Capital gains tax: Ripe for reform?

In October 2020, an unprecedented £72 million was raised in capital gains tax, compared with £4 million in October 2019. According to an article in the Financial Times, the new (since April 2020) requirement to account for and pay CGT on residential property sales within 30 days of the transaction, combined with an increase in property sales fuelled by the stamp duty holiday, are two of the factors that have led to this spike in receipts. A third is a general expectation that CGT rates are likely to go up, following publication of the Office of Tax Simplification’s (OTS) report Capital Gains Tax Review: Simplifying by Design

When commissioning that report, the Chancellor of the Exchequer asked the OTS 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 administrative and technical issues will come in the OTS’s second CGT report; the current review concentrates on policy design and principles underpinning the tax, and looks at features that can distort taxpayer behaviour, particularly in the interaction of CGT with income tax and inheritance tax.

The OTS’s recommendations

Contrary to the impression given by much press coverage, the report makes hardly any firm recommendations. Instead, it takes the position that ‘it is for the government to determine the principles and role of the tax when framing policy and determining tax rates.’ The recommendations are couched in terms that if the government wishes to achieve X, it should consider doing Y. If it does Y, it should also consider Z.

The following are four areas on which the report focuses.

Differential rates of CGT and income tax

The first set of recommendations is based on the finding that the differential in rates between income tax and CGT is a source of complexity and can distort decision making.

Using the approach described above, the OTS says that if the government considers that the simplification priority is to reduce distortions to behaviour, it should consider either aligning rates more closely, or addressing the boundary issues between the two taxes, such as use of share-based remuneration and accumulation of retained earnings in smaller, owner-managed companies. The latter option would involve yet more complex rules which would not be needed if the rates were more closely aligned.

Annual exempt amount

Similarly, the second set of recommendations – about the annual exempt amount (AEA) – asks first whether the government considers the AEA to be an administrative de minimis, or a more substantive relief like the income tax personal allowance, or a rough and ready way to compensate for inflation.

If the government sees it mainly as an administrative de minimis, it should consider reducing it. This would bring in between 300 and 400 new taxpayers if its level were set at between £2,000 and £4,000.

If the AEA is reduced, the government should consider broadening the chattel exemption, formalising the administrative arrangements for the real time capital gains service (linking with the personal tax account or PTA), and exploring the possibility of requiring investment managers and others to report CGT information to taxpayers and HMRC.

Asset transfers

On the taxation of asset transfers, the report says that ‘capital gains tax incentivises owners to transfer business and personal assets to others on death rather than during their lifetime. This may not be best for the business, the individuals or families involved, or the wider economy.’

The interaction between CGT and IHT can be incoherent, leading in some cases to no CGT or IHT (for example where IHT-exempt property such as business assets, farming businesses or spouse-inherited property is subject to a CGT uplift on death) and in other cases to both taxes (such as gifts to children attracting CGT on the lifetime transfer and IHT if the donor then dies within seven years).

The report recommends that where an IHT relief applies, the government should consider removing the tax-free uplift on death so that inheritance takes place on a no-gain, no-loss basis. In addition, the government could remove the tax-free uplift on death more widely so that the person inheriting the asset is treated as acquiring it at the deceased person’s base cost; and if that is done, the government should then consider re-basing to (say) the year 2000, and extending hold-over relief to gifts of a wider class of assets.

Business reliefs

On business reliefs, the government should consider whether CGT reliefs are intended to incentivise business investment and risk-taking. If that is the purpose of the business asset disposal relief (formerly entrepreneurs’ relief), it is mistargeted. People do not regard the prospect of a favourable rate of tax when they finally retire or hand over the business as an incentive for investing in the first place: the incentive should apply at the time the investment decision is made. Accordingly, the report recommends that business asset disposal relief should be replaced with one more focused on retirement, as was the original purpose of the relief.

As for investors’ relief, the report recommends that it should be abolished because nobody uses it.

Changes ahead?

Given the Chancellor’s declared interest in ‘where the present rules can distort behaviour or do not meet their policy intent’, one would expect him to pay particular attention, when considering the report, to its recommendations in relation to distortive aspects of the tax. Such distortions could be reduced by following the OTS’s recommendations on CGT and income tax rates alignment or restricting business transfer reliefs. Tax rises seem to be indicated either way.

The report’s publication was greeted by predictable howls of anguish from some of the well-heeled and their representatives, complaining that its recommendations amounted to an attack on business, an assault on the economy, and similarly unspecific accusations. More thoughtful reactions acknowledged that if it was necessary to raise taxes in the aftermath of Covid (and it is looking increasingly likely that taxes rather than public expenditure cuts will do most of the heavy lifting), CGT was one obvious target.

CGT and income tax rates were aligned from 1988 right through to 2008, during which period – leaving aside the recession of the late 1980s – the economy performed tolerably well. The Conservative Chancellor Nigel Lawson, when aligning CGT and income tax rates in 1988, expressed the view that there was ‘little economic difference between income and capital gains’.

Except, of course, that paying CGT is very much a minority sport. The report states that in 2017/18, £8.5 billion CGT was paid by 265,000 UK individuals as against £180 billion income tax paid by 31.2 million individuals. (The amount of CGT paid in 2018/19, by comparison, was £9.5 billion.) Nevertheless, as I argued in an earlier blog, wealth is inadequately taxed in the UK in comparison with earnings, and the Conservative manifesto rules out increasing the headline rates of income tax, VAT or national insurance. So unless the Wealth Tax Commission makes a compelling case for imposing a one-off tax on wealth when it publishes its report in the near future, changes to CGT and possibly IHT to increase revenue from those sources seem inevitable if the public finances are to be restored in time.

Subscribers to Bloomsbury Professional Tax Online can read more about capital gains tax in our Capital Gains Tax Reliefs for SMEs and Entrepreneurs 2020/21 and Capital Gains Tax 2020/21 commentaries. Want to take a look at the range of high quality tax news and commentary our subscribers enjoy? Visit our website for further information.

Robin Williamson

Written by Robin Williamson

Robin Williamson MBE CTA (Fellow) is an author and commentator on tax, welfare and public policy. He was technical director of the CIOT’s Low Incomes Tax Reform Group from 2003 to 2018 and a part-time senior policy adviser at the Office of Tax Simplification from 2018 to 2019. In May 2020 he won the lifetime achievement award at the Tolley Taxation Awards. He was recently appointed UK country reporter to the Observatory on the Protection of Taxpayer Rights at the IBFD.

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