In July, the Chancellor wrote to the Office of Tax Simplification (OTS) asking it to, ‘to undertake a review of capital gains tax (CGT) and aspects of the taxation of chargeable gains in relation to individuals and smaller businesses.’ In response, the OTS has been gathering evidence, asking for detailed comments to be submitted by 12 October 2020.
Although we cannot tell what changes the review may provoke, the questions being asked suggest the areas where reform may be considered, and with these in mind we can think about whether action should be taken now to avoid uncertainty later.
Joining the dots
Earlier this year the OTS published a review of inheritance tax. We would hope that any CGT proposals take account of this, to deliver a single vision for UK capital taxes. This is an ideal opportunity to create a harmonised tax code where words have the same meaning for all tax purposes and complying with one set of rules does not penalise you under another.
Areas of interest
The questions the OTS has asked may provide some clues about the main areas of concern. Based on these, we would not be surprised to see changes in various areas:
Allowances such as the annual exemption for net gains of up to £12,300 for 2020/21 are likely to be reviewed. The annual exemption can remove the need for tax returns where only small gains are made, reducing the reporting burden for many. However, the annual estimated cost to the Treasury was around £4bn as long ago as 2015/16, so a reduction could be seen as an easy way to raise funds. Using your annual exemption to sell investments at a gain before any change may make sense, but tax savings could be outweighed by investment considerations, and care is required.
Exemptions and reliefs
Exemptions and reliefs such as business asset disposal relief (the old entrepreneur’s relief) could certainly do with some rationalisation. Some of these reliefs are powerful tools for encouraging the growth of early-stage companies, but there are anomalies – for example, treating external investors more generously through investors’ relief than employees under business asset disposal relief suggests these are ripe for review. As a result, anyone expecting to make use of investors relief may want to trigger a capital gain sooner rather than later.
Distorting effects of legislation
The distorting effects of legislation is an area of interest to the OTS. Here the truth is that many parts of the CGT code do distort behaviour, but often in a good way. Enterprise investment scheme (EIS) relief encourages riskier investments by cushioning the blow if businesses fail and enhancing the returns if they succeed. We would be surprised to see material changes to EIS tax reliefs, however, because the EIS rules are deliberately designed to distort investor behaviour in this way.
Interaction with income, and short-term v long-term gains
The interaction between amounts taxed as income and those taxed as gains, and a possible distinction between short-term and long-term gains is the final area of initial interest for the OTS. Aligning CGT rates with income tax rates might appear attractive, but it would be far from a simplification. CGT rates are lower than income tax rates to encourage long term investment and to compensate for the absence of indexation allowances that distinguish between ‘real’ profits and the effects of inflation. Increasing CGT rates without introducing indexation or a tapering relief would distort the economy by making longer term investment actively disadvantageous.
The possibility of an increase in CGT rates could encourage taxpayers to sell assets now. However, before acting it is important to think about the consequences. A disposal will create a tax charge that could otherwise be deferred indefinitely, and to be effective, assets sold must not be bought back within 30 days, leaving taxpayers vulnerable to price changes. A more prudent approach may be to limit any disposals to assets you planned to sell in the next couple of years anyway.
The OTS review of CGT is very welcome. CGT already functions reasonably effectively, but a serious review could help save money for HMRC and taxpayers and improve everybody’s quality of life.
For more information please get in touch with Andrew Robins.