In July the Chancellor Rishi Sunak requested the Office of Tax Simplification (‘OTS’) to undertake a review of Capital Gains Tax (‘CGT’) with a particular focus on areas where the existing rules can distort taxpayer behaviour.
The subsequent report published towards the end of November asks the Government to consider making changes that will have a significant impact if they eventually become law. The key OTS proposals are as follows:
- CGT rates to be aligned to Income Tax rates;
- Annual CGT exemption reduced from £12,300 to between £2,000 and £4,000;
- CGT losses to be used in a more flexible way;
- On death beneficiaries would be deemed to have acquired inherited assets at the historic base cost of the deceased rather than their value at the date of death;
- Lifetime gifts of assets to be on a no gain/no loss basis.
We do not propose to go into any technical details in this Wealth Insight. Instead we will consider briefly the potential impact should these changes become law.
An increase to the rate of tax payable on capital gains together with a cut to the annual exemption is not good for private investors. Savings in unit trusts and open-ended investment companies (‘OEICs’) could see the rate of CGT payable on gains double. Having said that, under the OTS proposals only the gain above inflation would be taxed.
A reduction in the annual exempt amount would reduce the benefit of crystallising gains up to the exemption at the end of each year. Currently using the exemption in this way is worth up to £2,460 a year for a higher rate taxpayer but if it is cut to £4,000, combined with a move to Income Tax rates, the annual tax saving is reduced to £1,600.
The reduction would also leave little room for larger portfolios that are actively managed to rebalance assets without triggering a CGT liability. Of course, such a change could increase the popularity of passive and multi-manager type funds by removing the necessity to make regular disposals to maintain chosen risk strategies. However, if this year has taught us anything it is the value of active management in mitigating risk.
Under current rules, capital losses can be carried forward indefinitely and used to offset future capital gains. But for those who rarely realise capital gains, capital losses relief is limited. Aligning CGT rates with Income Tax offers scope to open up allowing capital losses to be offset against income. The OTS also suggests the possibility of allowing losses to be carried back to allow tax to be reclaimed against capital gains from earlier tax years.
There is no CGT payable on death and the deceased’s beneficiaries are deemed to have acquired the assets they inherit at their value at probate value. This CGT-free uplift could disappear under the OTS proposals and be replaced with a transfer on a no gain/no loss basis. As a consequence, there would still be no CGT paid on death; however, beneficiaries’ base cost for future disposals would be the deceased’s historic acquisition cost. Of course this could slow estate administration down as the executors search records for acquisition costs. Helpfully, the OTS have suggested that base costs are revalued to the year 2000.
Additionally, the CGT-free uplift on death was also deemed to act as a deterrent to lifetime gifting, with the possibility of a double tax charge as CGT could be payable at the time of the gift and potentially IHT too if the donor failed to survive for seven years from the date of the gift. The OTS report suggests that the lifetime gift of assets is also moved to a no gain/no loss basis to encourage the intergenerational wealth transfers. The proposals would see gains deferred until the donee disposes of the asset. Of course, this is something that is only currently possible where the gift is of unquoted shares or gifts into relevant property trusts where CGT holdover relief can be claimed.
Finally, the OTS have also suggested that HMRC put anti-avoidance measures in place to prevent higher and additional rate taxpayers routes such as family investment companies to convert gains that could be taxable at 40% or 45% to 19%. Those in private equity with ‘carried interest’ could also be adversely affected by such anti-avoidance changes.
While there are no guarantees the Government will adopt these recommendations, it is interesting to note that in many of its proposals the OTS has answered particular questions that were raise by Mr Sunak. So, we can get a sense of current thinking in Government, which makes preparing the ground for such changes all the more important.