The recently published Office of Tax Simplification (OTS) report on capital gains tax (CGT) went a lot further than simply proposing an increase in CGT rates. While it's important not to read too much into the report, rumours of changes to the CGT regime have been around for some time now. CGT raises only around £8bn in tax each year - compared to £180bn from income tax – but the present government's commitment not to raise income tax, National Insurance contributions or VAT definitely puts CGT in the firing line.
The main recommendations from the OTS are:
- Aligning CGT rates with income tax rates, on the basis that the current disparity creates an incentive for wealthier taxpayers in particular to arrange their affairs in ways that effectively re-characterise income as capital gains. This can mean that they pay proportionately less tax on their overall income and gains than others. CGT and income tax rates were fully aligned between 1988 and 2008, so it is not hard to see this happening again. However, if rates are aligned, so that higher rate taxpayers would suffer CGT at 40% (or 45% for additional rate payers) then the OTS also recommends reintroducing relief for purely inflationary gains and a more flexible regime for the use of capital losses
- As an alternative to a full alignment of CGT and income tax rates, specific areas which currently attract lower CGT rates could be targeted. The OTS mentions share-based remuneration for employees and retained earnings in smaller owner-managed companies
- Reducing the annual CGT exemption, currently £12,300 for individuals in the 2020/21 tax year. If the main purpose of the exemption is to prevent large numbers of taxpayers with small gains from having onerous reporting obligations, then the OTS argues that its level should be lowered. The report suggests that it is only once the exemption falls below £2,000-£4,000 that significant number of taxpayers would be brought within the tax net. The OTS recommends that any reduction in the exemption is coupled with a reform of CGT on the disposal of personal possessions (to introduce a wider exemption) and perhaps also requiring investment managers and others to report gains to taxpayers and HMRC to make tax compliance easier for individuals
- A restriction or removal of the 'CGT uplift' on death. At present the CGT base cost of all assets owned at death is the open market value as at the date of death. This allows assets to be sold or given away shortly after death without any CGT becoming due. If the assets are also exempt from inheritance tax (IHT), for example because they attract the 100% exemption which applies to gifts between spouses, or attract 100% relief (such as business property or agricultural property relief), these assets can often be passed to the next generation tax free. The OTS recommends that where an IHT relief or exemption applies the recipient should receive the assets at their historic base cost. This would greatly reduce the scope for estate planning, where reliance on the IHT spouse exemption on the first death of a married couple (or civil partners) followed by CGT free onward gifts by the survivor, represents a common planning technique. The alternative option put forward by the OTS is removing the uplift on death altogether, so that the person inheriting an asset is treated as acquiring it with the historic base cost of the person who has died. The only exception would be a person’s main or only home. The OTS suggests that if this was done the government should also consider a general 'rebasing' of all assets, perhaps to the year 2000, and extending hold over relief on gifts (a deferral only of tax which currently allows most business or agricultural assets to be given away without an immediate CGT charge) to a broader range of assets
- Business Asset Disposal Relief (BADR) – formerly Entrepreneurs Relief – should be reformed. The OTS's view is that BADR does not encourage entrepreneurship and may distort behaviours, and should be targeted at retirement instead, harking back to the old Retirement Relief which was withdrawn in 2003. The reformed relief should require a much longer holding period of up to 10 years, a 25% shareholding threshold and a minimum age requirement.
The government has recently confirmed that there will be a Budget in March 2021. While its stated intent has been to defer tax increases in the short term to avoid exacerbating the economic fall-out from coronavirus, it's just possible that some changes in March could be on the cards. The CGT reforms could raise up to £14bn additional tax each year. Some of the OTS's earlier recommendations on IHT, such as restrictions on business property or agricultural property relief, might also be introduced, and the two changes together would make future succession planning harder for many families.
There may also be a case, in appropriate situations, at looking to trigger capital gains early to take advantage of what are, after all, historically low rates of CGT. This is most likely where a sale is expected within a relatively short time frame anyway and individuals or trustees want to try to bank the current CGT rates. Either steps might be taken to bring the sale forward if it is commercially feasible and sensible, or a disposal could be engineered, for example by means of a gift. This is of course easier said than done, and comes with risks attached, but we have already started to have conversations along these lines with some of our clients.