4 reasons capital gains tax could increase
I think we can all agree that tax rises are inevitable given the cost of the Covid support measures provided this year. When this happens will depend on the state of the economy, the COVID19 pandemic, and the political agenda. But one thing is for sure, changes to capital gains tax (CGT) are on the table.
The Office of Tax Simplification (OTS) published their first report on the simplification of CGT on 11 November 2020. This first report covers the design and principles of CGT, and a second report due in early 2021 will focus on technical and administrative issues.
The report includes recommendations for simplification under 4 key headings:
1. Fewer and higher rates of CGT
We currently have 4 different rates of CGT (10%, 18%, 20% and 28%) depending on the level of income the individual has, and the type of asset being sold. These rates are far lower than taxpayers pay on income (20%, 40% and 45%). The OTS suggest that that number of rates, and disparity with income tax rates can cause confusion, and can distort taxpayer behaviour.
The OTS recommendation is to more closely align CGT and income tax. This means taxpayers could see their CGT liability double.
2. Reduced annual exempt amount
The annual exempt amount stands at £12,300 for 2020/21, the result of which, understandably, is that many taxpayers aim to make gains each year within the allowance. For example, a couple with a joint investment portfolio may actively aim to realise gains just under £24,600 in 2020/21, which would be free of tax.
The OTS suggest reducing the level of the annual exempt amount, to between £2,000 and £4,000. This would increase the number of people needing to file a UK tax return to report gains. Therefore if the annual exempt amount is reduce, then a way to report CGT, perhaps with investment managers reporting directly to HMRC, should also be considered.
3. Change the interaction with lifetime gifts and Inheritance Tax (IHT)
IHT and CGT operate differently but the impact can significantly overlap.
For example, an individual holds an investment which was purchased for £10,000 and is now worth £100,000. If they die leaving the investment to their spouse, no IHT is due because of the spouse exemption, and the spouse inherits the asset at a value of £100,000. In this example, no IHT or CGT is paid.
If instead they gifted the investment to their children during their lifetime, the gain of £90,000 would be taxable on the individual, and if their didn’t survive for 7 years from the date of the gift, the value of the gift (£100,000) would be included in the IHT computation. In this case, both CGT and IHT are due.
The OTS recommend removing this valuable CGT uplift on death where an IHT exemption applies, such as spouse exemption on Business Property Relief. The intention of this is to reduce the incentive to hold on to business and personal assets until death, and instead pass them on during lifetime. If the CGT uplift is removed more widely, then a revaluation of assets, perhaps to the year 2000 is to be considered.
4. Reduced business reliefs
Anyone with valuable business interests will already know that in March 2020 the Chancellor announced a cut to the lifetime allowance for Entrepreneurs’ Relief from £10m to £1m. Entrepreneurs’ Relief, since renamed and reshaped as Business Asset Disposal Relief, results in tax being due at just 10% on qualifying gains.
The OTS recommend that Business Asset Disposal Relief could instead be replaced with a relief focused on retirement of the business owner, and be limited to those who build up their businesses over time by increasing the qualifying holding period to perhaps 10 years.
In addition, it is recommended that Investors’ Relief, which was only introduced in April 2016, and only applied to qualifying disposals after April 2019, should be abolished.
What next?
I agree with the OTS that CGT, and the interaction with income tax and IHT, can create distortions in taxpayer behaviour – why would someone choose to pay more tax than they need to? CGT only generates about £9 billion a year in total, in comparison with £180 billion from income tax. A doubling of CGT rates would impact a relatively small number of people and could be an easier pill to swallow.
If you think you or your clients would be impacted by changes to CGT, and would like to discuss your options, get in touch with our specialists today.