Schedule 2
Finance Bill
9:00 am
Mark Hoban (Shadow Minister, Treasury; Fareham, Conservative)
I beg to move amendment No. 3, in schedule 2, page 116, leave out lines 11 to 29.
I welcome you to the Chair, Sir Nicholas. I am not sure that I enjoy scrutinising the Finance Bill when the sun is shining as brightly it is today; indeed, I would much rather that it was wet, miserable and grey outside so that I did not think that I was missing out on very much by being here.
This is a straightforward amendment, which I hope will be accepted with the same ease as the Government amendments that we have just accepted. It would reinstate the indexation relief that the Chancellor abolished when he introduced his capital gains tax regime changes last year. Indexation relief was introduced at a time of inflation, when the uplift in the value of assets was partly due to increases in prices rather than in the intrinsic value of the assets. The proceeds from the sale of such assets were reduced not just by the cost of those assets, but by the indexation allowance.
The rules have been modified over time. Until this year’s Finance Bill—assuming that the schedule is passed unamended—the rules calculated the indexation allowance on the basis of the increase in the retail prices index between the date of acquisition and April 1998 or of the market value in April 1982, depending on which was the later. The indexation allowance was frozen in 1998, when reforms led to the creation of taper relief, which in some way reflects the inflationary gains that may have taken place since that date. The schedule now scraps the indexation allowance completely.
As a consequence, people who are disposing of assets acquired before 1998 will be taxed on the gains attributable to inflation. The Government could argue that the level of uplift in the value of assets acquired recently is relatively slight given existing inflation rates, but that does not apply to assets held over a long period. It is worth bearing it in mind that the compulsory rebasing of assets at March 1982 values captures inflationary gains up to that point, but that gains accrued due to inflation between 1982 and 1998 will be taxed.
A number of groups that have sought to hold assets for the long term will be affected by the proposed change. One group that will be particularly affected is farmers. Following the pre-Budget report, concern has been expressed in the farming industry about the impact of the changes. An article in Farmers Weekly immediately after the PBR hit the nail on the head when it said that the Chancellor’s
“decision to scrap indexation allowance means inflationary rises in the value of farmland—which have been protected from taxation—will now be liable for a hefty tax bill.”
Jeremy Moody, secretary of the Central Association of Agricultural Valuers, said:
“There’s a lot more in it than first appeared. The public’s eye was caught by Mr Darling’s announcements on inheritance tax. But the changes to the capital gains tax system are quite a serious exercise in raising money from business.”
For farmers, the abolition of indexation allowance was seen as a more serious hit than the increase in the effective rate of CGT for business assets from 10 to 18 per cent. Farmers Weekly was not the only publication to identify that issue. By considering land prices, Farmers Guardian gave an example of how the abolition of indexation allowance would affect farmers. In 1982, an acre of farmland would have cost £1,500 and could now be sold for £4,000—I suspect that the price is going up all the time due to some of the problems with food supply. The indexation allowance would have increased the base cost of an acre of land bought for £1,500 in 1982 to £3,070, roughly doubling the cost of the land. In that case, the gain per acre was £930 and, with tax at 10 per cent., the tax paid would be £93.
Under the new rules, the gain would be calculated on the cost of the land in 1982—£1,500. The gain, therefore, would be £2,500 and, with tax at 18 per cent., we are talking about a figure of £450, so there is quite a significant increase in the tax to be paid by farmers due to the abolition of the indexation allowance.
The longer an asset has been held, the greater the loss from indexation relief. Let me give an example. An asset acquired for 100 in April 1982 would attract an indexation allowance of 100.7. If the sale value of that asset increased in line with the retail prices index from the date of acquisition to the date of disposal, it would be worth on disposal now about 260. Based on last year’s rules, the gain on disposal would be 59.7 and the tax would be 14.3 per cent., assuming maximum taper relief on a non-business asset. Under the rules set out in the Bill, the gain would be 60.4, as there was no taper relief and, with CGT of 18 per cent., the tax charge would be 28.9—double the charge under the old rules.
If an asset was acquired more recently, say in 1996, the indexation allowance would be only 6.55. Assuming that the value of the asset grew in line with RPI over its life, the proceeds would be 138.2, giving a gain of 31.65 based on a CGT rate of 24 per cent. The tax paid would be 7.6 per cent. However, under the new rules, without indexation and at 18 per cent., the tax paid would be 7.2, so there would be a small gain in those circumstances, but that would be for an asset that was acquired relatively close to the freezing of indexation relief. Depending on how long the asset is held before 1998, the lower rate, which was announced in October in the pre-Budget report, does not automatically compensate for the scrapping of the indexation allowance, so there will be a significant impact on assets held for a long period.
It would be easy to suggest that the problem will diminish over time, and indeed it will diminish over time, but it is worth bearing it in mind that the most recent figures for CGT on the HMRC website, which relate to the 2004-05 financial year, suggest that more than half of all assets sold in that tax year were held before 1998 and therefore would have been subject to some form of indexation allowance. So the change will affect a not inconsiderable pool of assets. The people holding those assets will have to pay increased tax as a consequence of the decision to scrap the indexation allowance.
What is the cost of that relief? Looking at the 2007 Red Book, the cost of indexation allowance is estimated to be £300 million in 2005-06, and £280 million in 2006-07. Therefore, the abolition of indexation allowance will yield for the Treasury quite a significant part of the tax to be raised from the package of CGT reforms. However, that will come at a cost to people who have held shares for a long time. Although I have talked about farmers at some length, it is not just farmers who are affected. I have seen correspondence from constituents who have held shares for a considerable period of time who will lose out as a consequence. People who have held other types of assets over a long period of time will be similarly affected.
So, the question that we need to ask the Government is why they decided to proceed with the scrapping of the indexation allowance given that it is going to decline over time. Why did they think it appropriate to tax people on inflationary gains rather than on the real increase in the value of their assets? When the package of reforms was introduced in October and when the further changes were announced at the start of this year to reflect the widespread anger about the scrapping of various aspects of the CGT reform, did the Treasury consider providing some form of transitional relief to help people who had held their assets for a long time? Did the Treasury do any work at all to determine whether any particular sectors would be affected by the scrapping of the indexation allowance? It is not clear whether that work was done. I shall be grateful if the Financial Secretary will elaborate on that.
In conclusion, there are a number of issues around the indexation allowance. It is a valuable relief for people who have held assets for a long time, which is something that I thought the Government were trying to encourage. The move, however, penalises people who have done so, as it will raise significant tax revenue from them. I think that we deserve an explanation from the Treasury as to why the Government took this step when they announced the CGT reforms in October last year.