Back in July 2020, I wrote about the Chancellor commissioning the Office of Tax Simplification (OTS) to undertake a review into Capital Gains Tax (CGT) in this article OTS review of Capital Gains Tax. The OTS have duly now released the first of two reports – this one being focused on policy design.
To be frank, the report is quite jaw-dropping. If the Government choose to implement all recommendations, the changes to the CGT system in this country would be enormous. In fact, the publishing of the report was even one of the main headline stories on the BBC News website on Wednesday evening – which when you consider the other news stories at present, is arguably an indicator of just how striking its contents are!
Before I go any further, I should stress that the Government is not under any obligation to adopt the recommendations set out in the report. In theory, every single recommendation could be rejected. But it does provide an insight as what the future of CGT might look like and, without wanting to get too political, many people are expecting some form of tax rises in the future due to COVID19.
What are the recommendations from the OTS report?
- Consider closer alignment between CGT rates and income tax rates.
At present, the highest rate of CGT is 28% (although often it will be 20% or less). Whereas the highest rate of income tax is 45% (with potentially national insurance to pay on top of that). A closer alignment of the rates would, most likely, be achieved by increasing the rates of CGT. There can sometimes be a very fine line between whether an activity is within the realms of CGT or income tax – so a closer alignment in rates would reduce the impact of a taxpayer being on one side of the line or the other.
- If such closer alignment is introduced, consideration as to the reintroduction of a form of inflation relief, in addition to considering the use of capital losses and taxation of companies.
An element of gains is often attributable merely to the impact of inflation. Therefore, to somewhat counteract a rise in the rate of CGT, it is suggested that there would be the reintroduction of a form of relief which essentially removes the inflation element of a gain.
A rise in CGT rates would increase the incentive for using companies (eg to hold assets), given that corporation tax rates are currently lower than income tax rates. So the option of aligning CGT and income tax rates should also include consideration of corporation tax.
Aligning the two rates also brings into question whether a similar alignment of losses should be introduced – such as a wider ability to offset capital losses against income.
- Alternatively, if closer alignment is not introduced, consideration should instead be given to making CGT rates easier to understand.
At present, there are four different rates. And it is not always possible to confirm which rate will apply, at the time the gain is being realised.
- Consider reducing the level of the annual exemption.
For the current 2020-21 tax year, the annual exemption is £12,300. However, some see this as large enough to be thought of as “tax relief” rather than a “de minimis threshold”.
- If the annual exemption is reduced, also consider expanding the list of exempt assets.
Certain assets are specifically exempt from CGT (such as cars). By widening this list, this would reduce the number of taxpayers who would otherwise be “caught” by any reduction to the annual exemption.
- Consider removing the CGT “probate uplift” on death, if an IHT exemption or relief applies.
At present, death is not an occasion for a charge to CGT. Instead, the beneficiary who inherits an asset from a deceased person is treated as acquiring that asset at its probate value. If an IHT exemption or relief applies (eg spouse exemption), this means that at present the asset is passed free of both IHT and CGT. By removing the uplift, the beneficiary would instead acquire the asset for the same amount that the deceased did. It would still pass free of IHT and CGT, but with any unrealised capital gain still present.
- Consider removing the CGT “probate uplift” on all deaths (ie regardless of the IHT position), but alongside consideration of rebasing the acquisition cost of assets, and a widening of lifetime gift relief.
The report tentatively suggests the year 2000 as the method of rebasing. This would mean that for assets acquired before 2000, the actual acquisition cost would be replaced by the market value in 2000. This in turn means that where such an asset is still held at death, the beneficiary would also be treated as acquiring it at its later 2000 market value.
Even without probate uplift, no CGT on a transfer on death is still preferable to CGT on a transfer during life. Therefore, expansion of gift relief could reduce the lifetime CGT.
- Consider replacing or amending Business Asset Disposal Relief (BADR – formerly known as Entrepreneurs Relief) with a relief which is targeted specifically at business owners who are retiring. Abolish the sister relief, Investors Relief, completely.
BADR is a relief which can sometimes apply when a person is disposing of their business. The report considers whether the relief should be restricted to focusing on where such a disposal is made in the course of the person retiring.
The question now is will any of these recommendations be adopted by the Government? And if so, when and in what form? We will have to wait and see. The second OTS report, to be focused on the administrative side of CGT (eg reporting requirements), will be published next year.
You can read OTS’s first report – OTS Capital Gains Tax review – first report: Simplifying by design released in November 2020.