The Office of Tax Simplification (OTS) have published the first part of their report into simplifying the design of Capital Gains Tax (CGT).
The report makes 11 recommendations in four main areas, as follows:
Rates and Boundaries
The rates of tax paid on capital gains are considerably lower than the rates of tax paid on income and this can lead to taxpayers seeking to re-characterise income as capital gains. The OTS noted two areas of particular concern:
- Retained profits held by limited companies. Shareholders of owner-managed companies will pay less tax overall if they reduce their income from the company each year and instead accumulate profits within the company and pay capital gains tax when the company is liquidated at the end of its life.
- Share based remuneration for employees. There are a number of remuneration schemes with differing tax benefits, however employees can pay a much lower rate of tax on receiving bonuses paid with company shares than in cash.
The OTS make four recommendations in this area:
1. Consider aligning capital gains tax rates and income tax rates more closely.
2. If rates are to be aligned, the OTS recommends the reintroduction of a relief for the inflationary increase in assets (in the past we have had indexation and taper relief) and a more flexible use of capital losses.
3. The rate of capital gains tax paid by an individual depends upon their level of income. If rates are not to be aligned, the OTS recommends reducing the number of capital gains tax rates and reducing the extent of this link between capital gains tax rates and income.
4. Consider taxing more share based remuneration and retained earnings in companies at income tax rates.
The Annual Exemption
This exemption is currently £12,300 and this is the level of net capital gains which can be made in a single tax year before CGT becomes payable.
The OTS suggests that the exemption could be reduced alongside improved administration for reporting and paying CGT.
Recommendations in this area are:
5. Reducing the level of the annual exemption so that it acts as an administrative de-minimus rather than a relief.
6. This reduction should take place in conjunction with:
- The introduction of a broader exemption for personal belongings (chattels) so that only certain types of asset are chargeable.
- Linking the real-time capital gains tax service (currently used for residential property gains) to the personal tax account.
- Consider requiring investment managers to produce a capital gains tax report for investors to make compliance easier.
Interaction with Inheritance Tax
This was also considered by the OTS as part of their report into simplifying Inheritance Tax (IHT) so for more details please see my blog: Summary of the OTS Inheritance Tax Report.
Assets that are held at death benefit from a ‘capital gains free uplift’ meaning that they are inherited at the market value for CGT enabling beneficiaries to immediately sell the asset at that market value without any CGT being payable. This can affect decision-making around lifetime gifts and passing on business property.
The OTS makes the following recommendations:
7. Some assets, such as business or agricultural property, are exempt from IHT. The OTS suggests that these assets should not also benefit from the capital gains tax free uplift. Instead, beneficiaries should acquire assets at the same capital gains tax base cost as the deceased so that they would pay CGT on an immediate disposal.
8. The OTS takes this a step further, suggesting that the government should consider removing the capital gains tax free uplift on death from all assets, not just those benefiting from an IHT exemption.
9. If the capital gains tax free uplift were removed, the government should consider re-basing assets so that only gains accruing since, say, the year 2000 are chargeable. It could also consider extending CGT reliefs when making gifts of assets.
Business reliefs
The OTS reviewed the effectiveness of Business Asset Disposal relief (previously known as Entrepreneurs’ relief) and Investors’ relief in terms of incentivising investment and providing relief for business owners on retirement and withdrawing from their business.
Their recommendations were as follows:
10. Business Asset Disposal relief should be focussed more on retirement, perhaps by increasing the required holding period and minimum shareholding, and by introducing an age limit linked to pension freedoms.
11. Investors relief should be abolished as it is rarely used.
Further information
All of the above are of course just proposals and recommendations and whether any are taken further or implemented in future remains to be seen.
However, now that both this report and the Inheritance Tax Report have recommended a re-think of the capital gains tax treatment of inherited assets this does seem an area where changes are likely at some point.
A second report will be published next year which looks at ‘key technical and administrative issues’.
The full report can be viewed here.
