Now that the dust has settled on Alastair Darling’s first Budget, it is time to take stock of the effects its proposals are likely to have on the private investor. To tell the truth, there was little of note in the Budget speech, at least little that hadn’t already been trailed in December’s Pre-Budget Statement.

As Martin Rimmer, tax manager at The Fry Group, put it, ‘Alistair Darling focused instead on Britain’s stability and its preparedness to weather any future economic slowdown.’

The big picture
There is a temptation to ignore the statements of financial intent that form a large part of the Budget speech, but government policies do have a significant impact on investment markets. For example, John Broome Saunders, actuarial director at BDO Stoy Hayward Investment Management, argues that the government’s continued borrowing to fund public spending is likely to push up gilt yields, especially at the long end
of the yield curve.

He says, ‘This is good news for final-salary pension schemes, whose liabilities are driven by long-term gilt yields. Of course, the news is less rosy for schemes heavily invested in gilts, as reductions in liabilities are likely to be offset by poor returns from gilts.’

Small businesses also found little to cheer in the proposals. Patrick King, tax principal at chartered accountant MacIntyre Hudson, observed that ‘For all the talk of tax simplification, Darling is merely tinkering at the fringes of the genuine cuts urgently needed to boost small and enterprising businesses. The chancellor has inherited more from his predecessor than a precarious level of debt as we sit on an economic knife-edge. Brown’s final headline cut in corporation tax was at the expense of small businesses, who are faced with three successive hikes, with the final one per cent due next year.

‘Combined with a reduction in capital allowances, small businesses were delivered a double blow. By contrast, large businesses were amply compensated for the decrease in capital allowances by the enticing headline reduction in corporation tax. Darling’s committing of £60 million in loan guarantees is a paltry carrot, set against a significant combined tax increase that will be even harder for small businesses to shoulder in the present climate.’

A sense of frustration
The Budget similarly did little to address some long-standing concerns of private investors. Immediately after the chancellor’s speech, broker The Share Centre conducted a survey among users of its website as to how they viewed the Budget’s contents. The response was less than enthusiastic.

Gavin Oldham, chief executive of The Share Centre, reports, ‘On how they felt about the Budget proposals for private investors, the largest proportion, 69 per cent, said “frustrated”. The general feeling was that individual investors had been overlooked by the Budget, and only 8.3 per cent said they were “happy” with what the Budget contained, so I don’t think Alastair Darling has anything to be proud of there.’

He adds, ‘We also asked what changes investors most wanted to see, and 81 per cent said the abolition of stamp duty on share purchases, while 56 per cent said an increase in the ISA investment limits. Next on the list were tax breaks for green investments and raising the amounts you can put into a Child Trust Fund.’

Oldham observes that ‘It is very interesting that people are still concerned about stamp duty, as it is a pointless tax. We didn’t lobby on the area this year as the government made it clear last year that they weren’t going to move over stamp duty, and this year they had even less room for manoeuvre. But it remains a major concern for investors.’

Investment limits
Indeed, it is regarded as curious, to say the least, that a Budget that was billed as providing ‘stability and opportunity’ contained so few concrete proposals designed to encourage investors to save more. Gavin Oldham asserts, ‘We think that there is something not quite right about a government making a great fanfare about this when, at the same time, it is not allowing for inflation by increasing the investment limits for things like ISAs and Child Trust Funds.’

Malcolm Cuthbert, managing director of financial planning at Killik & Co, points out that ‘It is almost ten years since Gordon Brown introduced ISAs with an annual allowance of £7,000 and there was a minimal increase in April this year taking the limit to £7,200. If the government is serious about encouraging people to save, then they should push up this limit to £10,000 a year.’

He adds, ‘The launch of the Savings Gateway is an excellent way to help encourage those on low incomes, but Darling’s boast of “providing better incentives for saving” doesn’t ring true for the average working family.’ Indeed, the Savings Gateway seems to have been the ‘big idea’ to emerge from the Budget, the latest in a series of government initiatives to encourage the less well off to save.

Gateway to nowhere
But even this modest proposal achieved a mixed reception. Andrew Townsley, chief executive of Sheffield Mutual Friendly Society and president of the Association of Friendly Societies, observes that ‘The Savings Gateway is a short-term incentive that won’t encourage long-term saving for people on low incomes, and ISAs are not always suitable. There needs to be a middle ground.’

He points out that ‘While the launch of the Savings Gateway will go some way to helping those on low incomes to save in the short term, the government is still failing to help people with small amounts of money to save for the long term. The below-inflation increase in ISA allowances to £7,200 will not help either, because many people on low incomes are put off by high thresholds or confusion over what they can invest in.’

As you might expect, Townsley’s view is that enhancing the existing products offered by friendly societies would be a better option than trying to reinvent the wheel. ‘The obvious stepping stone to encourage people on low incomes to save
for long-term goals is the “tax exempt savings plan” offered by friendly societies,’ he says, ‘which will bring far higher returns and a larger capital fund in the long run than the Savings Gateway. Yet, despite a promise earlier this year from Kitty Ussher, economic secretary to the Treasury, to review the tax-exempt savings limit, the £25
per month threshold has remained unchanged for an unacceptable 13 years.’

