What the CGT hike means for trusts and international investors

There was a lot of speculation as to what the rate will be raised to, when and how. However, what was certain was that there would be a change and this prompted many advisers to contact their clients who they feel could potentially be adversely affected by any amendments to the legislation, despite being unaware of the exact details.

What would be the 'worst case scenario'?

Many advisers had provided opinions on what they believe the Emergency Budget could include for CGT and these include raising the rate of CGT to income tax levels i.e. 40% and 50% for individuals who earn over £150,000, coupled with a reduction in the annual exempt allowance from £10,100 down to as little as £2,000. What noone opined on with any conviction is when the changes would be introduced. Some said it was likely to be the start of the next tax year i.e. 6 April 2011, while others said it could be either Emergency Budget day itself (22 June) or  even retrospectively backdated.

On the day, George Osborne laid all rumours to rest by announcing that the rate of CGT would be raised for higher rate taxpayers from 18% to 28% effective from midnight on the 22^nd June with the annual allowance remaining in place at £10,100.

What does this mean for those people with non-UK connections?

For international investors looking to invest into the UK, this change is unlikely to have any impact on their UK tax exposure as non UK resident individuals are not liable to UK CGT in any event. The timing of the introduction of the new rate was also interesting as it effectively shut the door on a short window of opportunity to sell assets such as second properties, which would have been a possible investment opportunity for foreign investors.

It is not good news for everyone though – the 'Stockpiled Gains' conundrum

One of the areas that has been worst hit by the increase in the CGT rates is offshore trusts. This may surprise some given that offshore trusts do not ordinarily have any UK CGT exposure, which is one of their main attractions. However, where there are UK resident beneficiaries (irrespective of whether they are UK domiciled or not), certain anti-avoidance rules apply where the trust sells an asset at a profit and these provisions are generally speaking unfavourable where beneficiaries are to receive any benefits from the trust - one of the key reasons for establishing the trust in the first place.

Broadly speaking, these rules serve to apply an incremental supplementary charge to the rate of CGT that would be applied to the beneficiary if they were to receive a distribution from a trust which had made a profit on its investments. The supplemental charge is applied each year for up to 6 years after the profit has been made, unless the profits are distributed from the trust to those beneficiaries, thereby triggering a UK CGT liability. Effectively, the charge is an inducement for the trustees to make a distribution, rather than holding on to the profits within the trust, or “stockpiling” the gains.

The supplemental charge is calculated as a 10% incremental, year on year, charge of the applicable rate of CGT. Therefore, if the current flat rate of 18% is to be applied, the supplemental charges would be 10% of 18% (1.8%) in year, 10% of 19.8% (1.98%) in year two, and so on, until a maximum charge of 28.8% after six years accumulation.

If the rate of CGT had been increased to a maximum rate of 40 or 50%, this could have meant that the supplemental charge could reach as high as 64 or even 80%! As it is, the maximum supplemental charge will now be 44.8% - much higher than the 28% rate itself.

In addition, for those UK resident individuals looking to invest abroad, where the rate of local CGT in the foreign country is relatively low, they may have an additional tax liability. For example, where someone owns Spanish real estate where the Spanish rate of CGT is currently 19%, if they were to sell this, they could be subject to additional UK CGT.

What should individuals do?

In short, there might not actually be anything that those potentially affected can now do, given the fact that the new rate is already in place. Notwithstanding this, one should speak to their tax or legal advisers as well as their trustees and/or private bankers to review the position and consider their options as this is a complex area.

Summary

The issue of the CGT rate increase has proved hugely divisive, particularly given the recessionary environment at present. Supporters would point to the fact that the rates of CGT in most cases were previously up to 40% and therefore this could be seen as a move back to the previous position, in which case individuals with long term positions are still better off than they were before the rate was reduced to 18%. For those individuals who changed their investment strategy to take advantage of the lower rate of tax, they should know that strategies based on tax motives can be undermined by rate changes, as would be the case here.  

Of course, everyone will have their own views on the effectiveness or otherwise of rate changes, but the new rate is arguably a sensible compromise and could have been a lot worse.