Britain’s super-rich were under fire last week for using generous tax breaks
to pay almost nothing on their profits, but millions of ordinary investors
can use the same perks to save thousands in tax on their company-share
schemes and even their holiday homes.
The row centres on the use of the lucrative tax breaks by the bosses of
private-equity firms – among the wealthiest men in Britain. They take firms
private, overhaul them and then sell them on, often netting
multi-million-pound profits on which they may pay tax at 10 per cent or less
compared with the 40 per cent that many of us pay on our incomes.
The debate has reached fever pitch in the past fortnight as a lineup of
private equity’s most powerful bosses have been grilled by parliament’s
Treasury select committee.
MPs pounced on comments by Nicholas Ferguson, chairman of SVG Capital, that
private equity chiefs paid “less tax than a cleaning lady”. Committee member
and Labour MP Jim Cousins said the bosses were part of a “charmed circle of
extremely wealthy people” using tax advantages not open to others.
However, he was only half right. The way that private-equity fat cats use the
tax breaks is peculiar to them, but all of us can benefit from one of the
key perks – a device known as business-asset taper relief that cuts tax on
profits from investments.
John Whiting at Price Waterhouse Coopers, an accountant, said: “It’s one of
the most generous perks around as it can slash your tax bill in just two
years and is easier to take advantage of than many people imagine.
“Workers who buy shares in their employer, including the popular
save-as-you-earn schemes, can benefit, as can holiday-home owners. Most
investors in farmland, stocks listed on the Alternative Investment Market
and small private firms also qualify.”
The savings can be huge. A higher-rate taxpayer who holds a qualifying
investment for a year pays 20% tax on any gains, instead of the usual 40%,
when it is sold. After two years, he or she would pay just 10%. On a profit
of £100,000 that’s a £10,000 bill rather than £40,000 – a £30,000 saving.
The Treasury, which introduced the tax break to encourage investment,estimates
taxpayers have reclaimed £6.3 billion in taper relief in the past year.
However, many individuals are still believed to be missing out because they
are unsure how it should be calculated or don’t even know it exists.
The anger directed at private equity has raised fears Gordon Brown’s successor
as chancellor will scrap the perk. But ordinary investors say they would
suffer as a result.
John Caines, 58, from Cheltenham, sold his software business several years ago
and has invested some of the proceeds in private firms via a syndicate
called Hotbed, which pools his money with other like-minded investors. He
said: “I like helping young entrepreneurs to push their business forward,
but it’s also very risky. Some of the firms I invest in are going to be
failures. Without the tax break there wouldn’t be enough of an incentive to
take such a risk.”
Investors in syndicates such as Hotbed are not the only ones who would suffer
if business-asset taper relief was scrapped.
Company share schemes
In 2000 Brown applied business-asset taper relief to the shares of companies
in which you work, to encourage employees to take a stake in their own
firms. Millions of people in workplace schemes, including employees at
Bar-clays, Orange and Tesco, can take advantage.
Save-as-you-earn plans are one of the most popular, used by about 2m people.
If you make a profit on shares acquired through the scheme you will be
liable to capital gains tax (CGT) on more than £9,200. However,
business-asset taper relief can be applied to the gain to significantly
reduce the tax bill.
The perk can be applied to other employee share schemes such as Share
Incentive Plans and Enterprise Management Incentives. Even if your employer
doesn’t offer a workplace plan, you can buy shares in your company through a
stockbroker and still get the taper relief.
You have to continue to work for the company to claim business-asset taper
relief on your gains. If you bought shares in your company five years ago,
leave or retire now, and sell them in five years’ time only half of your
gain will qualify. You will get non-business-asset taper relief on the
remainder, but this is less generous.
Holiday homes
Hundreds of thousands of second home owners can also take advantage. While
your primary family home is exempt from CGT, profits made on second
properties are taxable. By turning your second home into a furnished holiday
let, you qualify for business-asset taper relief and pay a lower rate of CGT
– though you must adhere to strict rules.
