Capital gains tax a deterrent to the sale of shares
Privatisations and demutualisation of building societies over recent years, and the expansion of employee share participation schemes, have resulted in a significant increase in the number of individual shareholders. The overall rise in stock market prices over recent years has also meant that the value of these holdings continues to increase. Theoretically, this should have led to a windfall for the Government in terms of increased revenue from capital gains tax (CGT) on the share sales.
However, the complexities of the CGT regime and the relatively high 40 per cent rate of tax, have proved somewhat of a deterrent to the sale of shares and the ultimate reinvestment of in-built profits. The lower 26 per cent rate of CGT which was first introduced in 1994 to assist the entrepreneurial individual on the disposal of shares in certain Irish private trading companies has proved effective. Given that the net receipts from CGT represent only about half of one per cent of the Exchequer tax take, perhaps next Wednesday is the time for Mr McCreevy to embark upon a broader reform of the capital gains tax code as it applies to share transactions.
In particular, a rebasing from the current 1974 base date where shares have been held for an extended period, a general lowering of the CGT rate to 26 per annum for non speculative gains and an increase in the personal annual exemption, which at £1,000 per individual is substantially lower than the corresponding level of £6,500 available in the UK, are all options that he might consider.
These reforms would lead to a significant simplification of the CGT code, streamlining the whole administrative process and could potentially lead to an increase in the current CGT yield.
The Government has indicated in its Action Programme for the Millennium that they are committed to fulfil the terms and commitments of Partnership 2000. This includes support for more favourable tax treatment of employee share schemes and profit sharing as a means of deepening partnership and securing commitment to competitiveness at the level of the enterprise. The Government has also undertaken to reduce the basic rate of income tax to 20 per cent and the higher rate to 42 per cent over the next five years. However, a reduction in the income tax rates while welcome is not enough if, as Mr McCreevy has indicated, the Government is committed to reducing the burden of personal taxation in order to reward effort and give people an incentive to work. In the current competitive business environment more and more employers are offering employees a remuneration package of flexible benefits. This gives the employer the opportunity to deliver better value to employees as they can elect which benefits suit their own personal circumstances. As part of this flexible benefits approach, these companies now include a performance related bonus as part of the overall package.
In the case of Revenue-approved profit sharing schemes favourable income tax treatment is available to encourage share participation. However, the difficulty with this mechanism is that it is too narrowly focused. In order to retain this favourable tax treatment the employee has to hold the shares for three years, during which there is an exposure to the market. On the ultimate sale of the shares there is a potential exposure to capital gains tax at 40 per cent, even where income may only be taxable at 26 per cent. While it is possible to undertake certain tax planning so as to minimise the potential CGT exposure on the sale of these shares, this can be a difficult and complex process to administer. This could be circumvented in part if Mr McCreevy gave consideration to facilitating the transfer of scheme shares to a special portfolio investment account, without crystallising any inbuilt capital gain. This would provide that future income and gains could avail of the favourable 10 per cent tax rate which applies to such accounts. If the Government is genuinely serious about encouraging wider employee share ownership then some reforms of the income tax code would also be desirable. The Irish Profit Sharing Association along with other interested groups continue to lobby for reforms in these areas.
For example many companies need the flexibility to offer share participation outside the parameters of the standard profit sharing schemes, but in a way which still offers the employee some level of tax incentive.
This could easily be achieved by the introduction of favourable tax treatment for all employee type share option schemes. This could include a reintroduction of the relief which previously applied for Revenue-approved share option schemes.
Gearoid Deegan is a senior tax manager with Price Waterhouse