The Office of Tax Simplification (‘OTS’) has published their first report, entitled ‘Simplifying By Design’, following their review of Capital Gains Tax (‘CGT’), which was undertaken at the request of the Chancellor in July 2020.
The report focuses on the “policy design and principles underpinning the tax” and it is due to be followed by a second report early next year, which will focus on the technical detail and practical operation of GGT.
The report sets out eleven recommendations which are divided into four interlinked areas, as follows: (i) rates and boundaries; (ii) the Annual Exempt Amount; (iii) capital transfers; and (iv) business reliefs. Many of the recommendations involve policy choices for the Government to make with alternative recommendations offered depending on the Government’s chosen approach.
Rates and boundaries
Four of the eleven recommendations concern the rates of CGT and the boundaries between CGT and Income Tax, including the much-publicised recommendation to align CGT rates more closely with Income Tax rates, which was put forward with an alternative option of addressing the boundary issues between CGT and Income Tax. The report highlighted the incentive for taxpayers to try and generate capital gains rather than income due to the higher rates of Income Tax and the recommendations seek to address this. In full, they are as follows:
Recommendation 1: 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
Recommendation 2: 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
Recommendation 3: 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.
Recommendation 4: 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
The Annual Exempt Amount (AEA)
The AEA is the threshold below which gains are not chargeable to CGT. For the current tax year (2020/21), the threshold is £12,300. The report begs the question as to the purpose of the AEA; is it an administrative de minis, a substantive relief (like the Income Tax personal allowance), or a way of compensating for inflation? The report included the following recommendation in respect of the AEA:
Recommendation 5: 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.
Although not included within the recommendation itself, the report suggests a level of between £2,000 to £4,000 would be appropriate for an administrative de minimis.
The OTS recognises that there is a balance to be found between the additional tax generated by a lower AEA and the administrative costs involved (for both the individual and HMRC) in terms of reporting the gains. This leads to their next recommendation:
Recommendation 6: 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.
The report flags the “incoherent and distortionary” interaction between CGT and Inheritance Tax (‘IHT’), such that similar transactions can lead to a charge to one tax, both taxes or neither tax due to the combined effect of IHT exemptions and reliefs, and the CGT exemption and tax-free uplift in value on death. Echoing the recommendation made in their review into IHT, the OTS recommends:
Recommendation 7: 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.
The report refers to the “lock in effect” caused by the CGT free uplift on death, which can deter individuals from disposing of assets during their lifetime, leading to the following recommendation:
Recommendation 8: 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.
To help mitigate the significant administrative challenge that removing the capital gains uplift on death would trigger, the OTS makes a further recommendation in this area:
Recommendation 9: 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
Taxpayers who are looking to make lifetime gifts but have previously been deterred by the immediate charge to CGT may be particularly interested by the suggested extension of Gift Holdover Relief to a wider range of assets than just business assets.
The report also suggests (although not within the main body of recommendations) that it is envisaged that the pre-death gains on a main or only home would continue to be exempt from CGT.
The final two recommendations concern Investors’ Relief and Business Asset Disposal (‘BAD’) Relief (which was previously known as Entrepreneurs’ Relief). Both these reliefs are designed to encourage investment by reducing the rate of CGT payable on the disposal of qualifying business assets. However, the OTS queries to what extent BAD Relief encourages investment given that it applies not at the time the investment is made, but on the subsequent disposal. The OTS recommends:
Recommendation 10: The government should consider replacing Business Asset Disposal Relief with a relief more focused on retirement.
The idea would be to provide a specific relief for when business owners retire, in acknowledgement of the fact that a person’s business may be their pension. In order to achieve this, the OTS suggests several specific measures including: increasing the minimum shareholding from 5% (to possibly 25%) so that the relief is targeted at owner-managers rather than employees; increasing the holding period from two years to ten years; and reintroducing an age limit, possibly with reference to pension freedom age thresholds, so that it mainly benefits those who are retiring.
In relation to Investors’ Relief (a relatively new relief which external investors have been able to claim in relation to investments made from April 2016 and disposed of from April 2019), the OTS considers that it has had minimal interest or use. Accordingly, they recommend:
Recommendation 11: The government should abolish Investors’ Relief.
This seems a bit premature given that the relief could not be claimed before 2019/20 tax returns, which do not need to be submitted until 31st January 2021.
Please note that all of the above recommendations are simply that: recommendations. It is entirely up to the Government whether they choose to implement any of the proposals and how they go about doing so. The Government is likely to want to wait for the OTS to publish their second report (which is expected soon) before making any decisions. It is also worth noting that we are still waiting for the Government’s response to the OTS review of IHT (which was completed in July 2019) so an overhaul of CGT may not be that imminent and, ideally, one would hope that the two taxes will be reformed together given their interconnection. That said, the Government is under increasing pressure to raise tax revenue due to the rising cost of the Coronavirus pandemic so this may accelerate matters and it will be interesting to see what is announced at the Budget on 3rd March. It is unlikely to be prudent simply disposing of assets just because of a possible change to CGT, but if in the short to medium term clients are anyway considering making a disposal, then it could be worthwhile bringing such plans forward.
If you have any questions, please do not hesitate to speak to your usual contact at Hunters or to get in touch with any of the Partners in the Private Client Department.