Tuesday, 9 March 2010

Anomaly (or perversity) of the tax system?

In all my years of experience as a practicing accountant, I cannot recall of a bigger anomaly in the tax system than using market values to pay capital gain in cases where none should be due.

I am not referring here to the situation where an individual disposes a capital asset that has appreciated in value for a consideration. Provided that money changes hands at market values, I can understand the logic behind charging CGT on the gain (as computed by the difference between original cost and market value on the sale). I have no serious problem with that, other than the fact that it would be fairer if the gain is adjusted downwards by the effect of the inflation since purchase(inflation is a fact of life and eats into profits and gains). Regretfully, that concession was also gone a couple of years ago...

My biggest objection is taxing an individual on a ghost gain (a book gain!) when there is no consideration, i.e. in the case of gifts. In my opinion this comes close to amounting as a rip-off (big brother poking his hand into people's pockets to take money when none was actually made!!)

Take for example the unfortunate parents who have been letting a second house for a number of years and when the time comes, they affectionately want to pass it on to their offspring to help him/her out to start out in life. Here is where the anomaly comes in: since the house has appreciated in value over the years, they will not be able to help their child unless they fork out a respectful amount of tax to the taxman based on the gain made - from which of course the poor parents will not enjoy any benefits in any way. Pay tax out of an unrealised profit,that is. How more cruel could it get?

Amazingly, this anomaly does not occur in other taxes e.g. stamp duty land tax (tax is paid only due where consideration).

I think there should be some rectification in the law to ensure that the gain is taxed only where a disposal for a consideration at market value occurs, i.e. when the child eventually sells the house to a third party and the gain is realised.

For the time being, the regime is fairer for capital gains on disposal of assets used in a trading business, like goodwill, shares etc. These gains can be deferred where disposal is to connected persons (limited companies, relatives) or where the gain is re-invested into another asset and taxed only where eventually the asset is old to a third party or the asset sold is not replaced. In other words, there is some kind of "hold-over" or "gift" relief. The effect is the same, no matter what the name is: tax on the gain is postponed. These concessions exist to encourage continuation of business and enterpeneurial spirit.

Someone could ask: Shouldn't help to family members be among government priorities and a good enough reason to enjoy some kind of relief for gifting non-trading assets, for passing a house or a plot to a child by parents to help them out (especially in a age where it has become harder and harder for young people to buy their own home because of the sky-rocketing house prices?)

Am I missing something here? Any more thoughts?

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