On 9 October, Alistair Darling announced radical changes to the rules for Capital Gains Tax (CGT). These changes take effect from 5 April 2008 and include the abolition of the indexation allowance.
The indexation allowance was introduced to prevent taxpayers from paying CGT on the inflationary growth in the value of their assets. It worked by allowing you to increase the “base cost” of an asset for CGT purposes by a factor derived from the difference between the Retail Price Index on the day you bought it, and the RPI on the day you sold it. Indexation lasted from March 1982 until April 1998, when it was “frozen” for assets owned by individuals or trustees, and taper relief (also to be abolished) was introduced to replace it.
Although it was frozen in 1998, the indexation allowance remains a valuable relief for those who still own assets they owned in the period from 1982 to 1998. For example, if you bought some shares for £10,000 in April 1982, and you sold them today, the indexation allowance for the period from April 1982 to April 1998 would more than double the “cost” you could deduct from the resulting capital gain – in fact, you could deduct a total of £20,060.
If you sell those shares after 5 April 2008, however, you will only be able to deduct the original cost of £10,000, because the indexation allowance will be abolished then.
That is why a gift of those shares to your spouse (or civil partner) would be such a thoughtful Christmas present. Gifts between spouses are deemed to pass at a price that produces “no gain, no loss”. Because your “cost” for CGT purposes currently includes the indexation allowance, if you were to give those shares to your spouse, the deemed sale proceeds (and thus the “cost” she can deduct on a future sale) would include the indexation allowance. In the case of the shares referred to above, she would have a cost of £20,060, and when she eventually sells them (before or after 5 April 2008), that will be what she can deduct from the sale proceeds.
Unfortunately, as the law stands at present, if you owned the shares (or any other asset) before 31 March 1982, this trick will not work. Without going into the technicalities, because your spouse will be deemed to have acquired the asset at the time you did, the same rules would apply to him/her and no indexation allowance would be due on a sale after 5 April 2008.
Rather surprisingly, HM Revenue and Customs have let it be known that they intend to change the law to remedy this, so that the indexation allowance can be “crystallised” by way of a gift between spouses even if the asset was owned before March 1982. At the time of writing this, it is only a rumour so don’t rely on it until there is a formal announcement, but for assets acquired after 31 March 1982 and before April 1998, you can use such a gift to “lock in” (as Gordon Brown is fond of saying) the indexation allowance.
Of course, as an allowance for inflation, the indexation allowance gets less valuable as your date of acquisition approaches April 1998, so it may not be worth the trouble to gift an asset you acquired in, say, 1997. As a rule of thumb, assets acquired in 1992 would only attract an indexation allowance of about 20%, reducing to nil if they were acquired in April 1998.
That is why the indexation allowance makes such an ideal gift – if you don’t like your Marks and Spencer sweater, you can take it back to the store and get the money back, but only the indexation allowance will give you double the cost!