The Revenue will prevail on capital gains tax

Comment

The Chancellor's undignified retreat on share options, under pressure from his next-door neighbour at Number 10, may have other more far reaching effects. After their latest trouncing at the hands of the electorate, Tory MPs will press even more vigorously for tax concessions in the forthcoming budget. Their hope will be that they can take advantage of a weakened Chancellor.

One front-runner is sure to be abolition of capital gains tax (CGT). Earlier this week, the right-wing 92 Group called for the tax to be phased out over three years. They know they're knocking at an open door - the one to Number 10.

This is a project close to the Prime Minister's heart. In his speech to the Tory party after winning his leadership election gamble, John Major singled out capital and inheritance taxes as ones he wanted to reduce and eventually abolish. They form part of his romantic vision of wealth cascading down the generations.

The proposal is ostensibly all the more attractive in as much as capital gains tax does not raise that much money - and so would be a relatively cheap tax to consign to history. According to the Treasury's latest assessment, CGT will bring in less than a billion pounds in the current financial year.

So far Mr Clarke has been stoutly resisting the stream of helpful suggestions from the Number 10 policy unit. He batted ideas for special help for the housing market into the long grass in his testimony to the Treasury Select Committee three weeks ago. He apparently takes the robust view that cuts in the standard rate of tax will reach more voters than a string of concessions to the better-off.

However, anyone hoping that a battered Chancellor will now have to concede ground on CGT will be gravely disappointed. Capital gains tax may not raise that much money, but in its absence, the Inland Revenue would lose a heap. It's what tax experts call "a book-end tax" - one to prevent tax losses rather than raise revenue. If CGT were abolished, the tax avoidance industry would go into hyperdrive to convert income into capital gain, as it used to do with great success when income tax rates were higher than CGT. Mr Clarke may be on the ropes. But the Inland Revenue's arguments will prevail. Anyone hoping for a knock-out blow on CGT needs to wrap a wet towel round their heads.

Require regulators to take account of markets

Michael Lawrence, the Stock Exchange's chief executive, said earlier this month that he plans to put the whole class of regulators in detention because one child - or rather Professor Stephen Littlechild, the electricity regulator - misbehaved. He has summoned them all to his study for a wigging, and wants them to promise to draw up new rules to govern their own behaviour. This week's Treasury report on the fiasco surrounding the generator sale certainly suggests that this is a problem specific to one regulator. How is it that the Office of Fair Trading and the Independent Television Commission, to name but two of the 11 other regulators Mr Lawrence has asked to see, have managed to avoid leaving a similar trail of chaos behind their announcements in the markets?

The simple answer is that they do not mess around changing their minds about price sensitive policy issues the weekend of a government flotation, which is Professor Littlechild's very singular offence. His changes of mind contributed to the Treasury's miasma of misunderstanding of what was going on at the time of the sale of the government's remaining stake in the generators. This was one of the causes of the Treasury's failure to warn the market that a decision on a new distribution price review was possible.

Mind you, the Treasury should have judged the Professor's very uncertainty of mind as a price-sensitive factor and said something, anything about the risks of a new development. But in true Whitehall style, the Treasury's report on the fiasco makes clear that nobody is to blame, except that it left some mud sticking with the Treasury's City advisers as well as the Professor and - reading between the lines - even with Whitehall itself. Why else would the report tell officials to talk a bit more often with their ministers? The report says it is improbable that the same will happen again during another share sale by the government. The Treasury must have forgotten that the planned nuclear privatisation is within Professor Littlechild's regulatory remit. So is the purely private sector sale of the grid, now owned by the regional electricity companies. Let's not be too confident.

The Treasury has recommended improvements in the liason between regulators and vendor departments and with the exchange, coupled with tighter procedures inside government. But while Professor Littlechild remains in office, there will always be a wild card in play, whatever the exchange does.

The best solution would be to impose a formal obligation on regulators to take account of market sensitivities, which would at least allow those who repeatedly fail to do so to be sacked.

Why all the fuss over options?

For all those company directors who rang us yesterday in despair about the abolition of new executive share option schemes, a word of comfort from David Oliver of Arthur Andersen, the accountants. He says that in recent years there have probably been more new unapproved schemes started than approved ones, because they are cheaper to put in place and do not have to go through hoops put up by the Inland Revenue.

To recap, an approved scheme gets capital gains tax treatment, while in an unapproved one the profits are treated as income and are taxed immediately. The Chancellor has abolished new approved schemes, but there is nothing to stop companies continuing to set up the unapproved version, with their employees taking the income tax hit on the chin.

The options can only be held for seven years rather than the 10 under the approved scheme, but they can be exercised at any time during that period. Companies are also free to stipulate the dates of exercise, and can set limits, for example by stipulating that options must be held for a certain number of years before exercise. The unapproved schemes also sidestep a restriction in the Inland Revenue's scheme to exercising no more than once every three years.

Unapproved options are just as much of a one way bet for an employee, who still does not have to put up cash in advance. If the shares perform well there is still a decent profit to be had after tax, at no cost or risk. If so many companies were already going for unapproved schemes - even while the controversial approved version was available - what has all the fuss been about?

Edited by Peter Rodgers

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