The property has to be available to the public for at least 140 days a year;
lettings have to amount to at least 70 days; it must be fully furnished; and
must be let at a market price.
The home cannot be occupied by the same person for more than 31 days in any
seven months. That prevents student lets from qualifying. These and other
buy-to-lets qualify for less generous relief.
Unquoted firms
Another way to benefit is to buy unquoted stocks – shares in private companies
that are not listed on an exchange. While the private-equity firms under
fire last week have been targeting big names such as Boots, investors who
use syndicates such as Hotbed and Beer & Partners take stakes in small
firms worth several million pounds at most – which makes them more risky.
Syndicates are therefore open only to sophisticated investors.
Most shares on the junior AIM market, such as Domino’s Pizza and Majestic
Wine, also benefit from business-asset taper relief.
Farmland
Investors have been snapping up rural land because of the tax perks – one of
which is business-asset taper relief. Investors can claim the 10% tax break
on any profits from land that is let or contracted to a farming business.
How you can claim the perks
What’s the fuss about?
MPs and trade unions are angry that the top partners of private-equity groups
are paying little or no tax.
These firms buy listed companies that have been having a tough time, overhaul
them by cutting costs, before taking them back to the stock market and
selling them at a huge profit.
A few years ago they mainly invested in start-ups looking for capital, and few
people took any notice. Recently, though, they have been borrowing billions
of pounds to take into private ownership some of the biggest companies in
the world.
Household names that have been bought by private-equity firms include Boots,
the AA and Birds Eye.
The taxes paid on the profits are a bone of contention. Although they pay
normal levels of tax on their salaries and bonuses, most executives’
earnings come from “carried interest” – typically a 20% share of any profit
made when they sell a business.
Special rules mean that this income is treated as a capital gain.
Business-asset taper relief rules allow the tax paid to be reduced from the
top rate of 40% down to 10% as long as the private-equity firm holds the
company for two years before selling it.
How does taper relief work?
Taper relief reduces the capital gains tax (CGT) that individuals must pay
when they sell an asset. The longer you hold an asset, the lower the tax
rate.
There are two types. More generous rates apply to investments termed business
assets, including holiday lets, most stocks on the Alternative Investment
Market, and shares in your employer. If you have held the asset for at least
one year then only 50% of the profit you have made is taxable. In other
words a higher-rate taxpayer pays 20% tax instead of the top rate of 40%. If
you hold an asset for two or more years only 25% of the profit is taxed: a
10% tax rate.
Other assets, including buy-to-let and most quoted shares, qualify for the
less generous non-business-asset taper relief. You need to have held the
asset for at least three years to obtain relief. After that, you pay tax on
95% of the gain; after 10 or more years you pay tax on only 60%.
A higher-rate taxpayer who sold a basket of shares after less than three years
would pay £4,000 on a chargeable gain of £10,000: 40% tax. After three
years, the bill would be cut to £3,800 (38% tax) and after 10 years to
£2,400: a rate of 24%.
Some private-equity fat cats pay tax of less than 10%. Can I do the same?
Private-equity firms can offset part of the cost of their investments against
profits, reducing the tax they pay to well below 10%. Private individuals
can’t copy this. But there are other ways to cut your CGT bill. Everyone has
an annual CGT exemption: in this tax year, you can make tax-free profits of
up to £9,200. Married couples can transfer assets between one another to
make the best use of each allowance.
Take care if the shares count as business assets. If you hold shares in your
company and pass these to your spouse, they will no longer be eligible for
business taper relief if he or she doesn’t work for the same firm.
You can also set losses against your gains to reduce tax. If you had gains of
£100,000 but suffered losses of £10,000, you would have a gain for tax
purposes of £90,000. You usually have to sell investments to register a
capital loss.
Is taper relief under threat?
Gordon Brown has signalled he is prepared to do something about the taxation
of private equity, but isn’t expected to scrap taper relief. Instead he
could revoke the rules that allow private-equity profits to be regarded as a
capital gain. If carried interest was regarded as income, most partners
would have to pay 40% tax without him having to change the relief.
