The Office of Tax Simplification (the 'OTS') has recently published its first report reviewing the UK's Capital Gains Tax ('CGT') regime. The thrust of the first report is to recommend changes to the CGT regime by design. The independent recommendations (which are not binding on the Government nor are they official Government policy) made by the OTS have the potential to raise billions of pounds worth of revenue to help the government fund its response to the coronavirus pandemic. On the other hand, the recommendations represent such a ground shift that they could, if implemented, lead to a significant reduction in investment in the UK (particularly by foreign investors). Perhaps understandably, there has already been a lot of opposition to these proposals.
The OTS' recommendations can broadly be broken down into three categories: alterations to the rates and boundaries; regulating the interaction of CGT with inheritance tax ('IHT'); and removing business asset reliefs.
Rates and boundaries:
Unsurprisingly (as this has been a topic of conversation for a number of months now), the OTS has suggested that the government should consider more closely aligning CGT rates with the much higher rates of income tax. For higher and additional rate taxpayers this would mean a rate rise from 20% on asset sales (28% on residential property sales) to 40% (or45% for additional rate taxpayers). Alongside this, the OTS has also suggested reducing the annual exemption from £12,300 to £5,000. The OTS states that 50,000 people avoid triggering a CGT charge each year by realising gains that fall just below the £12,300 threshold. Reducing the exemption could result in more taxpayers being caught, assuming it does not lead to a change in behaviour by taxpayers, which is a clear possibility.
The OTS' justification for the change is that the current rate disparity distorts decision making in businesses and families, incentivising taxpayers to come up with arrangements that allow them to characterise income as capital gains and benefit from a lower tax rate.
The OTS considers that mirroring the income tax levels for capital gains could result in a further £14 billion of tax revenue a year. Historically CGT rates have been lower than income tax, in part, because the lower rate rewards taxpayers for taking risk by investment. To align the rates would make the UK a much less attractive place for non-residents to invest. It is worth saying that the CGT regime currently does not allow for gains in line with inflation. It was thought the annual exemption broadly compensated for this lack of inflationary relief. To counter this, the OTS has suggested that the government consider reintroducing a form of relief for inflationary gains. Many will recall that when rates were previously much more aligned, both indexation relief and taper relief were available to taxpayers.
The OTS have steered clear of recommending changes to the exemption for the sale of a principal private residence and so we expect this exemption to continue.
The effect of the rate change is that someone who pays income tax at a rate of 45% who sells their company (putting Business Asset Disposal Relief to one side) with a £5 million gain would pay £2.25 million in CGT as opposed to £1m under the present rules, representing a 125% increase.
Interaction with IHT:
There are circumstances under the present rules where a taxpayer can benefit from both an IHT exemption and a CGT uplift on death (for example the transfer of business assets). The OTS' view is that taxpayers should not be able to benefit from both. Instead they have suggested that where relief from IHT applies, the government should consider removing the CGT uplift on death and provide that the recipient is treated as acquiring the assets at the historic base cost of the person who has died. They also suggest rebasing all assets to their value as at the year 2000.
The treatment of business assets:
The OTS has recommended that the government should abolish Investors' Relief entirely. Under the current rules for this relief, investors benefit from a 10% CGT rate up to a £10m lifetime limit for the disposal or ordinary shares in unlisted trading companies in which the shareholder is neither an officer or an employee. To qualify for the relief investors need to have held the shares for a period of three years prior to the disposal.
We wrote back in January this year that the government was targeting Entrepreneurs' Relief (please see our article on this here). This relief (which is now known as 'Business Asset Disposal Relief') was reduced from a £10m lifetime limit to a £1m lifetime limit for qualifying business disposals. In their report the OTS has recommended that the government should consider replacing Business Asset Disposal Relief with a relief more focused on retirement.
Much as we suggested back in January in Entrepreneurs Relief on the Chopping Block, investors who currently qualify for Investors' Relief or Business Asset Disposal Relief (or both) should consider whether it would be worth triggering a taxable event now to ensure that they can benefit from the lower 10% rate. Indeed, even if investors have not yet held their shares for three years they may consider triggering a tax charge now in any event on the basis that a 20% charge would still be preferable to paying CGT at a rate aligned with income tax.
What should you do if you currently hold assets standing at a gain?
If the OTS recommendations (and, again, it is to be noted that they are independent recommendations and are not binding) are implemented then now might be the opportune time to consider crystallising your gains. The most obvious method to trigger a CGT liability would be to sell the asset which has increased in value, however this may not be practical or desirable in the timeframe or circumstances (particularly for individuals who are running their own businesses).
An alternative method of triggering the CGT charge would be to transfer the asset to another person (other than a spouse or a charity). The disadvantage to gifting assets in this way, for example to one's children, is that it will result in a 'dry' tax charge (meaning that there are no sale proceeds to actually fund the tax). Where the assets are shares in a company this could also result in control being transferred away from the donor which may not be practical or desirable.
A further alternative would be to transfer the assets on trust. Such a transfer amounts to a disposal for CGT purpose. Privately held business assets would most likely qualify for business property relief from IHT so that they would not be subject to the 20% IHT entry charge imposed on lifetime transfers to trust. The issue of the individual losing control could then be mitigated by the choice of appropriate trustees (which could include, in certain circumstances, the donor).
You should always bear in mind that investment decisions should not be led by the tax considerations alone and so you should proceed cautiously with appropriate advice before seeking to realise gains on your investments. The OTS review of CGT is just part of the government's response to coronavirus and we anticipate there are likely to be further changes to the tax regime. Please click here to access an article to see some thoughts from earlier in the summer as to potential changes to the tax regime which could be introduced.
The changes recommended by the OTS would impact wealthier taxpayers significantly, and are already proving unpopular with the Conservative government's core voter base. Resistance from traditional Conservative voters as well as the Party backbenchers, could well dissuade the Chancellor from implementing the recommendations and so, at this stage, there is still no certainty that any of the recommendations will be implemented.
However, given the wider political landscape and the need to raise significant finances to fund the Government's ongoing Coronavirus support package, it seems likely that we will see some changes to CGT coming in at the next Budget.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.