In 2019, the Office of Tax Simplification (OTS) gathered information for a report it issued on a review of inheritance tax (IHT). In 2020, it did the same for capital gains tax (CGT) and issued its first of two reports in November. However, what started as a need for reform of these two capital taxes has perhaps become a need to find greater revenue to fund the costs of the 2020 coronavirus pandemic.
Both taxes were reviewed at request of the Government, so we should assume it will take note of what is being said. What follows focuses on the OTS CGT report.
Some key points
Around 265,000 people pay CGT each year, with an average of around £32,000 in tax paid each. It currently raises just over £8bn a year, compared to £180bn a year from income tax. So both the pool of people that pay CGT and the relative tax take are small.
This means that simply increasing the rate of tax won’t make a very big difference to HMRC’s overall tax take; it may actually mean the tax take goes down as planning is undertaken to defer CGT, when taxpayers would otherwise be happy to pay it immediately at a lower rate. The option is to also greatly widen the pool of CGT payers, but administratively that’s burdensome for HMRC as it would then require more individuals to file tax returns.
So, a more fundamental review is needed and the OTS has looked not only at the rate of tax, but the annual exempt amount, rules relating to transfers and business reliefs.
Rates of tax
There is always the question of why the rate of CGT is lower than income tax. The simple answer is inflation - if something is sold for a greater amount of money today, compared to when it was acquired, but the buying power of the two amounts is the same, why should the difference be taxed at all? So, increasing the rate of CGT to the same level as income tax rates, without allowing for inflation, would actually make paying income tax more preferable than CGT if there is inflation in the economy.
CGT annual exemption
The annual CGT exemption is helpful but underutilised by the majority of taxpayers, in that most do not have gains that exceed it. The OTS suggests reducing it, but that would create complexity for taxpayers, with more having to undertake CGT calculations to see whether they are within the annual exemption limit, and potentially more work for an already burdened HMRC by bringing many more smaller taxpayers into the system. Far better, in our view, would be to have a proceeds-based de minimis amount, at say £25,000, below which taxpayers would not even have to go through the mechanics of the CGT calculation.
Transfers on death
Capital transfers was an area raised in the both the IHT and initial CGT reports and, in particular, the CGT rebasing to assets owned on a taxpayer’s death. This can mean that there is often no IHT payable on death in cases where a relief is available, and there is an uplift in base cost for CGT purposes, so that if the asset is sold by the legatee soon after they receive it, no tax is likely to be due at all; neither IHT nor CGT being chargeable. Changes may be considered with a view to influencing modified taxpayer behaviours.
Finally, the OTS considered business asset disposal relief (formerly known as entrepreneurs’ relief) and is recommending a relief more focused on retirement. Businesses need entrepreneurs and investors, who in turn often need an incentive to take the risks involved in starting or funding a business. If changes are made, we would want to see more significant tax relief available for entrepreneurs at the front end, in support of business start-ups. While investors may get relief, such as under the enterprise investment scheme (EIS), entrepreneurs themselves don’t get any tax relief for taking the plunge on a new venture.
In our view, simply raising the level of CGT is not the answer for a modernised capital taxes regime. The factors at work are complicated and require a joined-up review of all capital taxes once the OTS evidence gathering phase is complete. We also now have a separate report on a possible wealth tax from the Wealth Tax Commission to add to the mix. Read our thoughts on that here.
We hope that the Government does not make any rash decisions on CGT if there are to be Spring Budget changes, but we would urge business owners and investors to at least have a plan in place now, should immediate changes be announced in March and introduced from 6 April 2021.
For more information, please get in touch with Gary Heynes.