The noises around increases to Capital Gains Tax (‘CGT’) won’t go away. Ever since the Chancellor, Rishi Sunak, announced the first coronavirus economic support measures in March, speculation started almost immediately that future tax increases were inevitable, starting with CGT.
What started with a short letter from Rishi Sunak in July, the Office of Tax Simplification (‘OTS’) published its report on simplifying the CGT regime on 11 November. The report contains a dangerous set of proposals to radically reform CGT, and is a far cry from simplification in some regard – it is arguable that some of the proposals contained in the report serve to complicate the existing CGT regime.
What does the report say?
The standout headline of the report is to simplify CGT by aligning it to income tax rates up to 45%. Given the complexity of the income tax system, with various spikes and cliff edges, it is questionable whether this represents simplification.
The other proposals covered in the report include:
- Reducing the capital gains annual exemption to less than £4,000 – this would cost a higher/additional rate tax payer up to an additional £2,300 in CGT (based on current rates) as well as bring more individuals into the scope of CGT and the associated reporting.
- Reforming the chattels regime by increasing the exemption threshold for such assets.
- Re-introduce indexation relief, which in itself, was complicated to calculate.
- One of the more controversial aspects of the report is the proposal to remove the CGT uplift which currently applies when someone inherits any asset asset upon a person’s death. The proposal from the OTS is to remove the uplift where inheritance tax (‘IHT’) is not payable because an exemption or relief. It also offers a revaluation of assets at 2000 if such a change is to be introduced. (The complexities and challenges around obtaining adequate valuation cause an immediate frustration.)
- Business Asset Disposal Relief (the £1m successor to entrepreneurs’ relief introduced at Rishi Sunak’s first budget) would be abolished and replaced with a relief applying on business retirement. Retirement Relief provided CGT exemption for certain business assets but was replaced by taper relief in 1998, with some arguing that it was complicated in its operation.
- Abolition of Investors Relief – this provides a 10% CGT rate to the first £10m of qualifying capital gains. Investors Relief was introduced in April 2016 and was intended to broadly mirror Entrepreneurs’ Relief. Bizarrely, when Rishi Sunak reduced the entrepreneurs’ relief lifetime limit to £1m in the March 2020 Budget, the Investors Relief limit remained unchanged. Some made the argument at the time that the Chancellor was favouring investors over entrepreneurs.
How much would the measures actually raise
The Institute for Public Policy Research (IPPR) suggested last year that aligning CGT to income tax would raise £90bn, but this figure seems incredibly far-fetched.
In the latest available statistics from HMRC, the Treasury raised £9.6bn from CGT in 2018/19 against capital gains of £62.4bn – this represented 1.5% of total tax receipts. The tax was paid by 276,000 individuals at an effective rate of CGT of around 15% suggesting a reasonable proportion of gains were taxed at the 10% entrepreneurs’ relief rate.
Using very basic maths based on the latest available statistics, applying a 45% tax rate to £62.4bn of capital gains would raise the Treasury an additional £18.45bn. However, and in reality, not everyone would pay the tax at the highest rates. It is also important to note that the entrepreneurs’ relief (or Business Asset Disposal Relief) limit is now only £1m, compared to £10m in 2018/19 – therefore, the comparable tax increase will be far lower, and at best, the Government would expect to double receipts to around £20bn (which would cover two months of furlough payments).
Income tax, National Insurance contributions and VAT accounts for almost three quarters of the UK’s £635bn tax receipts – any changes to CGT are unlikely to yield significant amounts relative to the big three taxes.
What does mean for tax liabilities?
