The Future of Capital Gains Tax
On 14 July the chancellor wrote a letter to the Office of Tax Simplification requesting it “undertake a review of capital gains tax”. Interestingly, there was no announcement of the letter on the Treasury website.
The tone of the correspondence was distinctly different from Philip Hammond’s letter requesting a simplification review of inheritance tax. Although Rishi Sunak gives a nod to “opportunities to simplify the taxation of chargeable gains”, his letter also refers to:
- Areas where the present rules can distort behaviour or do not meet their policy intent and
- Any proposals from the OTS on the regime of allowances, exemptions, reliefs and the treatment of losses within CGT, and the interactions of how gains are taxed compared to other types of income”
The OTS had already responded with a scoping document, a call for evidence and, as it did with IHT, an online survey for individual taxpayers. Together, these make clear the review will be wide-ranging, covering areas including:
- The overall scope of the tax and the various rates which can apply
- Stand-alone owner-managed trading or investment companies
- Interactions with other parts of the tax system
- The practical operation of principal private residence relief and
- Consideration of the issues arising from the boundary between income tax and capital gains tax in relation to employees.
As was the case with IHT, the OTS has access to HM Revenue and Customs data that is not publicly available. One good example of this, contained in the scoping document, is the 2017/18 distribution of CGT taxpayers by highest income tax band.
The issue of how to treat capital gains for tax purposes has been an issue ever since the tax was originally introduced in April 1965. Of late, a number of think tanks – such as the IPPR and the Resolution Foundation – have called for gains to be taxed as income. Ironically, that idea was arguably put into practice by a Conservative chancellor (Nigel Lawson) in 1988 and survived for 20 years, albeit with various complicating tweaks along the way (anyone remember taper relief?).
At the last election, both the Liberal Democrats and Labour called for gains to be taxed as income and for the annual exemption to be reduced to £1,000 (Liberal Democrats) or scrapped completely (Labour). The Conservative manifesto made no comment on CGT. Doubtless the government could argue that, to the extent it has any post-coronavirus relevance, the Conservative manifesto pledge not to increase income tax rates did not stretch to gains taxed as income.
CGT “is a modest source of revenue for the Exchequer”, to quote the OTS. The latest Office for Budget Responsibility projections are that it will raise £10.5bn in 2020/21 (on gains realised in 2019/20) and £7.6bn in 2021/22. Set against a 2020/21 deficit heading above £350bn, doubling CGT revenue would make only a minor contribution.
However, from a political viewpoint, CGT has similar advantages to a wealth tax in that it is perceived as a tax on the better off that will not affect most people – fewer than 300,000 taxpayers paid CGT in 2017/18. It also has the benefit of being an existing tax, so would not require new infrastructure.
Having said that, there is an argument that with IHT already in the simmering simplification pot, a case could be made for some rationalisation of CGT and IHT into a single capital tax.
Charged to income tax?
The call for evidence is divided into two parts: “principles of CGT”, which had a response deadline of 10 August, and “technical details and practical operation”, for which the deadline has been extended from 12 October to 9 November.
Those dates – particularly the new 9 November deadline – left a short timescale for any feed into an autumn Budget.
We now know, of course, that the autumn Budget has effectively been cancelled this year following the chancellor’s announcement on 24 September.
Interestingly, the OTS says it “may publish more than one report on its findings”. CGT rates have been changed mid-year in the past (June 2010 by George Osborne, for instance). With the exception of tax on residential property gains, CGT is generally payable on 31 January in the tax year after the tax year of disposal.
There is not the administrative problem in dealing with an instant change to CGT that there can be with other measures. The timing of any change to CGT is, however, an obvious area of taxation, along with many others, that has been shrouded in further uncertainty following the cancellation of this year’s autumn Budget.
Perhaps one of the most concerning potential changes for taxpayers holding chargeable assets with large unrealised gains is the possibility that capital gains will one day be charged to income tax.
The idea put into practice by Lawson survived for 20 years, albeit substantially coupled with indexation relief so that only ‘real’ gains were taxed. It has the advantages of removing the current avoidance incentive to transform income into capital gains, and potentially raising more tax.
However, behavioural effects could limit just how much extra revenue comes to HMRC/. A mere 10,000 individuals accounted for over half the CGT paid in 2018/19 according to the latest HMRC statistics. Some have even suggested that capital gains should be made subject to National Insurance Contributions as well as income tax.
What is to be done?
What, if anything, should be done by investors if they have this fear? Possibly nothing at this stage, and of course any actions might have cashflow implications that then generate a liability. By all means consider using the annual exemption – but then anyone would do that as good tax practice, wouldn’t they?
There is also the incredibly important point that if you are looking to make a disposal to trigger a gain under the current rules but retain the investment, you will need to remember that you will have to keep the ‘bed and breakfast’ anti-avoidance rules in mind. Under these provisions, broadly speaking there need to be at least 30 days between the sale and reacquisition of ‘securities’ by the same individual. This would include shares and most collective investments, such as unit trusts and open-ended investment companies.
If these rules apply – that is, you do dispose and reacquire the same investments within 30 days – then the disposal and reacquisition is effectively ignored and the hoped-for gain realisation does not take place.
Reacquisition of different but similar securities or reacquisition by another individual (a spouse, for instance) might be something to be considered.
However, extreme caution should be exercised before getting carried away with a desire to prevent a possible income-taxable gain. It could easily trigger an actual current CGT liability that results in an outflow of funds to HMRC much earlier than would otherwise be the case..