Capital Gains Tax - what's going on??

Capital Gains Tax (“CGT”) has been the subject of speculation for quite some time, with fears that the rates may be brought in line with personal tax rates. This would result in what would be a significant jump from 10% and 20% (18% and 28% in respect of residential property) to rates of up to 45%.

Earlier in the year, the Chancellor asked The Office of Tax Simplification (the “OTS”) to review 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 received contributions from professional advisers, professional bodies, businesses and members of the public and have recently released their first report relating to the policy design and principles underpinning CGT, with a further report expected in early 2021 which will explore technical and administrative issues.

The revenues generated by CGT pale in comparison to those generated by income tax, with the number of people paying income tax during 2017/18 amounting to around 32 million, compared to approximately 265,000 in respect of CGT.

WHAT ARE THE CONCERNS WITH CGT?

The main concerns with CGT as it currently stands are that there is a disparity between the rates applied to income and those that are applied to gains, and that this results in taxpayers managing their affairs in such a way that income may be re-characterised as gains in order to take advantage of the reduced rates.

In contrast, given that there are four rates of CGT, and these rates are interlinked with a person’s income, an individual might not know the rate to be applied if it is not clear what their income might be for the year.

It is thought that this may discourage people from making capital transactions.

Further, it is considered by the OTS that the annual exemption for CGT purposes (currently £12,300) is too generous and that, based on the data they interrogated, many of those making capital disposals manipulate their position such that they generate gains of the annual exempt amount each year and no more.

OTS RECOMMENDATIONS

The OTS makes a number of recommendations to the government as follows:

Where simplification is the priority:

• they should look to align CGT rates with income tax rates, or
• consider addressing boundary issues between CGT and income tax.

If the government proceeds with aligning CGT and income tax rates, the OTS recommend that:

• they should also consider reintroducing a relief for inflation (previously indexation allowance) as one of the concerns highlighted by many was that gains are often the result of inflation only, and the general consensus of those surveyed was that taxing inflation was unfair.
• the government should consider the interaction with the tax position of companies – with gains currently taxable in companies at corporation tax rates, and
• should also think about offering more flexible use of capital losses.

Finally, the OTS recommend that, where an IHT exemption applies on death (for example the spousal exemption or where the assets are qualifying business property), the CGT uplift on death should be removed. They go further to suggest that the government may also consider removing the CGT uplift upon death more generally, and where this is the case, they may consider introducing a rebasing of assets such that their value is rebased as at the year 2000.

ALTERNATIVE OPTIONS

If the government choose not to align the CGT and income tax rates, they could consider reducing the number of CGT rates in place (currently four).

Two key areas explored by the OTS were share-based remuneration and the accumulation of retained earnings in smaller owner-managed businesses.

Presently, profits are often retained within a company until such time that a shareholder wishes to exit the business, at which point they ‘cash in’ their investment by either selling their shares or liquidating the business.

This results in a gain subject to CGT. This gain potentially arises as a result of retained earnings which, had they been taken throughout the life of the business or over the shareholding period, would have been subject to income tax.

When considering the boundary issues between CGT and income tax, the OTS suggests that the government should consider whether rewards from personal labour are treated consistently and consider whether share-related rewards from employment and accumulated, retained earnings should be chargeable to income tax.

OUR CONCERNS

• One of Hamilton Rose's main concerns is that, if CGT and income tax rates are aligned (or if retained earnings become chargeable to income tax), those individuals who planned on using their personal companies as a retirement planning vehicle may suddenly find themselves in a very different position than anticipated. This is because, where funds are extracted at the point of retirement (i.e. by way of liquidation of the company), a greater proportion of the amount may then be subject to tax at the additional rates than would have been, had they taken those funds as income over a number of years.

• With regards to the annual exemption, the OTS note that when the amount began to increase back in the 80s, it was intended to compensate for inflation. Increasing the annual exemption does not achieve this.

• It is recognised that the level of the annual exemption eases the administrative burden for many taxpayers who would not ordinarily have to complete a tax return. By reducing it, a considerable number of people may be brought within self-assessment, meaning a huge potential increase in the administrative burden for both taxpayers and HMRC. However, the OTS consider that if the annual exemption is merely intended to operate as an administrative de-minimis, the government should consider reducing its level to between £2,000 and £4,000 along with pushing forward with real time reporting for CGT and the potential for investment managers to report gains.

• The interaction between CGT and Inheritance Tax (“IHT”) is (to quote the OTS) "incoherent and distortionary". It is possible for either one, both or neither taxes to apply in some transactions due to IHT reliefs and the current CGT exemption and uplift rules upon death.

• It is no secret that the significant spend in respect of the COVID-19 pandemic has to be funded somehow, with the expectation that the funds will be raised through taxes for many years to come. Whilst aligning CGT and income tax rates fits the bill of simplifying taxes to an extent, it will also help the government to raise additional funds. The question is whether the lack of certainty over CGT rates (and the potential removal of some of the reliefs currently afforded to those selling their businesses) will discourage people from entering into business themselves (which, in turn, generates employment) to begin with. This could have a significant impact on the economy as a whole.

HOW CAN HAMILTON ROSE HELP?

For those who may be entering into transactions in the not too distant future, it may be worthwhile considering doing so before the tax year end in order to secure current CGT rates.

Hamilton Rose are well-placed to advise on the potential tax implications of doing so, in order to help you make a commercial decision regarding how to proceed. If this is of interest, please do not hesitate to contact us at info@hamiltonrose.tax.