Reforms to Capital Gains Tax – What can you expect?

25 November 2020 - Elizabeth Nichols

“The latest indication as to how the government will try to recoup some of their huge spending rises this year has come in a new policy report on proposed changes to Capital Gains Tax. Whilst we do not usually advise that financial plans should change as a result of policy speculation, the implied message from the government seems clear: 2021 will bring a harsher tax environment, and independent financial advice is crucial for businesses and individuals who need assistance in understanding how
they may be affected.”

Jason Fayers and Gavin Birchall, Tax Partners, examine possible future changes to Capital Gains Tax (CGT) and the implications for businesses and individuals.

It has come as no surprise to anyone that the government is looking to fast-track solutions to recoup some of the billions spent so far on the COVID-19 pandemic. According to the Institute for Fiscal Studies, Rishi Sunak needs to find £40 billion in additional revenue, or cuts, to cover these costs, although in September he reassured MPs that there would not be a “horror show of tax rises with no end in sight”.

The most recent indication of forthcoming changes to the tax regime has come with the report from the Office of Tax Simplifications (OTS), commissioned in July this year by Mr Sunak, which has just been published. According to the report, about £14 billion could be raised by 11 proposed changes to Capital Gains Tax (CGT), involving cutting exemptions and doubling rates.

Very broadly speaking the report suggests that CGT rates should be aligned with income tax rates, and that the annual tax-free allowance is lowered from £12,300 to approximately £4,000, since the current CGT regime “creates odd incentives” or “create[s] odd opportunities for tax avoidance”. The OTS also proposes that the government should tax the accrued profits of owner-managed companies and share-based rewards (shares issued to employees), at income tax rates. This would represent a significant change for any private companies that generate but do not distribute any substantial profits.

Currently Capital Gains Tax (CGT) is levied on the profits (or capital gains) made when selling or disposing of an asset, such as a property, or shares in a business. The first £12,300 of the capital gain is exempt, and anything more than that is taxed at 10% for basic rate taxpayers and 20% for higher rate taxpayers. These rates rise to 18% and 28% respectively if the gain is made on the sale of an additional home. The disparity between these existing low CGT rates and the rates of income tax means there is a perceived incentive for taxpayers to disguise their income as capital gain. Hence the OTS’s proposal that the two are brought into line, meaning that higher rate taxpayers could be subjected to CGT at 40% or 45% rates.

“The OTS also proposes that the government should tax the accrued profits of owner-managed companies and share-based rewards (shares issued to employees), at income tax rates”

Would these changes make taxation any fairer?

Whilst it could be argued that some people reduce their tax bill by disguising their income as a capital gain, there are strong arguments for not introducing such radical changes. Tory MPs have expressed strong opposition to any changes to CGT. “I think it would be very unwise,” said Marcus Fysh, deputy president of the Board of Trade. “It would kill off incentives within the economy at a time when we want to stimulate growth. We should be looking at ways of simplifying tax by reducing it.” There are also implications for investors, a number of whom have spoken up against the proposed changes which would stop people investing in the stock market, saying: “Why should I invest in companies when 40 per cent of any gain I make will be taken away in tax?”

“The government is then expected to move to a consultation or an announcement in the Spring Budget”

Capital gains aren’t the same as income

The OTS has justified aligning the rates by claiming that the present disparity “… can distort business and family decision making and creates an incentive for taxpayers to arrange their affairs in ways that effectively re-characterise income as capital gains.” However, the way capital gains are accumulated differs from income, since capital gains are accrued over several years, or sometimes decades. So for example, years of value built up in an owner-managed business that is sold can be taxed as though the increase in value happened overnight.

Would a change in CGT plug the COVID gap?

The government raised £9.5 billion in 2018-19 from 276,000 taxpayers against capital gains of £62.8 billion. Even taking these proposed changes into account, receipts from the tax would continue to be small compared with other levies, suggesting that the Chancellor would also have to raise rates elsewhere. There is also the fact that changing a complex tax regime in one area, such as CGT, would have implications in other parts of the system, such as Inheritance Tax.

What happens next?

This report will be followed by a more detailed document in early 2021. The government is then expected to move to a consultation or an announcement in the Spring Budget. If any of the proposals in the OTS reports are realised, the balance between the taxation of capital and income will shift, and there may be a significant erosion to the existing tax reliefs which are available to business owners.

For individuals who are thinking of selling their company or business or personally held assets, they may wish to consider accelerating their plans to ensure that they benefit from the existing low rates of Capital Gains Tax (and specific reliefs) before the rules are reformed.

Equally, for individuals who are considering passing their wealth on to the next generation, this may be the time to accelerate those plans before any rate hike.

It should be highlighted that there is likely to be significant opposition to any Government implementation of the OTS recommendations given the fragility of the economy and the concern that any tax changes could hamper any economic recovery. However, a tax rate increase in the near future seems inevitable given the need to raise additional finances.

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