The Office of Taxation Simplification report on Capital Gains Tax
Last week, the Office of Tax Simplification published its first report in response to the Chancellor’s request that it “identify opportunities relating to administrative and technical issues as well as areas where the present rules can distort behaviour or to not meet their policy intent”.
This report is on policy design and the principles underpinning capital gains tax (CGT) – it will be followed next year, by a second report examining technical and administrative issues. The cynic might suggest that the government is simply trying to find a to increase tax receipts for the exchequer and CGT on the disposal of assets is as good away as any and at the same time, put a stop to the various means by which taxpayers re-characterise income (which is taxed at higher rates) as capital gains.
In the 2017/18 tax year £8.3 billion of CGT was paid by 265,000 individuals in comparison with £180 billion of income tax by 31.2 million individuals – in a nutshell fewer people come within the CGT regime (and far more infrequently) but when they do, their liability to capital gains tax is more than five times greater.
CGT is anomalous in a number of ways: There are more than 4 rates at which is it is payable depending on the income tax status of the tax payer and the nature of the asset being disposed of, an individual may not know that rate at which gains will be taxed until the end of the tax year which is unhelpful particularly in relation to the sale of residential property where the CGT is due within 30 days of the disposal and where lifetime gifts give rise to a CGT charge, the donor will not have “sale proceeds” to fund the payment of his or her CGT liability.
The report makes recommendations framed by reference to four interlinked areas in which the government has policy choices to make. These are in relation to:
- Rates and boundaries
- The Annual Exempt Amount
- Capital Transfers
- Reliefs and losses
Rates and boundaries
As alluded to above the disparity between income tax and capital gains tax rates is thought to distort family and business decision making. The report observes that while generally speaking, the tax payer can control the time at which the disposal giving rise to a gain/loss takes place (where as income is generally taxed on an arising basis) more wealthy tax payers have greater opportunity to take professional tax advice and to structure their affairs though companies which additionally enables them to choose when to receive income through dividends or leave profits to accumulate, attracting not only corporation tax at a lower level but ultimately capital gains tax at a lower (and possible exempted/relieved level) on the ultimate disposal of the business.
Annual Exempt Amount (currently £12,300 for 2020/21)
The report characterised this as a rough and ready way to compensate for inflation (and akin to the income tax allowance) observing that it was inappropriate to tax part of a gain which has arisen to do inflation, and an administrative de minimis. Given taken with, for example, the chattels exemption (currently £6,000) it means that a huge proportion of disposals by the majority of individuals are simply outside the scope of CGT.
The OTS sees the interaction between CGT and inheritance tax (IHT) as “incoherent and distortionary”. In an earlier report on the simplification of IHT by the OTS we saw an indication that its preference was to abolish the tax free uplift in value of assets for CGT purposes on death, which it says encourages “lock-in” and has a great impact on an individual’s willingness to dispose of assets during lifetime, given the stark difference timing can make.
Reliefs and losses
In the context of practical administrability and enforceability, the report looked at the personal chattels exemption and two of the main reliefs which are intended to encourage business investment. In relation to the former, they observed that Business Asset Disposal relief (formerly Entrepreneur’s relief and now significantly curtailed) is mistargeted, if its objective is to stimulate investment and risk-taking as the incentive should come at the time the investment decision is made and not at the end of the process (although that was the rationale behind an earlier forerunner – Retirement Relief – in recognition that a person’s business can be an alternative to a pension). In relation to the latter, the view was that it should simply be abolished.
In full, the recommendations, some of which are more radical than others, are:
If the government considers the simplification priority is to reduce distortions to behaviour, it should either:
- consider more closely aligning Capital Gains Tax rates with Income Tax rates, or
- consider addressing boundary issues as between Capital Gains Tax and Income Tax
If the government considers more closely aligning Capital Gains Tax and Income Tax rates it should also:
- consider reintroducing a form of relief for inflationary gains,
- consider the interactions with the tax position of companies, and
- consider allowing a more flexible use of capital losses
If there remains a disparity between Capital Gains Tax rates and Income Tax rates and the government wishes to make tax liabilities easier to understand and predict, it should consider reducing the number of Capital Gains Tax rates and the extent to which liabilities depend on the level of a taxpayer’s income.
If the government considers addressing Capital Gains Tax and Income Tax boundary issues, it should:
- consider whether employees and owner-managers’ rewards from personal labour (as distinct from capital investment) are treated consistently and, in particular
- consider taxing more of the share-based rewards arising from employment, and of the accumulated retained earnings in smaller companies, at Income Tax rates
If the government’s policy is that the Annual Exempt Amount is intended mainly to operate as an administrative de minimis, it should consider reducing its level.
If the government does reduce the Annual Exempt Amount, it should do so in conjunction with:
- considering reforming the current chattels exemption by introducing a broader exemption for personal effects, with only specific categories of assets being taxable,
- formalising the administrative arrangements for the real time capital gains service, and linking up these returns to the Personal Tax Account, and
- exploring requiring investment managers and others to report Capital Gains Tax information to taxpayers and HMRC, to make tax compliance easier for individuals.
Where a relief or exemption from Inheritance Tax applies, the government should consider removing the capital gains uplift on death, and instead provide that the recipient is treated as acquiring the assets at the historic base cost of the person who has died.
In addition, the government should consider removing the capital gains uplift on death more widely, and instead provide that the person inheriting the asset is treated as acquiring the assets at the historic base cost of the person who has died.
If the government does remove the capital gains uplift on death more widely, it should:
- consider a rebasing of all assets, perhaps to the year 2000
- consider extending Gift Holdover Relief to a broader range of assets
The government should consider replacing Business Asset Disposal Relief with a relief more focused on retirement.
The government should abolish Investors’ Relief.
In conclusion, we must stress that these are what they say they are – namely Recommendations. Given the other issues facing the government, in our view:
- It is unlikely that any major tax reforms aimed at recouping some of the cost of COVID will be introduced until we are on the other side of the pandemic and the true cost can be quantified. With that in mind a great reform Budget is more likely to be announced next Autumn, rather than in Spring.
- Other potential tax reforms should not be forgotten, for example,
- it would be easier increase revenue for the Exchequer by making changes to income tax, NIC and VAT
- there could be an alignment between rates for the employed and self employed
- the prospect of a wealth tax may be reintroduced, particularly given the creation earlier this year of the Wealth Tax Commission and its initial report “Is it time for a UK Wealth Tax” published by Arun Advani, Emma Chamberlain and Andy Summers.
These notes do not contain or constitute legal advice, and no reliance should be placed on them. If you have any questions, please do not hesitate to speak to your usual contact at Maurice Turnor Gardner LLP, and if you would like to receive further updates, please email email@example.com to be added to our distribution list.
Related in brief posts
Covid-19 has led to far-reaching restrictions on travel and the ability of individuals to move freely to and from the UK. For those reliant on spending a limited number of days in the UK to avoid becoming UK tax resident this could prove costly.
Since 2000, HMRC has been sending “one to many” (OTM) letters to taxpayers as part of its “promote, prevent, respond strategy”. These letters are sent where HMRC perceives risks to compliance but a one-to-one approach would not be cost effective.
Maurice Turnor Gardner has been included in the Times 2021 list of the best lawyers for business, public and private-client law of the top 200 legal practices in England and Wales.