November 16, 2020
The stakes are high. The potential changes to CGT, including the rates at which this is paid, would substantially increase the tax bills of individuals disposing of chargeable assets. If you would like to discuss how this might impact your plans re any potential disposals or share schemes, please contact one of the listed team members or your usual Wiggin contact.
On 11 November, the Office of Tax Simplification (OTS) sparked headlines when it published its report on capital gains tax (CGT) reform. As an (oft ignored) independent adviser to the Treasury, the publications of the OTS do not typically prompt a media frenzy. But times have changed. Right now the Exchequer desperately needs to find ways to pay for its Covid support measures and so political priorities and tax theorising appear aligned. Consequently, this is not yet another think tank report exploring the art of the possible but, most likely, the basis of more concrete government proposals to be put forward for consultation or as part of Budget announcements in the Spring.
So what’s on the table?
The OTS made numerous recommendations, not all of which made the papers. Uncertain times make predictions difficult, but we look at 4 core proposals, their context, and how they may be taken forward from here.
Uplift CGT Rates
At present, for both basic and high or higher rate taxpayers the standard CGT rates (10%/20%) are broadly half that of income tax rates (20%/40 or 45%). This gap is less for certain assets (second homes or investment properties) but stretched further by CGT reliefs for profits on sale of businesses or business assets (see below). The OTS concludes that this has led to behavioural distortions as taxpayers seek to classify income as capital gains. The OTS does not propose any specific rate but recommends that the government “consider more closely aligning CGT rates with income tax rates”.
Our view: Whilst there is mounting pressure to uplift rates, alignment with income tax would mean a top CGT rate of 45% which will be too big a leap for many stakeholders, who will lobby the Government hard over the coming months. Consequently, we expect a significant uplift in CGT rates to bridge but not close the gap, with any uplift hopefully being softened with a reintroduction of some relief for inflationary increases in asset values.
Reduce CGT Annual Exemption
Each individual has an annual exempt amount (currently £12,300) which provides a tax free shelter for capital gains. The OTS observes that this leads to a bunching of reported gains around the threshold. To remove this happy coincidence, the OTS proposal is to reduce the annual exemption to a de minimis amount, to simply remove the administrative burden of collecting immaterial taxes.
Our view: If the annual exempt amount is substantively reduced, many more people would be bought into the self assessment net, including many employees benefitting from share schemes, making this an unpopular option with both businesses and individuals impacted. Furthermore, the current CGT annual exemption is set close to the tax free personal allowance for income (£12,500) so making any changes would throw the two taxes out of step. On balance, the Chancellor may not feel that the cost/benefit analysis for a reduction is worthwhile and so may simply settle for a freeze.
Rethink of Accrued Profits and Share Incentives
As an alternative to a full alignment, the OTS recommends that the government consider taxing the accrued profits of owner-managed companies and share based rewards, i.e. shares issued to employees, at income tax rates. This would be a major change for any private companies that generate but do not distribute any significant profits.
Our view: The scope of potential reforms is unclear but the share based remuneration could encompass growth shares schemes where senior employees receive a share on the growth in value of a company, as well as potentially the tax advantages of certain statutory schemes, such as EMI, CSOPs and SIPs, and the treatment of carried interest in a fund context. At its broadest, this would involve an overhaul of complex reliefs but these are ideas that do not seem fully worked up. There will be considerable pressure on the government to launch further consultations on this, rather than rush through measures in the Spring budget.
Call to scrap Entrepreneurs' Relief and Investors’ Relief
Entrepreneurs’ Relief (recently renamed Business Asset Disposal Relief) and the rarely utilised Investors’ Relief currently reduce CGT payable on the disposal of a business or business asset to 10 per cent is much maligned and should, says the OTS, be abolished. BADR has already been pruned back, with a new £1m lifetime limit (down from £10m).
Our view: These reliefs have long faced an existential challenge from OTS primarily on the grounds that they are baseless, i.e. entrepreneurs would innovate and investors invest with or without them. To date, they have survived as they have friends in high places. However, their survival seems more perilous than ever in a post-Covid environment where there is such dire need for additional tax revenue.
What comes next?
This is the first of two OTS reports. A second report, on more detailed technical aspects, is due to follow in early 2021 and government action in the form of a consultation or Spring Budget is expected to follow shortly thereafter. The realisation of just one or two of these proposals could significantly reshape the UK tax landscape, changing the balance between the taxation of income and capital. Many in Westminster are expected to take every opportunity to derail or delay however, the Treasury’s troubling bottom line speaks for itself and the current CGT regime may be unsustainable as we head into 2021.
It has been widely reported that owner managed businesses are looking to sell before the next Budget to secure lower rates of capital gains tax and Business Asset Disposal Relief. This needs to be balanced against the uncertainty surrounding the reforms and the impact of the current climate on any deal. Timing is everything. Businesses, their owners and their workforces should be watching closely.
If you have any questions or wish to discuss anything in relation to the above, please get in touch with one of the contacts listed above or your usual Wiggin contact.