Changes to capital gains tax (CGT) announced in the June Budget will affect millions of long-term investors, leaving them paying bigger tax bills on a misleading nominal gain, rather than a real inflation-adjusted profit.
While the new CGT rate of 28% for higher-rate taxpayers may not be as bad as the expected hike to 40%, without the the reintroduction of indexation or taper relief, which many tax experts were calling for, long-term investors will continue to be penalised.
The new regime, which came into effect at midnight on 22 June, missed an opportunity to distinguish between investments held for five, 10 or 15 years and those gains made from trading in the short-term; a failure which could discourage longer-term investors.
Prior to a Labour rule change, indexation meant that if an asset merely held its value in real terms, the owner would not have to pay tax when they decided to sell it.
If returns were made above inflation then tax was payable. Despite repeated industry calls for indexation, the Chancellor thinks that tapers or indexation allowances would create complexity in the system and be self-defeating.
Worst hit could be investors who have had a second property for many years as the gains are likely to be high in relation to the initial investment. This would be very bad news for anyone who is hoping to liquidate assets for their retirement in the coming years.
A home bought for £25,000 in 1980, for instance, would now likely to have increased greatly in value, but £55,000 of any increase would be down to inflation, according to official figures. Indexation would strip out this effect, leaving tax payable on the real return only.
Mike Warburton, leading tax partner at Grant Thornton, the accountancy firm, said: "I have had a lot of clients ringing up worried about this. They feel it is grossly unfair to pay tax on inflationary gains. And let's face it, inflation has not gone away. The dragon has not been slain. Taxing people on any gains they make from inflation is a big disincentive to save."
Bill Dodwell, head of tax policy at Deloitte, agrees, saying: "There are plenty of arguments in favour of increasing capital gains tax. But it would be very unfair to do so without reintroducing indexation. It has to happen, because the longer people hold assets, the more inflation affects the value of that asset," he says.
Indexation has been part of capital gains tax ever since it was raised to 30% in 1988. Only when Alistair Darling moved capital gains tax down to 18% two years ago did indexation get scrapped.
The latest CGT increase makes it even more essential for investors be tax efficient. Karen Barrett, Chief Executive of unbiased.co.uk says: "Research shows that even when CGT was at 18% for all, individuals subject to CGT were wasting a massive £516 million which could have been avoided if they were being tax efficient.
"This wastage is only set to increase with today's CGT rise for higher-rate tax payers. An independent financial adviser will be able to assess your personal CGT liabilities and ensure you are handling your assets in the most tax efficient manner."