The Chancellor is expected to look at capital gains tax (‘CGT’) changes in the upcoming Autumn Budget. His aim will be to help restore some fiscal headroom, but a simple increase in tax rates could backfire and reduce revenues.

An alternative approach could be to change the treatment of capital gains on inherited assets. CGT is currently wiped-out on death, sometimes described as ‘forgiveness’. Removing that forgiveness is more certain to raise funds in the short-term and could generate over £2bn a year in future CGT tax receipts.

There has been speculation that the Chancellor plans an increase in CGT rates. That speculation could be a distraction to a much more reliable CGT revenue-raising measure. Radical changes to the CGT regime are not without risk, as substantial changes to the CGT rules can also change taxpayer behaviour.

Given the limited time the Chancellor has had in office, it would be prudent to take time beyond the Budget to evaluate his options. Otherwise, there is a risk complex, rushed reform could backfire.

One capital gains tax reform could offer a more reliable return

There is one change to the CGT rules that’s certain to raise tax receipts in the short-term and generate substantial revenues in future. There are few perks to passing away, but one potential advantage is that any capital gains on assets held at death are effectively written off. Those inheriting an asset just need to know what its market value was at the date of death to calculate any capital gain on a future sale.

The existing rule can lead to some peculiar outcomes. A gift made during someone’s lifetime could be subject to CGT and inheritance tax, particularly if the donor dies within seven years of making the gift. That can result in individuals holding onto assets, as no double charge arises if the asset is passed on at death instead.

The rules can potentially deter someone from gifting or selling an asset during their lifetime.

How would capital gains tax on inherited assets work?

The Chancellor could be tempted to change this rule so that if someone inherits an asset, they also inherit any associated capital gain. That doesn’t mean that CGT would be payable on death, but it could be due if the inherited asset is sold in future.

A change in these rules could lead to administrative difficulties in calculating future gains. It’s therefore likely that a mechanism would be needed to agree the deferred capital gain with HMRC at the date of death. So even if no tax was payable on death, those selling the asset in the future would know the capital gain amount passed on to them.

There’s currently no need to submit information about capital gains at death to HMRC. As a result, it’s difficult to forecast how much extra tax would be generated if the Chancellor goes down this route.

Reform could raise more than £2bn a year

The Office of Tax Simplification estimated in 2020 that CGT receipts could increase by an average maximum of around £900m over a five-year period. This assumes that around a third of people would sell assets following someone’s death, and crystallise a CGT liability as a result.

The data relating to capital gains is historic and based on a main CGT rate of 20%, rather than the current 24%. Nonetheless, it’s reasonable to assume that the estimated maximum additional receipts in the short-term will now be at least £1bn.

The annual increase to CGT revenues is likely to grow over time, as the remaining two-thirds of inherited assets are sold by those who inherited them. HMRC’s previous analysis suggested that the additional tax revenues could increase to £1.6bn over a 20-year period, based on the asset values at the time. The main CGT rate has since risen to 24% and we have also seen increases to asset values. In light of that, it seems reasonable to estimate that additional CGT receipts could exceed £2bn a year over a 20-year period.

An inheritance tax concession could protect business succession

To sweeten the pill, the Chancellor could also announce in this Budget a reversal of the changes to inheritance tax relief on agricultural and business assets. These were fully introduced in April this year and have already been subject to change since they were originally announced.

They remain a commercial challenge for successful privately-owned businesses in the UK. The potential trade-off would mean businesses and farms could be passed on without incurring a tax liability on death, but more CGT could be payable on a future sale.

It’s still far from certain that death and taxes will be a theme for this Budget. But it’s easy to see why the Chancellor could be tempted to reform the CGT rules on inherited assets to fill a funding gap.

To discuss how CGT changes might impact your circumstances, contact Chris Etherington.

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