Brown's box of tricks

The Chancellor gave nothing away, but savers and investors all feel rewarded. Clifford German looks at the implications for PEPs, ISAs and capital gains tax
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The Independent Online
GORDON BROWN pulled a good trick on savers and investors last week. Everyone (almost) will be more cheerful about their personal finances after the Budget, but (almost) nobody will actually be better off, and some, including owners of houses over pounds 250,000 and investors in off-shore tax shelters, will be worse off.

For some people the best news in Tuesday's speech was the fact that tax relief on contributions to pension funds is still available at 40 per cent for top-rate taxpayers, and lump-sum payments from retirement funds are still tax free.

For others, the best news may be the decision to increase the assets protected from inheritance tax from pounds 215,000 to pounds 223,000, not to impose higher rates on larger estates and not to abolish PETs (potentially exempt transfers), which allow people to give assets away in life and progressively to reduce the rate of IHT if they live a further three or five years and to escape it altogether if they survive for a total of seven years.

For many employees, it is the decision not to tax car-parking spaces. Homebuyers will sigh with relief because there are no plans to reduce further the rate of tax relief on mortgage interest. The rate of relief comes down to just 10 per cent in April, worth about pounds 5 a week on a typical mortgage, but contrary to expectations it will not be reduced further in 1999-2000.

q ISAs and PEPs

For most investors, the good news is the decision to allow all Personal Equity Plans to retain their tax-free status after April 1999, and to improve the terms for the Individual Savings Accounts that will replace them as all-purpose tax-free investments for the next 10 years.

Investors can now buy their full allowance of PEPs this year and next, safe in the knowledge that all PEPs held on 5 April 1999 will remain exempt from income and capital gains taxes. PEP holders will be free to buy their full allowances of ISAs in addition to their existing PEPs.

The Chancellor has sweetened the start of the Individual Savings Accounts by allowing investors to put up to pounds 7,000 into an ISA in year one, including up to pounds 3,000 in a tax-free deposit account. From April 2000 the annual limit will be pounds 5,000, including pounds 1,000 in a deposit account and pounds 1,000 in an insurance-linked investment policy.

ISAs will run for at least 10 years, with a review after seven. Unlike PEPs there will be no limits on investing in shares in overseas companies, and unlike TESSAs, cash in an ISA deposit account can be withdrawn at any time without losing the tax benefits.

q Capital gains

The Chancellor has changed the nature of capital gains tax and made it fairer by taxing long-term gains at lower rates than short-term, but he has not necessarily simplified it. This could pose problems for investors filling in self-assessment forms.

The amount of gains you can take each year without becoming liable to pay CGT has been increased from pounds 6,500 this year to pounds 6,800 in 1998-99. Married couples effectively still have double that amount because no action was taken to stop spouses transferring assets to make full use of both allowances.

Assets that were acquired up to the end of this tax year can still be indexed to establish whether a taxable gain has been made when they are sold; that is, the purchase price can be upvalued in line with the retail price index from the time of purchase. But this indexation will be frozen from April 1998, and any extra gain between then and the time of sale will not be protected against inflation.

By definition, all assets bought from now on will not qualify for indexation at all, but it may be many years before indexation tables become entirely superfluous.

In future, however, the rate of tax paid can be reduced for assets which have been held for more than two years and up to 10 years after 6 April 1998. If the asset is a business the top rate of 40 per cent reduces by 3 points a year to just 10 per cent after 10 years, and a basic rate of 23 per cent reduces annually to just 5.75 per cent after 10 years.

With shares, property and other non-business assets the rules are tougher. An asset has to be held for three complete years from 6 April 1998 to qualify for tapering relief. The top rate then declines by two points a year to a minimum of 24 per cent after 10 years. The 23 per cent rate for a basic-rate taxpayer comes down to 21.85 per cent after three full years and falls in steps of 1.15 points a year to a minimum of 13.8 per cent after 10 years.

Whether tapering compensates for the loss of indexation depends on the amount of gain and the rate of inflation. If assets are sold in the early years the taper will not compensate for the loss of indexation but, according to the Inland Revenue, if assets appreciate by 8.5 per cent and inflation rises by

2.5 points the taper more than compensates if the assets are held for between seven and eight years, and in the case of business assets the faster taper is worth more than indexation would have been after as little as four years.

However, if asset growth is slower it will take longer for the taper to become more beneficial than indexation.

q Bed and breakfast

As part of the reform of capital gains tax, the Chancellor has put a stop to the time-honoured practice of bed and breakfast deals, which allowed investors to sell assets before the end of a tax year and immediately buy them back to establish a higher purchase price for calculating taxable gains on future disposals.

In future, if you sell shares and buy them back within 30 days the two deals will be cancelled out for tax purposes and you will be deemed still to have the shares at their original purchase price, which renders the exercise pointless.

q Guides to the 1998 Budget (and an updated guide to venture capital trusts) are available free to readers of the `Independent on Sunday' from the David Aaron Partnership, Shelton house, High Street, Woburn Sands MK17 8SD.

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