Budget - Implications for Investors

Bernard Doherty
Taxation Department, Matheson Ormsby Prentice. Bernard practises tax. He specialises in advising high net worth individuals, owner managed businesses and SME's. He also advices on acquisitions and disposals of businesses and on the tax aspects of property transactions.

January 2003

In the run-up to the Budget on 4 December, there was speculation that the capital gains tax rate of 20% was under threat.

The good news for investors is that the rate has survived for at least another year. However, the Minister has accelerated the payment of capital gains tax and introduced a number of changes to broaden the capital gains tax base which are seen by many as an attempt to pay for the retention of the 20% rate.

Capital gains tax payment dates

For disposals of assets in the tax year to 31 December 2002, the taxpayer is obliged to make a capital gains tax payment by 31 October 2003. Details of the disposals made must be included in the individual's tax return which also must be filed by that date.

The Minister has changed the payment dates for disposals on or after 1 January 2003.

Henceforth, capital gains tax due in respect of disposals made on or before 30 September in any tax year (1 January to 30 September) must be paid by October 31 of that year. For example, in the case of a disposal made on 15 June 2003, the capital gains tax arising must be paid by 31 October 2003. Capital gains tax arising in respect of disposals made in the period from 1 October to 31 December in any year must be paid by the following 31 January. For example, in the case of a disposal made on 15 November 2003, the capital gains tax must be paid by 31 January 2004.

This represents a significant acceleration in the payment of capital gains tax. For example, previously if a disposal was made on 2 January 2002, the capital gains tax due was not payable until 31 October 2003, ie effectively 22 months later. If a similar disposal is made on 2 January 2003, the capital gains tax is due on 31 October 2003, ie 10 months later.

The acceleration of payment dates may result in some compliance difficulties. For example, a disposal of shares in either September (payment required by 31 October) or December (payment due by 31 January), with a complicated share history may require time to ascertain the liability, thus delaying payment and leaving the taxpayer exposed to interest charges. The date for filing of a personal tax return which will include details of capital gains tax transactions remains as 31 October.

Removal of Reliefs

Indexation relief in respect of capital gains was introduced in the Capital Gains Tax Amendment Act 1978 and has been in the legislation ever since. The Minister removed indexation relief with effect from 1 January 2003. Indexation relief effectively provided an allowance for inflation by means of a multiplier which applied to the original cost of the asset. Indexation relief will only be available in respect of periods of ownership up to 31 December 2002. The abolition of indexation relief is seen by many as inequitable, particularly at the current rates of inflation. In effect, a charge to capital gains tax will arise, even where the increase in the value of the asset is less than the rate of inflation.

With effect from Budget Day, rollover relief has been abolished. Rollover relief allowed a business to dispose of assets without a charge to capital gains tax if the proceeds were reinvested in replacement assets within the prescribed time period. A similar relief was available in respect of disposals to an authority possessing Compulsory Purchase Powers - CPO relief. This relief has also been abolished with effect from Budget Day.

Tax Deferral Mechanism Closed

The Minister closed off the use of debentures/loan rates by entrepreneurs to defer capital gains tax arising on the sale of shares in their businesses. Previously, where persons sold shares in a company and the consideration received was in the form of loan notes in the acquiring company, the capital gains tax liability was not crystallised until such time as the loan notes were encashed. This provision clearly made sense as there was no cash generated to pay any capital gains tax liability arising. It was often the case, that loan notes were used where an entrepreneur received part of the sales proceeds by means of an earn-out which depended on profits arising in future years.

Where the earn out was in the form of a loan note, the capital gains tax was deferred until the end of the earn out period when the loan notes were received and could be encashed and the capital gains tax discharged. Deferral can still be achieved where the sale proceeds are in the form of shares, but will not be available where the sale proceeds are in the form of loan notes. Loan notes were clearly more attractive than shares as they provided value certainty. Entrepreneurs considering disposing of their businesses, those involved in MBO's and public to private transactions will have to look closely at these changes in structuring such transactions.

Stamp Duty

The Minister announced a significant increase in the stamp duty rates applicable to non residential property and the thresholds at which the new rates apply. This new scheme of rates will not only apply to commercial property but also will apply to goodwill, intellectual property, debtors and cash on deposit. The new scale of rates provides for a 9% rate which applies where the consideration is greater than €150,000. The rates for stamp duty applicable to residential property have not changed and the 1% rate in respect of transfers of shares continues.

Impact on Investment Choice

The capital gains tax changes (involving removal of indexation relief and rollover relief) and increases in stamp duty will particularly hit the commercial property sector. The sector is sluggish at this time and these changes will further dampen activity. The changes will put commercial property at a disadvantage to other investment assets such as shares, gilts and residential property. The UK equivalent rate of stamp duty is 4%. Irish investors have been investing in commercial property in the UK for some time and the stamp duty hike is likely to further accelerate the flight of commercial property investors away from the Irish market.