New capital gains tax changes to affect SAYE schemes
Any changes to government legislation are sure to have widespread implications, but on rare occasions they can also lead to unintended consequences as in the case of the forthcoming changes to capital gains tax (CGT) announced in October’s pre-Budget Report.
It has emerged that the new rules, aimed at ending a tax loophole allowing private equity investors to pay rates of tax as low as 10% on most of their income, will also penalise at least some of the 1.7 million UK employees currently investing in company save-as-you-earn (SAYE) share schemes.
Ongoing talks with Treasury
Acknowledging the problem, the Treasury is currently in talks with concerned parties to determine if it is possible to mitigate the adverse nature of the changes.
Removal of “taper relief”
The controversy surrounds the removal of what is known as the “taper relief” that reduces the level of CGT payable and its replacement with a flat-rate of CGT. Taper relief was introduced in 1998 to encourage long term-investment and allowed the level of CGT applied to an asset to reduce over time down to a lowest possible rate of 10% in the case of business assets. Reductions are not quite so generous for non-business assets.
From April 2008, the flat-rate of CGT will be set at 18%, higher than the 10% rate enjoyed by many at the present time.
Very few may have a problem with wealthy private equity investors paying more in tax, but because shares received from company share schemes such as SAYE qualify as business-related assets, in certain cases, employees investing in them may also have to pay more tax. This aspect of the changes has drawn widespread criticism of the policy.
How taper relief works
Under the current rules, rates of CGT before any taper relief is applied are determined by an individual‘s top rate of income tax. From April 2008, this would have been 40% for higher-rate and 20% for lower-rate taxpayers.
When taper relief is applied, however, these rates reduce so that, for business assets, the amount of CGT payable reduces by 50% after one year and 75% after two.
With the old CGT rules applying, therefore, if shares are held for two years, lower-rate taxpayers would have their bills cut to just 5% and higher-rate payers, similarly, to 10%.
Since both these percentages are lower than the new 18% flat-rate due to come in April 2008, it seems that at least some employees will be paying more tax on their SAYE profits from April 2008 – 13% and 8% more respectively.
Only a few likely to be affected
The situation is not that simple, however, because capital gains tax only arises above a certain threshold, currently £9,200 per year. Some argue that it is only in very few cases that SAYE profits exceed this level so are therefore unlikely to be affected by the new rules.
As Mike Landon, principal at Mercer, says: “In some circumstances, there will be a large increase in the capital gains tax bill. However, most employee shareholders currently do not pay any capital gains tax at all when they sell their shares. The capital gain they make is usually covered by the annual capital gains tax exemption”.
He adds further: “Even those employees who do make capital gains from SAYE plans which exceed the annual exemption quite frequently sell the shares immediately after they have acquired them. So they do not qualify for taper relief in any case”.
On the other hand . . .
While this is true, some commentators still believe the changes are not satisfactory for a number of reasons. Firstly, they say that we may not be talking about the gains from just one SAYE scheme because gains are often cumulative with employees that have been with their organisations for many years often participating in more than one SAYE scheme. In such cases, having held their shares for many years, they may have accrued a very large capital gain that is likely to exceed the £9,200 threshold and therefore will be penalised by the new rules.
Perhaps more importantly, they argue that whether it is a small or large number of employees affected, it is still unfair to penalise any SAYE members. After all, these are often lower-paid staff so why should they pay more tax when the policy was aimed to tackle the problems associated with an entirely separate higher-paid group?
What companies need to do
There are a number of things that firms can be doing to keep their employees informed. Firstly, they should monitor the Treasury discussions and, once concluded, they may want to update SAYE and other share scheme members of any new tax information that may affect them. If the changes stand, they can inform employees that by disposing of their SAYE option shares before 6 April 2008 they will be able to keep their accrued taper relief.
More generally, however, there are other simple ways of mitigating CGT bills that will not change, including:
Staggering sales of shares to use the annual exempt amounts (the current £9,200 threshold) over several years.
Transfer of shares to a spouse or civil partner to use their annual exempt amount.
Transfer of shares into an ISA or a personal pension.
A final word
"Whilst the Treasury may have sound reasons for simplifying CGT, it would appear the consequences for employees saving through employee share plans had not been fully assessed. These apparently unintended consequences contradict government's oft stated commitment to encouraging long-term saving and to their support for wider share ownership. As a result, we will be consulting with our members over the next few days and will then be seeking a meeting with Treasury officials to express the views of the share plans industry, provide evidence of the negative impact these changes may have on many hardworking employees and to discuss possible solutions." - IFS Proshare.
Want to know more?
For more information on the changes visit:
For a more in-depth reaction on the capital gains tax changes visit the Tax Research web site at www.taxresearch.org.uk/Documents/CGTafterthePBR.pdf.
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