You may have seen in the press the recent report from the Office of Tax Simplification on possible changes to the Capital Gains Tax (CGT) regime. The report contained a number of recommendations to reform CGT. Although it does not mean that such measures will be introduced, it is a clear indication of the likely direction of travel.
So, what are the recommendations and what actions might you take to safeguard your position?
1. Alignment of Capital Gains Tax to Income Tax rates
The main suggestion is that CGT rates should be “more closely aligned” with income tax rates. The upper CGT rates are currently 20% on the disposal of most assets and 28% on the disposal of residential property and carried interest. The highest rate of Income Tax is currently 45%, so a direct alignment would more than double the tax due. The aim behind alignment would be to prevent people planning to convert income to capital to avail themselves of the lower rates of CGT. It might then be possible to remove some of the anti-avoidance rules which would then no longer be required.
If you have assets which you were thinking of selling or gifting then it might be beneficial (investment considerations permitting) to trigger a disposal now in order to take advantage of the current low rates of CGT. Such assets might include shares in your own company or investments standing at a gain. We would anticipate such a change being introduced with effect from 6 April 2021.
Should you not wish to dispose of the assets from the family, it may be possible to trigger the tax at the current low rates through a gift or sale to a family member, a company or a trust.
2. Reduction in the annual exemption
The annual exemption for CGT is currently £12,300. The recommendation is that this might be reduced to between £2,000-£5,000. This would increase the number of people having to pay CGT considerably. It might therefore be sensible to review assets for the tax year 2020/2021 and see whether it is possible to take advantage of the annual exemption before any reduction is introduced.
3. Share incentives and owner-managed businesses
If tax rates are not aligned then the recommendation is that share-based rewards from employment should be taxed as income. Further, it is suggested that where an individual accumulates trading profits within a small company the part of the profit which represents accumulated earnings should be subject to Income Tax rather than CGT. It would be difficult to know where to draw the line in determining what element were to be taxed as income rather than gain.
At the moment gifts (other than to spouse or civil partner) will attract CGT if the asset being gifted is standing at a gain. However, when assets pass on death the base cost of the asset for CGT purposes is uplifted to market value. The rationale is that assets passing on death will be subject to Inheritance Tax and therefore no CGT should be payable. However, the CGT uplift applies even when the asset passing is not subject to Inheritance Tax (e.g. in relation to a business asset or on a gift to a spouse). This has led to the recommendation that the tax-free CGT uplift on death should be abolished. The recommendation is logical but would be far from a simplification and the interaction with Inheritance Tax would require detailed consideration.
5. Entrepreneurs’ Relief/business asset disposal relief
Last year Entrepreneurs’ Relief was significantly reduced to a £1m lifetime limit (down from £10m) and was renamed Business Asset Disposal Relief. The recommendation in the report is that Business Asset Disposal Relief should be abolished and replaced with some form of retirement relief. Retirement relief was phased out in 2003 as it was so complex! It seems to be that there are only a certain number of ways to tax business disposals and now we are recycling previous rules. However, if you have not already utilised your lifetime allowance then it might be worth triggering a disposal of qualifying assets to secure the effective rate of 10% whilst some form of relief for entrepreneurs is still available.
6. Investors’ Relief
Investors’ Relief was introduced in 2016 for qualifying shares in unquoted companies that were issued after 17 March 2016 and have been held for at least three years prior to the date of disposal. The relief offered a £10m lifetime limit for qualifying disposals where the effective rate of tax would be 10%. Rather surprisingly, when the lifetime limit available in relation to Entrepreneurs’ Relief was changed, they left this untouched. However, it now looks likely that the relief will be reduced or abolished. Therefore, again, the message must be (subject to investment considerations) use it before you lose it!