Capital annoyances
Another change that has caused much confusion is the abolition of the taper relief system for capital gains tax (CGT), starting from a top rate of 40 per cent (the same as for income), and its replacement with a flat rate of 18 per cent.

Gavin Oldham says, ‘When we asked “How do you feel about the new CGT rules?” the response was complete confusion. The most popular answer was that investors didn’t understand them. People are clearly in a stew about this. It is very difficult to compare how much CGT you will be paying in the future compared with what you would have paid in the past.’

Martin Rimmer explains, ‘CGT will be charged at a flat rate of 18 per cent, and taper and indexation relief have been withdrawn entirely for individuals and trusts. As a concession, a new relief known as “entrepreneurs’ relief” will be introduced. This will be available for gains on the sale or transfer of a business, disposal of certain assets following cessation of a business and gains made by certain individuals involved in the business. Effectively, the first £1 million of qualifying gains will be taxed at ten per cent, rather than 18 per cent. The £1 million limit is a lifetime allowance, to be reviewed annually by the chancellor.’

Positive aspects
These changes will create new opportunities in some asset classes. For example, Robert Fraser, managing director of Fraser & Co, a central London-based estate agent, asserts that ‘The new rate will be welcomed by property investors and will make owning property personally advantageous for many discerning owners. The previous rate was set at 40 per cent for higher-rate taxpayers who had owned their property for less than three years, and even after a ten-year ownership of a property the most a higher-rate taxpayer could hope for is a fall to a minimum of 24 per cent.’

He adds, ‘Alongside the change in rates, there is also the change in the indexation rule. A higher-rate taxpayer who bought five years ago for an average price of £123,000 and sold before 5 April for £200,000 could face a potential CGT bill of £22,500. However, if they waited until after 5 April, their tax bill would potentially fall to £12,204, which is a saving of £10,296, assuming they sold the property for the same amount. This reduced tax liability could have a positive effect on the property market, as those with extra capital to invest would be more inclined to do so with the introduction of this new rate.’

Bad for investment bonds
The reorganisation of the CGT regime will also have an impact on the attractiveness, or otherwise, of different forms of investment. Under the new system, returns classed as capital gains will be taxed at 18 per cent, whereas those regarded as income will be hit by 40 per cent, for a top-rate taxpayer.

A key example is the investment bonds issued by insurance companies. David Knight, research director at BDO Stoy Hayward Investment Management, notes, ‘The government’s proposal to introduce a flat-rate CGT rate has caused much debate within the financial services industry. The issue depends on the investor’s circumstances, whether they want capital gains or income and whether they are investing for the long or short term.’

He adds, ‘Broadly, under the new proposals, it appears that clients would be better off holding collective investments directly within the new capital gains tax regime. This contrasts with gains on investment bonds, which, at encashment, are taxed as income at an effective rate for higher-rate taxpayers of up to 40 per cent, although there are differences for onshore and offshore bonds.’

Andrew Fisher, chief executive of Towry Law, suggests that the new CGT regime represents an opportunity for investors to restructure their investments,
and thereby reduce their tax bills. In fact, Towry Law estimates that private investors could save up to £5 billion per year in tax by moving out of life assurance bonds and making effective use of their annual CGT allowance, something that many investors
fail to do at present.

He argues that ‘These changes represent a significant victory for investors, who are less likely to be sold high-commission-generating life assurance bonds and who have the opportunity to restructure their investments to be far more tax efficient. The difference between the tax regime on life assurance bonds and collective investment schemes now means that life assurance bonds will only be appropriate for a small minority of investors.’

IHT planning role
However, David Knight identifies a number of circumstances where the use of such bonds may still be valid: ‘The changes could limit the widespread use of investment bonds to clients investing in funds that generate an income (such as fixed-interest or UK equity income funds), those who use such bonds as part of a gifting solution to mitigate inheritance tax (such as a discounted gift trust), or those wishing to take the five per cent annual tax-deferred withdrawals permitted from these bonds, in preference to realising part of their capital in collective investments and making use of their annual CGT exemptions.’

Investment bond providers stress their continued usefulness in IHT planning. Ian Noble, head of life sales at Lincoln Financial Group, argues that ‘Suggestions from various parties that the CGT changes will dent the appeal of investment bonds tend to ignore many of the reasons investors favour them. Choosing an investment bond over a unit trust is a complex process, and while the tax implications do play a part, there are other considerations to bear in mind.

‘We believe that there will still be a significant market for investment bonds. Our research suggests that more bonds are sold for IHT and income tax planning than for CGT mitigation purposes. Indeed, the Treasury’s analysis has shown that the CGT reforms will make very little difference to the overall balance between investment in unit trusts and investment bonds for higher-rate taxpayers.’