In July 2020, 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 published its first report on 11 November 2020 and made recommendations covering four areas: rates and boundaries; the annual exempt amount; reliefs; and capital transfers. This briefing will consider the first three areas. The second report will be published early in 2021 and will be more technical and administrative in nature.
The Government clearly needs a way of reclaiming the estimated £394 billion it will borrow this financial year to fight the COVID-19 crisis, and the OTS sets out how some of its recommendations could raise additional revenue. However, it is not certain that the recommendations will raise the amounts estimated. There is also some concern that the recommendations are inappropriate from a policy point of view, although it will be for the Government to decide what changes it takes forward.
The OTS report showed that, in the 2017-18 tax year, £8.3 billion of CGT was paid by 265,000 UK taxpayers, compared with £180 billion of income tax paid by 31.2 million taxpayers. This highlights the unsurprising fact that CGT is paid by relatively few taxpayers when compared with income tax, and that the average individual CGT tax liability is much higher than the average income tax liability.
These statistics lead to the OTS’s first recommendation, that the Government should consider aligning CGT rates with income tax rates. This would prohibit often already wealthy individuals from taking advantage of methods of converting income into capital to benefit from a lower tax rate, and would also simplify the tax system. Aligning rates could, without a change in taxpayer behaviour, raise an additional £14 billion in CGT each year.
However, if the rates were aligned, there would likely be a change in taxpayer behaviour. The OTS itself recognised this; in particular the potential for taxpayers instead to hold their assets in companies, to benefit from what would be a lower rate of corporation tax. It is therefore unlikely that an alignment in rates would raise anywhere near the estimated £14 billion. Additionally, lower rates of CGT were originally introduced to encourage investment and reflect the fact that investments tend to carry more risk than income earned through employment, and so aligning rates may not be appropriate from a policy point of view.
Annual exempt amount
The current CGT annual exempt amount is £12,300, and the OTS highlighted that a high proportion of taxpayers are reporting gains that sit just below this threshold, arguing that individuals may be managing their gains so as to fall within the annual exempt amount. The OTS recommended that, if the purpose of the annual exempt amount is simply administrative (to reduce the number of people who are required to submit a CGT return), then it should be lowered to between £2,000 and £4,000. This would double the number of taxpayers required to pay CGT in any given year. However, this again assumes that taxpayer behaviour would not change, when it is likely that individuals would simply spread their gains across a greater number of years in order to stay below the threshold.
The most popular CGT relief is business asset disposal relief (formerly entrepreneurs’ relief) (BADR), which is targeted at company owner managers. This relief reduces the CGT payable on the disposal of business assets (including shares) to 10%. The OTS argued that the objective of BADR is to operate as an alternative to a pension when a business owner retires. If this is the case, the OTS recommended that the relief is amended to increase the minimum shareholding and holding period and to reintroduce a minimum age requirement.
However, this is not the only objective of BADR. The relief was also originally introduced to encourage investment, reinvestment and growth in UK businesses, which it cannot do if there is, for example, a minimum 10 year holding period for the asset.
The OTS’s first report highlights some clear inconsistencies in the CGT regime, particularly in comparison to the income tax regime. However, not all the recommendations set out in the report are likely to fix the issues they are intended to address. It remains to be seen which recommendations the Government adopts, and all eyes are on the next Budget for an indication of the approach that will be taken.
Christine Yuill, partner, and Zita Dempsey, solicitor, Pinsent Masons LLP
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