Tom's Tangles With Taper

Will a long-serving employee get the 10 per cent rate? RICHARD HOLME and ELIZABETH ROBERTSON of Creaseys Tax Consulting explain.

EMPLOYEE SHAREHOLDERS IN quoted trading companies have high expectations of getting the headline 10 per cent capital gains rate after 5 April 2002, but many will be disappointed. Although such shares became business assets for taper purposes on 6 April 2000, employees may need to plan carefully to achieve the 10 per cent rate generally available from 6 April 2002 for disposals of business assets held for two years.

Let us take Tom, an employee of PLC, who acquired 1,000 PLC shares in February 1998 and a further 500 shares in November 2001. He realises that the latter will not qualify for the 10 per cent capital gains rate until November 2003, but imagines that he can achieve a 10 per cent rate on the 1,000 shares he has held for four years. Of course he is mistaken; life is never that simple.

First of all, he discovers that the first shares he sells will be treated as the last he acquired (under section 106A, Taxation of Chargeable Gains Act 1992). He therefore takes advice from a colleague and transfers 500 shares to his wife Beryl in May 2002, leaving him with the 1,000 shares that he has held since 1998. He also now learns that he would pay a rate of 21.7 per cent on a sale of these in May 2002, as shown in Example 1 below. (To keep matters simple, it is assumed in the examples that all gains are £100,000 and that the capital gains tax annual exemptions are otherwise utilised.)

Example 1

The trust route

He then hears at a seminar that, unless he takes any action, he will not pay the fabled 10 per cent rate until 2007. However, he may manage it sooner if he transfers his shares to a trust, albeit a trust primarily for his benefit. So Tom could transfer his PLC shares to the Tom Trust (in which he has an interest) in May 2002 and sell these in August 2004. A new period of ownership for taper will have started and Tom may achieve a 10 per cent rate at that time... as if by magic. With no planning, Tom would have paid 16.3 per cent tax.

The problem he faces here is that, as the shares are quoted, no capital gains tax holdover relief can be claimed under section 165, Taxation of Chargeable Gains Act 1992 on the transfer of shares into the trust. The shares have increased in value and he is wary of paying tax on an unrealised gain for the sake of paying a lower rate of tax on subsequent growth. He could transfer the shares to a discretionary trust and claim relief under section 260, Taxation of Chargeable Gains Act 1992 with no inheritance tax liability, as the transfer in this case will be well within the nil rate band. Tom of course will want to be a beneficiary of the trust and yet the trust itself, being discretionary, will not get business asset taper on the shares (because Tom would not be an eligible beneficiary under paragraph 7 of Schedule A1 to the Taxation of Chargeable Gains Act 1992). Possibly though, the trustees might, after a suitable period, transfer the shares back to Tom or create an interest in possession in his favour so that a new period of taper begins. After receiving his newly appointed advisers' substantial account of charges for all this, Tom decides to follow their advice, but ponders why Parliament could not have thought of an easier way for him to arrange his affairs. Although a new period for taper has indeed started, he hopes an unexpected takeover of PLC within the following year does not trigger an unpleasant 40 per cent rate on sale.

The spousal shares

November 2003 comes along and he realises that the 500 shares he transferred to Beryl have now been held by both himself and Beryl for the period of two years needed to get the 10 per cent rate. Beryl therefore sells the shares, but ends up paying 32.5 per cent tax as shown in Example 2 because they did not realise that it is Tom, as the employee, who needs to make the disposal in order to achieve the 10 per cent rate on these shares.

Example 2

Into the future

The years pass and Tom, in the meantime, has acquired further shares in PLC by exercising both approved and unapproved share options. Often the exercise date is the same for both and he is pleased that he can choose which shares he is treated as selling first by virtue of the helpful provisions included in the Finance Act 2002. He also treads carefully so as to avoid a sale being matched with an acquisition of PLC shares through option exercises in the subsequent thirty days (see Feedback in Taxation, 21 March 2002 at page 600).

However, in July 2004 Tom is made redundant. He feels that his shares would be a useful source of income during his retirement and plans to sell when necessary to raise capital. In the meantime he and Beryl make disposals with a view to using their capital gains tax annual exemptions. He does not realise though that, since he has retired, he no longer benefits from business asset taper. As a result, the rate of tax on his PLC shares will actually increase, as he finds on a sale in July 2007 of shares acquired five years earlier (see Example 3).

Example 3

Clearly, he would have paid only 10 per cent on a sale at retirement and might have thought of crystallising a disposal at that time, or indeed, if feasible, continuing a part-time employment with PLC so as to continue full business asset taper.

Richard Holme and Elizabeth Robertson can be contacted at taxadvice@creaseys.co.uk or on 01892 546546.

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