The capital gains tax (CGT) system could be made simpler and fairer by reducing the annual exempt amount and raising rates to match income tax, according to a recent report from the Office of Tax Simplification (OTS).
This comes after Chancellor Rishi Sunak asked the OTS to carry out comprehensive review of the capital gains tax system in July 2020. This report is part of the result. Focusing on the design and principles underpinning CGT, it contains 11 recommendations for changes; a second report looking at technical and administrative issues is due to be released in early 2021.
Taxpayers paid £9.5bn in CGT in 2018-19 – the highest amount yet. But some of the suggested changes in the report could ‘raise a substantial amount of tax for the Exchequer’, suggesting this number could rise sharply if they’re brought in.
The OTS has previously looked into the inheritance tax system; it published its report back in July 2019 but none of its recommendations have been implemented to date.
Here, Which? explains what the main proposed changes are and how they could affect your tax bill if the government chooses to implement them.
What are the proposed capital gains tax changes?
The OTS was tasked with identifying areas where capital gains tax could be simplified and picking out any instances where the current rules do not deliver on their intent, and could be distorting people’s behaviour.
It’s a notoriously complex area of tax, which is probably why the work has had to be split into two separate reports.
The government does not have to take the recommendations offered by the OTS, but with the vast sums paid out this year to help people through the coronavirus pandemic, many are predicting big tax changes to help fill the deficit.
Each of the recommendations the OTS has made are suggestions to help fix a specific problem it has identified.
1. Fewer and higher CGT rates
The OTS has suggested that CGT rates should be ‘more closely aligned’ with income tax rates, which could lead to some of the current rates being doubled.
The OTS report says the current difference between CGT and income tax rates can distort the way people dispose of assets – for instance, choosing to pay or be paid for work in shares, where there is less tax to pay.
Additionally, the report says the fact that there are four different rates you might have to pay, depending on the asset and which income tax band you fall into, makes the tax difficult to understand.
Currently, basic-rate taxpayers pay 10% CGT on assets, and 18% CGT on property, while higher-rate taxpayers are charged 20% on assets and 28% on property. All rates are markedly less than the rate these taxpayers are charged for income tax, which is 20% for basic-rate taxpayers and 40% for higher-rate taxpayers.
If, for example, a higher flat-rate of tax was introduced, it could mean basic-rate taxpayers in particular will stand to pay a lot more in CGT than they currently do.
- Find out more: capital gains tax allowances and rates
2. Reduced CGT tax-free allowance
The OTS report has identified an issue with taxpayers ‘using up’ the annual exempt amount each year – that is the tax-free amount of profit someone can make from disposing of assets before being charged tax. It says, that people’s behaviour is being distorted by the allowance, and therefore it ought to be changed.
For 2020-21, the annual exempt amount is £12,300, but the OTS report suggests this should be reduced to between £2,000 to £4,000, as it says most taxpayers who are new to paying CGT would still come under this threshold.
If the government chooses to make this change, the report says it should be done along with exempting more personal items; if fewer assets come into the scope, then those who only make small profits will not need to start paying CGT.
It also says reporting CGT should be made easier, suggesting a real-time CGT reporting service, to be linked to personal tax accounts, and possibly the requirement for investment managers and others in similar positions to report CGT information to taxpayers and HMRC to make it easier for taxpayers to be compliant with the rules.
3. CGT on inherited assets
The OTS says CGT and inheritance tax (IHT) are not working well together – particularly with the rules around the CGT uplift that are currently in place when someone inherits an asset.
If someone were to inherit an asset, and then sell it for a profit, the CGT they’d pay would be based on the price difference of the asset when they receive it, and when they sell it – rather than the price the deceased bought it for. This is likely to massively reduce the amount of CGT paid on the asset, and is known as CGT uplift.
The OTS suggests that those who inherit assets that are exempt from IHT shouldn’t benefit from CGT uplift as well, as can be the case at the moment – and should instead pay CGT based on the price paid by the person who has died. Currently, this is calculated as being the asset’s estimated value in 1982.
It also says the government should consider removing CGT uplift more widely, but rebasing all assets to the year 2000 – as prices will have risen considerably since 1982, reducing the amount of CGT to pay.
- Find out more: inheritance tax rates and allowances
4. Reassess CGT reliefs
The OTS has identified that Business Asset Disposal Relief and Investors’ Relief, both of which are supposed to incentivise investment, are not working effectively.
It suggests replacing Business Asset Disposal Relief with a different relief scheme that is focused on retirement, specifically for owner-managers who have built up their business over time and are near retirement age.
As for Investors’ Relief, the report says as there has been so little interest shown since it launched in 2016, it should be abolished.