I listened with interest to what the Senators said. I compliment my colleagues, Senators Finneran and Bonner, for proposing and seconding the motion and the other Senators who have contributed.
The motion refers to both capital gains tax and capital acquisitions tax and I propose to deal with capital gains tax initially. The Minister for Finance, in his Budget Statement delivered in December 1997, halved the rate of capital gains tax from 40 per cent to 20 per cent for all disposals of assets except for development land. Under the capital gains tax system persons liable for tax are required to make their preliminary payments of tax on 1 November in respect of the previous tax year, which runs from 6 April to 5 April. Therefore, this current calendar year is the first year in which the Revenue Commissioners will have data for a full year's yield of capital gains tax based entirely on the new lower rate regime for the tax. I am pleased to inform the House that the early indications on the yield are extremely positive and it now appears likely that the outturn for this year will exceed the budget day projection by a considerable margin. It is worth noting that this increase in the yield confounds the predictions made by some commentators at the time the rate was reduced.
The Minister has often gone on the record as saying that a higher rate of capital gains tax serves only as an encouragement for people to hold on to their assets in ways which may contribute little to growing the overall size of the economy and its productive capacity. In these circumstances assets would only be transferred at death when of course there is no charge to capital gains tax as death is not treated as a disposal for capital gains tax purposes. Furthermore, he has long held the view that higher rates of capital gains tax discourage people from taking risks through investing their money in new ventures since the higher rate would lead to the erosion of so much of the gain. The new 20 per cent rate of tax has led to earlier disposals of assets than would otherwise have been the case as well as encouraging assets holders to dispose of assets which would otherwise have been locked in. This should lead to assets being in the hands of the types of people who are likely to use them most effectively to the advantage of the broader economy.
The Minister's rationale for reducing the rate of capital gains tax was to assist in the creation of an environment more conducive to the development of an enterprise culture. A dynamic enterprise culture, particularly in the new technologies sector, will be critically important for our continued economic well-being in the century which we are about to enter. We have extremely favourable economic conditions prevailing at present, a situation that has been greatly assisted by good policy choices in recent years. We should not forget, however, that throughout much of this century the economy failed to keep pace with what was happening elsewhere. Therefore, we cannot allow ourselves to become complacent and take enterprise for granted. It is not something that will happen in a vacuum without reference to an environment and a structure to provide capital is an essential ingredient of that environment.
Enterprise cannot flourish without adequate arrangements for the provision of capital. The lower rate of tax on capital gains that the Government has introduced provides an appropriate incentive for people to invest their capital in new undertakings that will lead to the creation of employment opportunities in the future. The lower rate also facilitates existing small and medium sized enterprises in attracting risk capital to help them grow new lines of business and develop existing activities. As I mentioned earlier, the unlocking of business assets as a result of the 20 per cent rate is likely to result in those assets coming into the hands of people who are more likely to use them to best effect.
I would like to set out for the House some of the principles that apply to our capital gains tax regime. First, it applies on the disposal of assets and is separate from the income tax regime. Our system incorporates arrangements for the indexation of the cost base for capital gains so that taxation is not applied to inflation. Other features of the system are that there is no capital gains tax imposed at death, nor is the principal private residence of an individual subject to the tax. The regime, of course, also contains roll-over relief for business assets, such as land, buildings, plant and machinery. This aspect of the system means that capital gains tax is deferred if the proceeds from the disposal of a business asset are reinvested in a new business asset within three years of the disposal. The tax position on the gain from the old asset is looked at when the new asset acquired is disposed of and there is not a subsequent reinvestment. This system of roll-over relief encourages reinvestment in the economy and is a desirable measure which encourages entrepreneurs to diversify into new business activities. There is also a special relief for people over 55 which is specifically designed to encourage the transfer of business or farm assets to the younger generation.
In discussing capital gains tax, the fact that income from an asset is subject to taxation under the income tax regime is quite often conveniently overlooked. In this regard there are, of course, exceptions allowed under legislation, for example, in the case of pension funds. It should always be remembered that providing capital usually involves taking on a risk. In general, investors will expect to see a higher overall return on the capital they have provided where there is a high risk involved in the investment.
