Of the tax changes in Alistair Darling's pre-budget report, it is the one that did not echo those in George Osborne's Conservative conference speech that is going to cause the biggest problems: the proposal to "simplify" capital gains tax (CGT) by introducing a single rate of 18 per cent—and in the process tackle the problem of the low tax bills currently faced by hedge fund and private equity operators. In the chorus of protest that is beginning to be heard, these victims have been curiously silent.
CGT is currently levied at anything between 5 to 40 per cent, depending on the type of asset held, the length of time for which it has been held and so on. From next April, the new 18 per cent rate will apply across the board. One immediate curiosity is that the new rate is forecast to raise the total revenue from CGT by about 9 per cent next year (£350m), by £750m in the following year, and an extra £900m in 2010-11. It can be deduced that the low rates of 5 and 10 per cent currently in force contribute 40 per cent of the £4bn revenue produced by CGT this year.
The current 10 per cent rate is notoriously applied to the profit built up by those running hedge funds and private equity ventures: if they hold on to these for more than two years, they are taxed at this rate, a quarter of the basic CGT of 40 per cent.
This concession, introduced by Gordon Brown in 1998, was originally designed to help those building up small businesses, into which they invested a substantial amount of their own money. It also applied to the purchase of shares in companies quoted on the junior (AIM) stock market—a nursery for growing enterprise. Employees who buy shares in the companies they work for under the Save as You Earn scheme (around 1.8m people) also pay reduced tax on eventual profits.
These groups have been caught in the crossfire aimed at other targets. These targets—the hedge fund and private equity managers—have kept their heads down and seem not to be complaining. This is understandable: they had feared having tax on their profits raised to 20 per cent or, worse, treated as income. In absolute terms, an 80 per cent tax increase (from 10 to 18 per cent) still leaves their rewards very juicy. True, those rewards depend on taking considerable risks, but those risks are predominantly run on other people's money. Typically, a hedge fund will take 20 per cent of the profits from the capital raised from its investors, on top of its management fee. The managers will subscribe 2 per cent of the capital. That means that the clients get just under 80 per cent of the profit for taking 98 per cent of the risks. To add insult to injury, they then pay 40 per cent CGT while the managers cough up 10.
Darling has proclaimed his intention of simplifying the tax system. Certainly, the CGT changes will make it very easy for people to calculate their liabilities. But simplification can create at least as many anomalies as complex regulation. The PBR proposals are subject to consultation before the publication of draft legislation in December. The 2008 finance bill may have to reintroduce some discrimination between different types of taxable assets, and perhaps some variation in rates together with renewed tapering of tax to reflect how long investments are held. Mild penalties for a few fat cats are being achieved at the cost of enraging millions of mild pussycats.
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