In July 2020, the government asked the Office of Tax Simplification (‘the OTS’) to undertake a review of the existing Capital Gains Tax (‘CGT’) regime. This week, the OTS have published the first in a series of reports, setting out their recommendations for potential changes to the CGT legislation for individuals.
The motivation behind modifying CGT regulations is being touted across the media as a plug to fill the fiscal hole left by the COVID 19 deficit. In reality, in comparison to income tax, only a small number of individuals actually pay CGT each year and it is far from the largest source of revenue for the government. However, there is certainly potential to raise additional revenues through a reform of the tax, and the fact that the Chancellor has asked the consultation to be performed in a shorter timeframe than usual implies that changes will be forthcoming.
What recommendations have been made?
The report states that the recommendations set out by the OTS aim to tackle ways in which CGT is counter-intuitive, creates odd incentives or creates opportunities for tax avoidance. In summary, the key changes that have been recommended for consideration by the government are as follows:
CGT Rates
There are currently four different tax rates in use depending on an individual’s level of income and the asset being disposed of, ranging from 10% to 28%. The OTS have suggested that the number of rates are reduced and their use simplified, and that the percentage rate of CGT is more aligned to that of income tax. Bearing in mind that the current highest rate of income tax is 45%, this could mean a significant rise.
Annual Exemption & Reporting of Gains
The OTS have recommended that the annual exemption (which currently exempts tax payers from reporting or paying tax if gains in the year are less than £12,300) is reduced to a lower amount, perhaps c£5,000, thereby increasing the number of disposals where a CGT liability arises and are reported.
The reporting of gains and indeed the payment of any liability arising could also be brought forward through the use of real time reporting. This is perhaps not surprising given the recent introduction of the 30 day CGT reporting of residential property disposals.
Capital Losses/Relief for Inflationary Gains
If rates are to be increased and the annual exemption reduced, the OTS recommend that the use of capital losses should be made more flexible and that they are potentially relievable against income. The OTS also supports the reintroduction of some form of relief for inflationary gains, such as the former indexation allowance.
Capital Gains Tax Uplift on Death
An individual’s estate is generally subject to inheritance tax on death and exempt from CGT, the basis being that the same assets should not be subject to both taxes. Beneficiaries to an estate are treated as acquiring assets at their probate value, thereby providing them with a CGT free uplift which limits the amount of CGT payable on a future disposal of the asset. The OTS has recommended removing this CGT uplift benefit, with the beneficiary then being treated as acquiring the asset at the historical cost of the person that has died.
If these recommendations are to proceed, the OTS have suggested that gifts of all assets (rather than just business assets, as is the current position) could be exempt for CGT , and also that “rebasing” all assets to their market value, possibly as at the year 2000 may be appropriate.
Owner-Managed Businesses
Profits which are retained within a company (rather than being taken out as salary or dividend income) can currently be realised on a sale or liquidation and taxed at CGT rates. The OTS report claims that this provides a tax advantage which can distort business and family decision making and have therefore put forward solutions to make the treatment of cash taken out of a business during and at the end of its life more neutral.
The first suggestion is to tax retained earnings on a disposal or liquidation at dividend income rates. Alternatively, the OTS suggest looking at ways in which the earnings are taxed within the company itself at an enhanced Corporation Tax rate.
The point is made that businesses do need to retain cash for legitimate trading purposes and so the report recognises that the taxation of surplus cash could be limited to certain types of businesses and that further thought would be needed on this recommendation.
Business Asset Disposal Relief
The OTS are suggesting that Business Asset Disposal Relief (formerly Entrepreneur’s Relief) which provides an owner with a 10% CGT rate on disposal of a business, should be focussed more on the retirement of owners as recognition for the number of years they have invested into a business. With this in mind, they have suggested consideration of the following:
- Increasing the minimum shareholding an individual to say 25% (Currently 5%)
- Increasing the number of years an individual must have owned their shares to 10 years (currently 2 years)
- The introduction of an age limit, perhaps linked to the age limits for drawing pensions
Employee Share Incentive Schemes
Most forms of employee remuneration are taxed at income tax rates, however, there are certain tax advantages available for share based remuneration, which may ultimately be taxed at much lower CGT rates than a more traditional cash bonus. The OTS have therefore suggested that consideration be given as to whether share based rewards could be taxed at rates more akin to income tax in order to close this gap, reducing the benefit of introducing tax advantaged share schemes such as EMI for employees.
What does this mean for you?
Many business owners will be part way through a transaction or disposal or considering making changes to their personal circumstances in the short term. Understandably, this week’s announcement leaves taxpayers wondering, what does this mean for me?
It is important to note that the above points are only OTS recommendations for potential changes and the Government can choose how, or whether, to use these. The information provided on potential changes is also speculative and not particularly detailed.
That said, the most likely, earliest time for any proposed changes to be made to the existing CGT regime is at the next Budget in March (a specific date is yet to be announced). As such, putting planning in place now or bringing forwards the date of intended transactions may help to achieve certainty over both the rate and timing of CGT liabilities.
Whatever your business type or structure, it is worth considering your position now. To help we have summarised some key areas in which we’d recommend consideration is made as to whether actions may be prudent
Individuals disposing of capital assets, business interests or shares in personal companies
Consider bringing forward any planned transactions to early 2021, to provide certainty over your CGT position before any potential changes are announced in March.
Companies currently implementing employee share incentive schemes
For those business owners who are considering implementing employee share incentive schemes such as EMI option schemes or growth shares, you may wish to consider bringing forward the introduction of such schemes. It is possible that future changes may affect existing schemes as well as new, but introducing them now gives them the best chance of being “grandfathered” and existing tax benefits being retained.
Landlords
The recommendations made by OTS can impact on landlords in a number of different ways, and therefore you may want to consider the ownership structure of property to maximise the use of multiple annual exemptions and capital losses. If disposals are planned you may wish to complete these before March 2021, however the rebasing of assets to their market value as at the year 2000 may be a welcome change and could open up opportunities to transfer property that otherwise may be subject to high CGT liabilities. Similarly, if holdover relief becomes available on investment assets, more opportunities may be available to landlords in the future.
For those landlords holding their properties through a company which has a significant surplus, you may wish to consider extracting profits by way of a dividend now in anticipation of potentially higher rates being applied to these retained profits in the future.
For most of the above changes, it is best for landlords to adopt a wait and see approach; to see what changes will be announced in March and then consider how could this provide new tax planning opportunities for you as a landlord.
If you would like to discuss any specific queries or concerns that you may have, or to have a discussion about your personal circumstances and potential tax planning in general, please get in touch with your usual BHP contact.
