Capital Gains Tax (CGT) could become a key tax raising measure for the Treasury to recoup some of the billions it has paid out during the pandemic.
The Office of Tax Simplification (OTS) has published a review of the CGT regime, commissioned by the Chancellor, which makes suggestions for cutting the £12,300 annual allowance to as little as £2,000 and aligning CGT rates much closer to those for income tax.
Should the government accept the proposals, more people could be caught in the CGT net, and wealthy taxpayers and business owners could see their exposure to CGT increase substantially.
The disparity in the rates of CGT and income tax incentivise taxpayers to change their behaviour to reduce their tax liabilities, says the OTS.
It adds: "The disparity in rates between capital gains tax and income tax can distort business and family decision-making and creates an incentive for taxpayers to arrange their affairs in ways that effectively re-characterise income as capital gains.”.
Those earning less than £50,000 are charged a CGT rate of 18% on residential property and 10% on profits from other assets. For those with income of more than £50,000, the CGT rate is 28% on residential property and 20% on other assets.
If CGT rates were aligned with those for income tax, that would mean higher rate taxpayers facing a CGT rate of 40% or 45%.
The OTS does not suggest what the rate of CGT should be, but rather pushes that on to the government to decide.
An alternative approach the government could take would be to change the taxation of share-based remuneration, affecting business owners.
Another key target for reform could be entrepreneurs’ relief, or business asset disposal relief, which reduces CGT for retiring business owners. The relief has already been reduced, with the lifetime allowance cut from £10m to £1m in the March 2020 Budget..
The OTS additionally suggests removing the CGT uplift on death, which allows beneficiaries to inherit assets at their market value, rather than their historic purchase value. The current regime encourages people to hold onto their assets until they die, but any change could encourage wealth transfers much sooner.
In the 2017-18 tax year, £8.3 billion of CGT was paid, and £55.4 billion of net gains (after deduction of losses) reported by 265,000 individual UK taxpayers. This compares with £180 billion of Income Tax paid in that tax year by 31.2 million individual taxpayers.
The Institute for Fiscal Studies has suggested the Chancellor needs to raise £40 billion a year in tax after the pandemic.
Given the wide scope of the review, the OTS will produce a separate report next year exploring key technical and administrative issues.
Reaction to the OTS review
Reaction to the above proposals has been swift, which no doubt the Chancellor will note when deciding on a future Budget.
Lord Leigh of Hurley, senior treasurer of the Conservative Party and a senior partner at Cavendish Corporate Finance, told The Times:
“Capital gains are rewards for a risk taken by investing in an asset which might become worthless. Income involves no risk at all. If you want people to move from a comfortable salary to invest in a new business, take a risk, employ people, as I did, they have to feel that tax on any success reflects that risk.”
The Federation of Small Businesses told the paper: the proposals risked “stifling rapid enterprise growth and serial entrepreneurship — [things] we want to increase within our small business community, not diminish”.