November 20, 2020 Capital Gains Tax Under Review
The Office of Tax Simplification (OTS) has, in response to the Chancellor’s request, produced a report reviewing Capital Gains Tax. Below, Elemental summarises the report and the reforms that it may herald.
The OTS is the independent adviser to government on simplifying the UK tax system. It makes recommendations for the government to consider but does not implement changes. The Government and Parliament must decide to do that.
Capital Gains Tax
Capital Gains Tax (or CGT) is broadly a tax on the difference between an asset’s value when acquired and its value at disposal, less any allowable expenses. Assets can be acquired in various ways including through purchase, inheritance or as a gift, and are generally disposed of either through selling or gifting.
The people who pay CGT are usually business owners (upon the sale of shares or business assets), investors (upon the sale of real estate or shares outside a pension or ISA) and employees (upon disposal of employment related securities). Principle Private Residence Relief provides 100% relief against CGT on a taxpayers’ home.
Although CGT has become politicised, it is in fact paid by very few taxpayers compared to income tax. In 2017-18 a total of £8.3 billion CGT was paid by 265,000 individuals in the UK compared with the 31.2 million people who paid income tax totalling £180 billion.
The Chancellor asked the OTS to ‘identify opportunities relating to administrative and technical issues as well as areas where the present rules can distort behaviour or do not meet their policy intent.’
The report sets out a framework of policy choice within which government could consider simplifying the design of CGT, to smooth out bigger picture distortions, improve administrative efficiency and make the tax easier to understand and predict. It does this over four areas which are summarised below.
Rates and Boundaries – alignment with Income Tax?
CGT is currently levied at much lower rates than income tax. The basic rate of income tax is 20% whilst CGT is 10% (18% on residential property). The higher rate of income tax is 40% whilst CGT is 20% (18% on residential property). The additional rate of income tax is 45%, but there is no corresponding additional rate of CGT.
The report finds that the disparity in rates between CGT and Income Tax can distort business and family decision-making and creates an incentive for taxpayers to arrange their affairs in ways that effectively re-characterise income as capital gains.
Bill Dodwell, Tax Director at the OTS said:
“If the government considers the simplification priority is to reduce distortions to behaviour, it should consider either more closely aligning Capital Gains Tax rates with Income Tax rates, or addressing boundary issues as between Capital Gains Tax and Income Tax. The report covers a range of other issues relevant to each policy choice, including relief for inflation.”
Annual Exempt Amount
The relatively high level of the Annual Exempt Amount (currently £12,300) can distort investment decisions. In tax year 2017-18, around 50,000 people reported net gains just below the threshold. This is likely driven by bed & breakfasting, a strategy where investors dispose of just enough assets to crystalise a gain to utilise their annual exempt amount before re-acquiring them shortly thereafter at a higher base cost. If the government’s policy is that the Annual Exempt Amount is intended mainly to operate as an administrative de minimis the report recommends it should consider reducing its level.
Interaction with Inheritance Tax
Transfer on death do not trigger a CGT liability, and create a ‘free’ uplift in an asset’s base cost for CGT purpose. CGT thereby incentivises owners to transfer business and personal assets to others on death rather than during their lifetime. This may not be best for the business, the individuals or families involved, or the wider economy.
The OTS suggests that persons inheriting assets are treated as acquiring the assets at the historic base cost of the person who has died.
The OTS notes that there is a policy judgement for government to make about the extent to which CGT reliefs should be used to seek to stimulate business investment and risk-taking. Business Asset Disposal Relief (which has in effect already been reduced from £10m to £1m) is mistargeted if its objective is to stimulate business investment and risk-taking.
The OTS’s view is that the government should, having regard to pensions policy more broadly, consider replacing Business Asset Disposal Relief with a relief more focused on retirement. It should also abolish Investors Relief.
How Elemental Can Help
It has been reported that the Chancellor is not currently minded to grasp the nettle of CGT reform and that the OTS proposals may gather dust.
In any event, the CGT regime has an important impact on how investments are structured, and Elemental can provide guidance in this area. Pro-active planning may be of particular interest to taxpayers sitting on latent or unrealised gains, especially entrepreneurs and real-estate investors.