Companies, Capital Gains And No Indexation Relief

Read HMRC’s policy paper “Corporation Tax: the removal of capital gains tax indexation allowance from 1 January 2018” and you might think there is nothing to worry about. Under the standard heading “Impact on individuals, households and families”, the document says:

“This measure has no impact on individuals or households as it only affects companies.”

On the evening of Budget Day, Techlink emailed the HMRC contact named in the paper and asked whether the measure would affect life companies despite the reference quoted above. The HMRC reply was a classic straight bat: “I can confirm that, as life assurance companies are subject to corporation tax on their capital gains, this measure will apply to them”.

In terms of UK life company fund returns, just how much policyholders returns will be hit depends upon three factors:

• The rate of capital growth within the fund;
• The rate of RPI inflation; and
• The reserving rate used by the life company to cover its eventual tax liability.

The Office for Budgetary Responsibility’s long term RPI estimate, which it needs to estimate the cost of servicing index-linked gilts, is 3% (against 2% for long term CPI).

The corporate tax rate on gains within the policyholders’ funds is set by s102 of Finance Act 2012 as “the rate at which income tax at the basic rate is charged for the tax year that begins on 6 April in the financial year”. When the Act was passed, basic rate was 20% and the CGT rate for basic rate taxpayers was 18%. In his final March 2016 Budget George Osborne cut 8% from the CGT rates (other than for residential property and carried interest), but made no changes to policyholder taxation. Thus, the policyholders’ fund rate is now double the 10% CGT rate payable by basic rate taxpayers and matches that for higher and additional rate taxpayers. As mentioned in our earlier Bulletin, gains on collective investments are subject to special rules, effectively spreading the tax charge over seven years. Long ago this used to mean that there was a useful saving, but in a world when seven-year gilts yield less than 1%, any discount for deferral is not significant and for simplicity’s sake can be ignored.

This leads to a calculation that if a fund’s underlying assets have capital growth at least matching 3% RPI, the reduction in annual returns due to the Chancellor’s measure will be a maximum of:

3% x 20% = 0.6% pa

Two other areas where the boundary between the individual and corporate investor blur are:

• Property holding companies The various tax moves against residential buy-to-let investment have encouraged the use of companies to hold residential property portfolios. This approach has always had the potential problem of double taxation of capital gains – once within the company and again for the individual on their shareholding. Indexation relief has helped to offset this somewhat, but will no longer from January 2018. The tax rate involved is corporation tax – 19% for now but 17% from 2020 (which has already been legislated for). As a result, the return reduction is marginally less than applies to policyholder funds.

To gain a feel for the impact, consider that over the last ten years to September 2017 the average UK house price rose by 19.1% according to the Land Registry. The corresponding indexation factor for the period was 32.3%, meaning that indexation would have comfortably negated any tax charge. Over the last five years, the corresponding figures are 33.0% (yes, average UK house prices fell between 2007 and 2012) and 12.7%, so indexation would have removed well over a third of the gain from tax.

• Private/personal investment companies These have become a popular way of holding investment assets for the wealthy, thanks to the fall in corporation tax rates, indexation relief on gains and relative simplicity of operation.

The Sun newspaper has already published a story about a “£500 million stealth tax on ten million savers”. No doubt the ABI will be making similar points in its representations. Watch this space…