1. A business owner, who is an additional rate (45%) taxpayer sells his company realising a £3m capital gain.
- Under the current CGT system, the individual would pay £500,000 in CGT – £1m at 10% and £2m at 20%
- If CGT is aligned to income tax, the individual would pay £1.35m in tax – this represents almost a three fold increase in the tax liability
2. A landlord who is an additional rate (45%) taxpayer sells a buy-to-let property realising a £500,000 capital gain.
- Under the current CGT system, the individual would pay £140,000 in CGT – £500,000 at 28%
- If CGT is aligned to income tax, the individual would pay £225,000 in tax – this represents a 1.6 fold increase in the tax liability
3. A pensioner, who is a basic rate (20%) taxpayer sells some quoted shares realising a £10,000 capital gain.
- Under the current CGT system, the individual would pay £1,000 in CGT – £10,000 at 10%
- If CGT is aligned to income tax, the individual would pay £2,000 in tax – this represents two fold increase in the tax liability
The above illustrations assume that the personal allowance and capital gains annual exemption are full utilised elsewhere.
Entrepreneurs’ selling their business may feel particularly aggrieved. Nine months ago, someone selling their business for £10m would pay £1m in CGT (where entrepreneurs’ relief applied); following the reduction to the entrepreneurs’ relief limit in March, they would pay £1.9m and they could now face a tax bill of £4.5m.
What should the Government do?
The proposals from the OTS are merely recommendations and it doesn’t mean that they will all be necessarily taken forward. CGT rates are expected to increase, but aligning them to income tax rates seems a stretch.
If the Government wanted to truly simplify CGT, it would introduce a single flat rate, which is what we had in 2008/09 and 2009/10 when there was an 18% rate of CGT. There are currently five different rates which could apply, and this is the main point which needs to be addressed, and disappointingly isn’t considered in the OTS report.
It would be more sensible to have a flat rate of CGT of 28% but any rate increase should not come into effect until after 5 April 2022 – it would be wrong of the Government to introduce tax rises from the start of the next tax year when the economy is fragile and the road to recovery has not started in earnest. Although a mid-year rate increase should not be ruled out, it is unlikely and complex in practice. The Government may announce its intention to increase the rate from 6 April 2022 at the Autumn Budget 2021, giving people time to crystallise transactions and ‘lock-in’ the present rate – this would also generate transactions which may otherwise not take place and could present an artificial boost to tax receipts through behaviour.
What should you do?
The proposals from the OTS are just that – there is no clear direction from the Government that changes will be introduced, and if so, when they will take effect. It is therefore difficult to plan with certainty, but individuals may want to consider the following options:
- Sell assets standing at a capital gain, to ‘lock in’ the current CGT rate. (If selling shares, specific advice should be taken around repurchasing the shares within 30 days given the ‘bed and breakfast’ rules.)
- Gift assets to a structure (such as a discretionary trust or company) to crystallise a capital gain, but there are wider tax and legal implications that need to be considered.
- If you expecting to make a gift to child or grandchild, consider gifting an asset standing at a capital gain. There are also IHT implications when making a gift.
- Give careful thought around electing to defer capital gains, for example when you have made an investment under the Enterprise Investment Scheme.
- Consider the use of a Family Investment Company and transferring assets to it – under the current rules, capital gains within the company are assessed to corporation tax at 19%, but there continues to be speculation around the future use of these structures.
It is important and relevant to note that the Government could introduce anti-forestalling rules to counteract any planning that could be undertaken, and all the options should be carefully considered.
Recent criticism of the reviews and proposals by the OTS is that they very firmly stray into matters of policy rather than recommendations on simplification – the latest report is no different, and in fact, it contains more policy direction than any other report from the OTS. The output from the OTS is disappointing, as it serves to increase the tension around higher taxes, when simplification should be at its core.
There are a number of areas concerning CGT which are not addressed, such as the computational aspects and there is little mention of reform to main residence relief, which is one of most complex and mis-understood tax reliefs, yet claimed by millions.
There is a prevalent risk that high taxation of capital gains forces business owners and wealth abroad, and the Government should not overlook that wealth is more mobile than ever.
Finally, any such radical reform of CGT needs to be coupled with an equal reform of IHT – one should not be altered so dramatically without consideration to the other.
Would you like to know more?
If you would like to discuss the above or how it may affect you, please get in touch with your usual Blick Rothenberg contact or one of our Partners listed on the right.