce a flat rate for Capital Gains Tax of 18%.  Capital Gains realised within the REIT most be largely distributed to shareholders as income, with correspondingly higher rates of tax.

In fairness, most REIT investors would not be buying investment property directly and appreciate the high liquidity of REITs, even if they bring with them higher volatility and slightly higher tax.  it does, though, look as if the hype has proved to be without substance and REITs in the UK may be confined to the fringes for a while.

Alistair Darling seems to have achieved the unprecedented in uniting almost every interested group against his proposed changes to Capital Gains Tax.  In essence, from next April, business tax payers, including entrepreneurs and those in holding shares in their employing company will see their tax bills rise in most instances.  Many private investors, including second property owners will pay much lower rates of tax, especially if they are high rate taxpayers.

Whenever a Government announces it is ‘simplifying’ something, it is almost always worth running for cover. At first sight, however, the changes to the Capital Gains Tax regime are fundamental and, indeed, represent a simplification. Most private individuals are unfamiliar with the workings of CGT, the annual exemption remains one of the least used tax breaks available and, despite a degree of simplification in recent years, it can be complicated.

At the moment, there are two types of gain, those which count as business gains, including the much publicised gains made by the Private Equity industry, and private gains, which include those made on listed shares and buy-to-let properties, for example. These gains are further subdivided into those made pre and post April 1998. The present system was supposed to favour those who held onto their assets for a long time (although, I am not sure why) and those whose gains resulted from a degree of greater risk such as entrepreneurial endeavour or buying shares in unlisted companies. It also bestowed a tax advantage on those owning shares in the company employing them, nice, if you happened to work for a listed company.

The tax on business gains could be as low as 10% and personal gains 25% but, in the case of the latter, only if held for at least ten years. Also the rate of tax depended on the level of income tax.

Now, it seems, all of this is to go being replaced by a flat rate of 18% on all gains. We shall have to see whether this simplification survives intact as many of these initiatives fall prey to the law of unintended consequences and it often looks like policy is made up on the hoof. Also, the problem it was designed to cure, namely, the ‘unseemly’ profits made by the Private Equity industry, may be about to disappear, victim to the global credit crunch.

Quite how these changes will affect investor behaviour will only become apparent in the longer run.