- A review of Capital Gains Tax (CGT), commissioned by the chancellor, has urged for a much stricter approach
- CGT could be more closely aligned with income tax
- Such suggestions, if enacted, could have a significant impact on investors
The Office of Tax Simplification (OTS) has thrown its weight behind the idea of much more punitive tax treatment for capital gains, arguing that the current system is “counter-intuitive” and creates odd incentives as well as opportunities for avoidance.
The OTS argued that the annual allowance for the tax, which currently stands at £12,300, should be slashed, with Capital Gains Tax (CGT) rates being aligned with income tax. Basic rate taxpayers would currently pay CGT at the rate of 10 per cent, with this rising to 20 per cent for higher and additional rate taxpayers. Capital gains are currently treated much more leniently than income, both in terms of the annual allowance and rates applied (see table below).
“The current rates of CGT are lower than standard income tax rates,” noted the OTS in a review recently commissioned by chancellor Rishi Sunak. “The rate disparity can distort business and family decision-making and it creates an incentive for taxpayers to arrange their affairs in ways that effectively re-characterise income as capital gains. Most gains are concentrated among relatively few taxpayers, who also tend to have more flexibility about when they dispose of their assets. This can mean that they pay proportionately less tax on their overall income and gains than others.”
The OTS also argued that it would be “administratively simpler” to do away with the four rates of CGT currently in play, opting instead for two, and removing CGT’s interdependence with income tax rates.
If enacted, any such proposals could have a major effect on portfolios of different kinds. Individuals with substantial investments outside of tax wrappers and those who own second homes, including buy-to-let landlords, could stand to lose out significantly. Some ways to prepare for such an overhaul are outlined here.
Laith Khalaf, a financial analyst at AJ Bell, warned investors should now be "on high alert" for a tax raid on capital gains, with the review teeing up the chancellor to boost revenues with a CGT reform.
“If a coronavirus vaccine starts to alleviate health concerns next year, the government’s attention will quickly turn to repairing the huge hole in its budget and CGT looks like it’s very much in the crosshairs. The chancellor ordered this review of capital tax and while recommendations are conditional rather than categoric, it seems like change is afoot, possibly in a spring Budget," he said.
“If CGT rates are increased, there could be a fire sale of assets as investors sitting on big gains seek to take advantage of current rates before any deadline for transition. Investors would also likely flock to pensions and Isas, where gains are not subject to capital gains tax."
Buy to let blow
Those who own second homes, including buy-to-let landlords, would be among those to lose out if the proposals were enacted. Currently, CGT on sales of second homes is charged at 18 per cent for basic income tax rate payers and 28 per cent for higher rate payers. Therefore landlords disposing of properties would face a considerably higher tax bill if CGT is brought more closely into line with income tax rates.
However, the OTS also recommended reintroducing an allowance for purely inflationary rises in the property value over the period of ownership, which would be offset against the overall gain.
Given how radical the proposals are, it is unlikely they would be introduced before April 2022, said Heather Self, partner at tax advisory Blick Rothenberg. “I think what this will do is create a lot of uncertainty,” she said. Yet depending on the amount of notice given, there could well be an increase in homeowners looking to sell their property ahead of any deadline for the change in the CGT regime, she said. “It would cause a spike,” said Ms Self.
The proposals come as concerns around the reliability of income have already caused landlords to reconsider their portfolios. A quarter of landlords surveyed by National Residential Landlords Association (NRLA) during the third quarter said they planned to sell some or all of their properties over the next 12 months.
Companies do not pay CGT and therefore buy-to-let properties owned by a limited company would not be affected by the proposed changes. That will likely exacerbate the prevalence of portfolio landlords in the market, which was initiated by the phasing-out of interest rate relief on buy-to-let mortgages.
CGT versus dividend tax | |||
Band | CGT | Income tax | Dividend tax |
Annual exemption/personal allowance | £12,300 | £12,500 | £2,000 |
Basic rate | 10% (18% property) | 20% | 7.50% |
Higher rate | 20% (28% property) | 40% | 32.50% |
Additional rate | 20% (28% property) | 45% | 38.10% |
Source: www.gov.uk |
IHT and other considerations
The review also considered the high degree of practical overlap between CGT and inheritance tax (IHT), noting that the interaction between the two was “incoherent and distortionary”. The OTS has stuck with a recommendation previously made that taxpayers should not get both an IHT exemption and a CGT death uplift. Under the latter, if an individual dies and they hold taxable assets that have appreciated in value, the measure of capital gains is effectively set back to zero when these are transferred to someone else.
“A less distortive alternative to the death uplift could be a ‘no gain no loss’ approach, where (except in relation to a person’s main or only home) the recipient is treated as acquiring the assets at the historic base cost of the person who has died. This approach would make transfers in life and on death more neutral,” the review said.
Entrepreneurs could also be among those affected by some of the OTS proposals, with the review noting that changes could made to the treatment of share-based remuneration in owner-managed companies.
“In relation to the accumulation of retained earnings within smaller owner-managed companies, the issue is that business owners are taxed at lower rates if they retain profits arising from their personal labour in their business and realise the benefit on sale or on liquidation, than if they withdraw them as dividends,” the report said.
“One approach would be to tax some or all of the retained earnings remaining in the business on liquidation or sale at dividend rates (in effect shifting the boundary between CGT and income tax). This could make the treatment of cash taken out of the business during and at the end of its life more neutral.”
