It should come as no surprise that in light of increased public spending, the government are looking at potential ways to reform the tax system.
The Office of Tax Simplification (OTS) has issued one of two reports on the Capital Gains Tax system which are written for the treasury to help inform them on how they can raise taxes to help sure up the country’s finances. Their initial recommendations would lead to significant changes if implemented as suggested.
Capital Gains Tax is a tax applied on profit when you sell or dispose of something (an ‘asset’) that’s increased in value.
As things stand the full gain after deduction of the annual exempt amount (with no adjustment for inflation) is added on top of income to determine the rate of tax which will apply. For gains made on non-residential assets falling within the basic rate threshold, a rate of 10% will apply. For gains falling into higher rate thresholds, a rate of 20% will apply. The rate of tax applying to residential property assets is higher for both basic rate and higher rate taxpayers and is charged at 18% and 28% respectively.
Some of the recommendations and policy considerations are discussed below.
- Annual Allowance
Currently the annual exemption allows chargeable gains up to £12,300 each year to be taken free of tax. This has the effect of taking many individuals with relatively modest gains out of the need to report or pay tax on them.
It is also a very effective way of limiting the gains payable on an investment portfolio by ensuring sufficient gains are realised each year to utilise the allowance. This is currently worth up to £2,460 a year for a higher rate taxpayer and £1,230 for a basic rate taxpayer. If the exercise is repeated each tax year, the tax savings can have a significant impact on the net investment return.
The OTS considers this allowance to be too generous after review of initial policy intentions and have suggested that the treasury reduce the allowance significantly.
- Rate of Capital Gains Tax
The OTS suggest that the multiple capital gains tax rates should be simplified and that Capital Gains Tax rates should align more closely with income tax rates.
If the latter is implemented, the OTS suggest the government should consider reintroducing a mechanism to relieve inflationary gains.
- Interaction with lifetime gifts and IHT
Inheritance tax (IHT) and CGT are linked. On death if one of these taxes is chargeable then generally the other does not apply.
The OTS looked at this interaction last year in their review of IHT. They concluded it was complex and could affect decision making particularly around how and when to pass on assets to future generations.
They also flagged that where assets benefit from business property relief (BPR), agricultural property relief (APR) or the spousal exemption, then neither IHT nor CGT would be payable.
When someone dies, there’s no CGT charged on the assets they own, just IHT. The beneficiaries of the estate will acquire assets at market value at the date of death. This is commonly known as ‘market uplift’.
The OTS recommended that where IHT relief is applied there should be no CGT market uplift. This would mean there’s still no charge on death but, instead, assets would be transferred on a ‘no gain, no loss’ basis meaning that beneficiaries will acquire the assets at the cost to the deceased.
They have also suggested that consideration is given to applying this principle more widely so that the Capital Gains Tax uplift on death is replaced with the base cost.
- Exemptions & Reliefs
The OTS are also investigating a range of exemptions and reliefs available to determine if they continue to meet their policy objective and aren’t distorting behaviours. Business Asset Disposal Relief and Gift Holdover relief are discussed below.
Entrepreneurs Relief (now known as Business Asset Disposal Relief) is under the spotlight. If you’re entitled to Entrepreneurs’ Relief, qualifying gains up to the lifetime limit applying at the time you make your disposal, will be charged to CGT at the rate of 10%. In his last Budget the Chancellor cut the lifetime limit on the amount of relief from £10m to £1m.
The OTS suggests the Government should consider replacing Business Asset Disposal Relief with a relief more focused on retirement; and abolish investors’ relief.
Gift Holdover Relief allows the donor to make gifts without triggering a disposal for CGT and any gain is deferred until the recipient of the gift disposes of the asset. The relief currently applies to gifts of business assets, including unquoted shares, and also where any asset is gifted to a ‘relevant property trust’ (i.e. discretionary trust). The OTS has suggested that the government consider extending Gift Holdover Relief to a broader range of assets.
In the 2017-18 tax year £8.3 billion of Capital Gains Tax was paid and £55.4 billion of net gains (after deduction of losses) reported by a total of 265,000 individual UK tax payers. Whilst not an insignificant amount, this compares with £180 billion of Income Tax paid in the same tax year by 31.2m individual taxpayers. Clearly, CGT has been identified as one area where tax collections could be increased substantially. It would therefore be fair to expect some – if not all – of the above recommendations to be brought in by the government in the not too distant future.
NB. The Financial Conduct Authority (FCA) does not regulate tax advice.