I would now like to deal with the arrangements under the capital gains tax code for development land. In November 1997, the Minister for housing and urban renewal commissioned a study on the housing market from the consultancy firm of Peter Bacon and Associates. The report, which was the output of this study, was received in April 1998. A number of important recommendations were made, including some in the taxation area. Arising from these recommendations the Government acted quickly and introduced the Finance (No. 2) Act, 1998, which changed the tax code in a number of respects in order to improve the efficiency of the housing market. The stamp duty regime was revised by a rationalisation of the number of rates and reductions in rates on lower value properties. However, of particular relevance to our discussion here is that a key alteration was made in respect of the taxation treatment of land which is earmarked for housing. As a special concession a 20 per cent rate of capital gains tax, instead of the usual 40 per cent rate, is levied on land which has full or outline planning permission or which is sold to a housing authority. The 1999 Finance Act extended this concession so that it applies to land that is zoned for residential development under a county development plan. Senators will note that it is not necessary for the land to enjoy full planning permission in order to qualify for the 20 per cent rate. The rationale for these amendments was to encourage land holders to sell land for housing so as to speed up the development of land for housing purposes and thereby increase the supply of accommodation. As Senators will be aware, the key issue in the housing market is the imbalance between the demand for, and the supply of, houses.
The capital acquisitions tax regime was introduced in 1976 as part of a package of capital taxes which replaced the old estate duties regime. The tax applies to gifts and inheritances. Capital acquisitions tax, including inheritance tax, operates in accordance with categories which are based on the degree of relationship between the person who gave the property – who is known as the disponer – and the recipient. The underlying principle is that the closer the relationship the higher the threshold. In accordance with this principle transfers between spouses are completely exempt from the tax.
Class I covers transfers from parents to children, minor children of a deceased child and children to parents. The threshold for this category during the current tax year is £192,900. It should be noted that the threshold of £192,900 applies to each child. Class II covers transfers between grandparents and their grandchildren, transfers between brothers and sisters, and transfers to nieces and nephews. The threshold for this class is £25,720 at present. Class III covers all other transfers and has a threshold of £12,860.
The rates of taxation apply to amounts in excess of the threshold and are graduated upwards from 20 per cent to 40 per cent. In the case of gifts received by the beneficiary, the rate of tax is reduced by one-quarter compared to the rate for inheritances. Senators should also be aware that the system includes aggregation so that gifts or inheritances received since 2 December 1988 are taken into account when computing the liability for capital acquisitions tax.
Relief from capital acquisitions tax has been available to the agricultural sector since the tax was introduced in 1976. To avail of the relief a farmer must have 80 per cent of his assets in agricultural assets after the gift or inheritance. Since 1997 the value of the gift or inheritance is reduced by 90 per cent for the purposes of calculating the liability to tax. The special relief for agricultural property takes account of the fact that the market value of such property often does not take cognisance of the actual economic return from the property.
Similar reliefs for the transfer of family businesses were subsequently introduced in the 1994 budget with a 50 per cent relief on the first £250,000 of business assets and 25 per cent relief on the balance. In the budget of 1995 the relief was increased to a flat 50 per cent on all qualifying assets. In 1996 the relief was increased to 75 per cent and the 1997 budget set it at the current 90 per cent, similar to the level applying for agricultural relief.
Business relief is available for property consisting of a business or an interest in a business, unquoted shares in Irish companies subject to certain conditions, and quoted shares in Irish companies which were owned by the disponer prior to their quotation. To qualify for business relief, a beneficiary must fulfil one of three conditions – he or she must hold more than 25 per cent of the voting rights of the company; or the beneficiary holds a percentage of the issued shares of the company and the company is controlled by the beneficiary and his or her relatives; or the beneficiary holds at least 10 per cent of the company and has worked full-time in the company for five years prior to the transfer.
An ownership period must also be satisfied in order to qualify for the relief. The assets, which are the subject of the transfer, must have been owned by the disponer or his spouse for at least five years prior to the transfer. In the case of a transfer arising on the death of the disponer, the five year period is reduced to two years.
There is also a clawback provision attaching to business relief. The clawback applies if, within six years, the business ceases to be a qualifying business, or the assets transferred are disposed of and are not replaced by other qualifying assets. If these events occur between six and ten years, one-third of the relief is clawed back.
Business relief under capital acquisitions tax is aimed mainly at small and medium sized businesses. The benefit for larger sized enterprises is less significant. The rationale for the relief is to enable family-owned and operated businesses to transfer to the next generation. If the various conditions attaching to these reliefs are fulfilled, the value of the business for the purposes of the tax is now reduced by 90 per cent, as I mentioned earlier. In these circumstances, in the current year tax would only be applied for assets transferred to a child where the value of the assets is in excess of £1.9 million.
During the debate on the Finance Bill earlier this year, the Minister indicated that he intended to carry out a review of the capital acquisitions tax regime in time for the next budget. Senators will understand that because of the imminence of the budget it would not be appropriate for me, at this juncture, to outline – much as I might like to do so – what the Government intends to do arising from this review.
