In July 2020, the Chancellor asked the Office of Tax Simplification (OTS) to carry out a review of Capital Gains Tax (CGT), 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”.
Given the wide scope of the review, the OTS will produce two reports. The first report was published on 11 November and covers the policy design and principles underpinning the tax; the second, which will follow early next year, will explore key technical and administrative issues.
The main thrust of the report is to highlight many features of CGT which can distort behaviour, including its boundary with Income Tax and interconnections with Inheritance Tax (IHT).
The resulting recommendations from the OTS, across four main areas, are quite radical but, perhaps, not wholly unexpected.
The main recommendations that have grabbed the headlines can be summarised as follows:
Rates and Boundaries:
The Government should either consider (i) aligning the CGT rates with Income Tax (as it has been in the past) or (ii) deal with the “boundary issues between CGT and income tax”.
If there is to be alignment with Income Tax rates i.e. taxing capital gains in the same way as income, then there should also be some measures to deal with (i.e. not tax) inflationary gains, e.g. re-introduction of indexation relief?
If the CGT rates are not aligned to Income Tax, then there should be fewer rates, and, with no reliance on the taxpayer’s income in determining what the rate should be, measures should be introduced to prevent the disparity in treatment between capital gains and income.
Annual Exempt Amount:
The OTS believes that the relatively high level of the annual exempt amount (currently £12,300) distorts investment decisions by encouraging its use each tax year.
One way to address this, according to the OTS, would be to reduce the annual exempt amount so that it mainly operates as an administrative ‘de minimis’ threshold, if this is what it is meant to be.
If taxpayer behaviour did not change (which, of course, can never be ruled out when tax changes are introduced), the number of taxpayers required to pay CGT in 2021/22 would double if the annual exempt amount were reduced to around £5,000, and would nearly triple at an annual exempt amount of around £1,000 (compared to the 265,000 individual taxpayers who paid CGT in 2017/18).
Capital Transfers: Interaction with Inheritance Tax:
The OTS has already reviewed and made recommendations in relation to IHT reform. In that report, they recommended that a taxpayer should not receive both an IHT exemption and a CGT death uplift. So, where an asset passes free of IHT, it should not also be uplifted in value for CGT.
The OTS now appears to be considering a ‘no gains, no loss’ approach on death (i.e. no revaluing for CGT) for all assets, not just those that pass on death free of IHT.
If there were a move towards a ‘no gain, no loss’ approach on death, the OTS considers that there is a good case for an expansion of Gift Holdover Relief to non-business assets, so that CGT is paid on a subsequent sale, rather than at the time of the gift. This would substantially help with IHT planning.
Entrepreneur’s Relief (re-named Business Asset Disposal Relief in this year’s Finance Act) was reviewed in the March Budget and the cumulative limit for disposals qualifying for the relief was reduced from £10m to £1m. The OTS has put forward a challenge to the appropriateness of the relief in its current format.
The OTS note that Business Asset Disposal Relief and its predecessors have also long been understood as having another objective; as a specific relief when business owners retire. This was originally in recognition that a person’s business can be an alternative to a pension, representing many years of constant reinvestment.
If this were the objective, the Government could, alongside having regard to the wider objectives of the pension system, consider:
- increasing the minimum shareholding to perhaps 25%, so that the relief goes to owner-managers rather than to a broader class of employees;
- increasing the qualifying holding period to perhaps 10 years, to ensure the relief only goes to people who have built up their businesses over time; and/or
- reintroducing an age limit, perhaps linked to the age limits in pension freedoms, to reflect the intention that it mainly benefits those who are retiring.
In reviewing these recommendations, it is worth pondering what the main motivation for change is; fairness, revenue raising or both?
In relation to ‘fairness’ then, superficially, it is hard to argue, given the material differences between rates on income and capital gains taxes. There again, gains are often built up over many years and to charge a gain at Income Tax rates when the gain is all realised in one year could produce a distortive result.
In relation to revenue raising, questions need to be asked here too. HM Revenue & Customs estimates that around £14bn could be raised by aligning Capital Gains Tax and Income Tax, but that assumes that taxpayer behaviours are not changed. This could be a somewhat unreliable assumption.
So, where we are is that the first report has been published and the Government will undoubtedly at least consider what has been put forward. The second report on technical and administrative issues will be published next year.
We may get a view on Government thinking on capital tax reform in the next Budget?