Office Of Tax Simplification Review Of Capital Gains Tax
In July 2020, the Chancellor asked the Office of Tax Simplification (OTS) to carry out a review of Capital Gains Tax (CGT). The scope of the wide-ranging review covers various aspects of the tax including rates, administration, interaction with other taxes and how it may influence the investment decisions of individuals.
The first report, ‘Simplifying by design’ was published in November 2020, and sets out a framework to simplify CGT to improve administrative efficiency and make the tax easier to understand and predict. Although there is no obligation on the Treasury to implement any of the recommendations, any changes to legislation are likely to be tax neutral given we are in a difficult economic climate to accept a radical overhaul at this time. Our EQ Taxperts discuss some of the main recommendations within the report below.
Aligning CGT to income tax rates
Historical Governments believed gains arising from investments should be taxed in the same way as earned income, and CGT rates were the same as income tax rates. Subsequent Governments tried to incentivise risk taking and entrepreneurship by reducing the rates of CGT. The current rates of CGT are much more favourable than income tax rates and may encourage taxpayers to manipulate the system to re-characterise income as gains, although there is a raft of anti-avoidance legislation to try and prevent this. Therefore, the first recommendation within the report is that the rates of CGT should be more closely aligned to income tax rates.
Historically relief was given for gains arising as a result of inflation, known as indexation allowance. This was abolished in 1998 but if rates of CGT are to be aligned with income tax then it is recommended that some relief is given for inflation.
Reducing the annual exemption
The annual exemption currently enables a taxpayer to realise up to £12,300 of gains without paying CGT. It has been stated that the purpose of the annual exemption is to ease administration burden and to give relief for inflation. The OTS suggests it achieves neither of these and, if it is to ease administration only, it should be reduced.
There is currently a disparity between employees and small company owners. A business owner can retain earned profits in a company and pay CGT on those profits by selling or liquidating the company, effectively shifting from income tax to CGT. The report suggests this should be addressed and perhaps retained profits charged at dividend rates on a liquidation. Business Asset Disposal Relief (formerly Entrepreneurs’ Relief) is also poorly targeted and should re-focus on retirement, perhaps returning to some form of retirement relief.
Interaction with Inheritance Tax (IHT)
Finally, it is noted that the current rules incentivise taxpayers to retain assets, particularly IHT relieved assets such as farms and businesses, until death, to obtain an uplift to market value on death and wash out the gain. The report suggests this may not be best for the business, the individuals involved or the economy. In a previous OTS report on IHT it was suggested that there should be no uplift to the base cost on death which this report supports and proposes rebasing cost which is long overdue.
In conclusion, the report does seem to suggest that we had a lot of good legislation in place previously, such as taxing gains at income tax rates, indexation allowance and retirement relief which begs the question – why did we get rid of them in the first place?
The second report, due in the coming months, will explore key technical and administrative issues. You can read the first report in full here.
For further information on CGT, and how these recommendations may affect your individual circumstances if they do come into force, contact our Private Client Taxperts by calling one of our offices.