Against the backdrop of much speculation over the combination of tax hikes that will be introduced to pay for the government’s Covid-19 spending, the Office of Tax Simplification (“OTS”) published its review on Capital Gains Tax (“CGT”) on 11 November 2020 in response to the Chancellor’s written request on 14 July 2020. Wedlake Bell responded to the call for evidence for this review and you can view our response here.
The OTS report focuses on individuals’ liabilities and there will be a second report to follow in the New Year, which will explore key technical and administrative issues that arise.
CGT review
CGT was particularly vulnerable to a review on the basis that rates are low in comparison to income tax. CGT also affects a relatively small group of taxpayers (business owners, investors and employees) and the yields are high. Most taxpayers are subject to CGT infrequently due to the application of the Annual Exempt Amount (currently £12,300), Principal Private Residence Relief and the chattels exemption (currently £6,000).
CGT rates for tax year 2020/21 are as follows:
a. gains over the Annual Exempt Amount of £12,300 up to the basic rate income tax threshold (currently £37,500) are charged at 18% on residential property and 10% on other chargeable assets; and
b. gains over the basic rate income tax threshold when added to other UK-source income are charged at 28% on residential property and 20% on other chargeable assets.
I discuss below some of the main points that are addressed in the OTS report.
Aligning CGT rates with income tax rates
HMRC estimates that raising CGT rates so that they are aligned with income tax rates could theoretically raise an additional £14billion. However, this does not take into account the need for the government to make adjustments to factor in inflation and the inevitability that taxpayers will rearrange their affairs to minimise their tax liability, for example, by holding assets through companies instead of personally so that gains are charged at the more favourable corporation tax rate of 19%.
In addition, interdependence between CGT and income tax rates adds further complexity for taxpayers on top of the current regime where the existence of multiple CGT rates is already tricky to apply. Taxpayers who straddle the basic and higher rate income tax bands will not be able to ascertain their CGT liability on a particular disposal until they are aware of their total income for the tax year in question. This pitfall highlights that careful consideration will need to be given to the spectrum of taxpayers who fall within the remit of CGT. To alleviate the pressures of taxing gains in the same way as income, the OTS suggests allowing a more flexible use of capital losses.
Annual Exempt Amount
Due to the relatively small number of individuals who are currently liable to pay CGT, the OTS further proposes to reduce the Annual Exempt Amount to a “de minimis” threshold. The OTS report highlights that a number of taxpayers use up their Annual Exempt Amount as an allowance which can distort investment decisions. Therefore lowering the threshold even slightly should significantly bring more people within the scope of the CGT tax charge if they continue to realise similar gains going forward. The OTS has suggested that a de minimis level could be as low as between £2,000 to £4,000 without it becoming too much of an administrative burden on the tax authorities so there is considerable scope for more people to become liable to CGT.
Business Reliefs
Nevertheless, the OTS recognises the need to promote enterprise and encourage risk-taking by business owners. Despite the recent reform to CGT Entrepreneurs’ Relief (a CGT relief for business assets – now known as Business Asset Disposal Relief), the OTS considers whether to redirect the focus of this relief so that it is more targeted towards retirement in order to reward business owners who have invested time and effort to grow their companies. It is appreciated that whilst there is scope for CGT to be charged to business owners, there needs to be sufficient incentive to stimulate investment.
The OTS has also proposed abolishing Investors’ Relief which the majority of professionals agreed has been hardly used since its introduction in 2016. For further information on how these reliefs currently operate, please listen to our podcast.
The CGT uplift on death
Another potential target is the interplay between CGT and inheritance tax (“IHT”). The OTS is of the view that the two taxes interact incoherently in that there are circumstances in which both taxes can be charged or neither tax charge arises.
For example, estate assets that are exempt or pass to a spouse attract no IHT or CGT on death as opposed to assets gifted during a person’s lifetime, which attract CGT on such transfer of assets and possibly IHT if the person does not survive the transfer by 7 years.
The OTS quotes that around 90% of wealth transfers are on death in the UK. Currently those inheriting assets on death do not incur CGT on any gains that have accrued on the assets during the deceased’s lifetime. The OTS therefore proposes that the recipient of an asset on a person’s death be deemed to acquire such asset at its historic base cost. To combat the complications that arise in respect of valuing assets historically, the OTS proposes rebasing values from 2000 onwards. It also considers making exemptions for low value items and extending the use of Gift Holdover Relief to include non-business assets. This proposal would encourage individuals to pass on wealth during their lifetime.
Looking forward
Whilst the government does not have to follow the recommendations of the OTS report, there is no doubt that the Chancellor will need to balance the nation’s books as a result of the government’s unprecedented spending that has occurred and continues to take place during these very difficult times, and CGT reform would be one way in which he could do this.
Taxpayers are therefore urged to seek specialist tax advice as soon as possible on the implications that these measures could have on their financial affairs, with a view to making use of the current CGT rates and reliefs whilst they are in force.
For further information on these CGT proposals and to discuss your tax and estate planning, please contact Jenny Cutts, Head of Wedlake Bell’s Private Client team, or your usual Wedlake Bell adviser