In July the Chancellor asked the Office of Tax Simplification (OTS) to carry out a review of capital gains tax (CGT), to “identify opportunities relating to administrative and technical issues as well as areas where the present rules can distort behaviour or do not meet their policy intent”. The OTS recently published its report on the policy design and principles underpinning CGT, with a second report, covering technical and administrative issues, to follow early next year.
Based on the findings of consultations with stakeholders (including Saffery), the report highlights a number of areas where the OTS considers CGT to be “counter-intuitive, create[s] odd incentives, or create[s] opportunities for tax avoidance”. The report makes 11 recommendations focusing on four areas:
- Rates and boundaries
- The annual exempt amount
- Capital transfers
- Business reliefs
Rates and boundaries
The OTS’ first recommendation is to simplify CGT by more closely aligning rates with income tax. Whilst the differential between income tax and CGT rates can make capital receipts more attractive, capital gains often only arise after an asset has been held for a period of time, so that an element of the gain will be as a result of inflationary increases. In the past this was managed by an indexation allowance which has now been abolished. The OTS recognises this and recommends reintroducing relief for inflationary gains if CGT and income tax rates are to be more closely aligned.
If income tax and CGT rates are to remain at different levels, the OTS comments that it would be simpler if there were two rates of CGT rather than four (currently 10% and 18% for basic rate taxpayers and 20% and 28% for higher and additional rate taxpayers). It also recommends that income levels are not used to determine CGT rates.
On the question of the boundary between CGT and income tax, the OTS recommends that consideration is given to the treatment of employee and owner-managed rewards from personal labour. This has always been something of a vexed area for HM Revenue & Customs (HMRC), so it would be no real surprise if there is action here. In particular, the report talks about taxing profits on employment share-based rewards and accumulated earnings in smaller companies at income tax rather than CGT rates.
The annual exempt amount
The tax free annual exempt amount (AEA) is currently £12,300. The OTS recommends that, if the purpose of the AEA is mainly administrative, to reduce the number of people required to file self-assessment tax returns, consideration should be given to reducing the threshold to somewhere in the range of £2,000 to £4,000.
Alongside any reduction, the OTS recommends reform of the current chattels exemption on assets sold for £6,000 or less and a review of reporting requirements to ease the compliance burden for individuals.
Current CGT rules give a tax-free uplift on assets to their market value at the date of death. Inherited assets can therefore be sold straight away with minimal or no capital gains arising.
There is (what some would consider) an anomaly, where the asset also qualifies for a relief or exemption from inheritance tax (IHT), leading the OTS to propose that consideration be given to removing the capital gains uplift in these situations, instead using the historic base cost of the person who has died to calculate future gains by the recipient. Two of the largest areas where this double benefit applies are in the case of qualifying business and agricultural property. The logic here is that it is to prevent situations where family businesses have to be sold to raise the funds to pay death duties.
The OTS proposals go further than this by recommending removing the uplift more generally and replacing it with the historic base cost of the person who has died. If this change were to be made, the OTS recommends rebasing all asset values to, say, the year 2000, together with Gift Holdover Relief being extended to a broader range of assets.
Under current rules, an individual can dispose of a qualifying business asset and be eligible for reliefs such as Business Asset Disposal Relief (BADR) or Investors’ Relief, both attracting a lower CGT rate of 10%.
The OTS recommends replacing BADR, the much less valuable replacement for Entrepreneurs’ Relief, with a relief focused on individuals who are retiring. This could involve increasing the period an individual is required to hold an asset to possibly 10 years, with a minimum shareholding of perhaps 25%, as well as reintroducing an age limit (a case of back to the future with a return to the days of CGT retirement relief which was abolished in the late 1990s).
The OTS also recommends that Investors’ Relief is abolished as it does not appear to have been widely used, albeit it was only introduced in April 2016 and the first disposals it would apply to are from April 2019 onwards.
While it is perhaps unlikely that all the OTS’ recommendations will be adopted, it would not be a surprise to see some form of CGT reform in the Chancellor’s March 2021 Budget in light of the expense of managing the Covid-19 emergency.
The OTS report includes comments on the interconnections between income tax, CGT and IHT and that all three taxes should be considered if any changes to the current rules are implemented. We would recommend that individuals use this opportunity to re-examine their tax position and consider the impact, if any, the proposed changes could have on them.