The Office of Tax Simplification (OTS) published their report on 11 November 2020 on Capital Gains Tax (CGT) reform and put forward eleven recommendations for the government to consider. Subject to government policy, the report recommends aligning CGT and income tax rates, cutting reliefs and CGT allowances. The changes, if enacted, could have a significant impact on business owners, individuals with investment portfolios and property investors.
What are the key OTS recommendations?
One of the main recommendations of the OTS is that CGT rates are more closely aligned with income tax rates, subject to the government deciding that its simplification priority is to reduce distortions in behaviour by taxpayers favouring capital over income. Currently there are four rates of CGT – 10%, 18%, 20% and 28%. Income tax rates go up to 45%. The OTS comment that an alignment of CGT and income tax rates ‘has the potential to raise a significant amount of tax for the Exchequer’. However, the OTS also say that if such an alignment is done, then the government should consider reintroducing some form of relief for inflationary gains, consider the interaction with the tax position of companies and consider a more flexible use of losses.
Outside of the above the OTS have recommended:
- If rates are not to be aligned between CGT and income tax, then there should be a review of boundary issues between the taxes. In particular the OTS recommends that the government consider whether employees’ and owner-managers’ rewards from personal labour (as distinct from capital investment) are treated consistently and, in particular consider taxing more of the share-based rewards arising from employment, and of the accumulated retained earnings in smaller companies, at income tax rates.
- A reduction in the annual CGT allowance if the main policy intention of the allowance is to act as an administrative de minimis. For 20/21 this is £12,300 and the OTS suggest an annual allowance of between £2,000 and £4,000. If this were introduced the OTS recommend a broader exemption for personal effects, with only specific categories of assets being taxable.
- To consider removing the current CGT uplift on death to probate value not only when a relief or exemption applies for inheritance tax, but also more widely. If this is done, the OTS recommend that where an IHT exemption applies on death the person inheriting the asset should be treated as acquiring it at the historical cost of the person who has died. If the uplift on death is fully removed the OTS recommend that the government considers a rebasing of all assets, perhaps to 2000, and extend gifts holdover relief to a broader range of assets.
- To consider replacing Business Asset Disposal Relief (BADR) which currently has a £1m lifetime relief (formerly entrepreneurs’ relief) with a relief more focused on retirement.
- To abolish Investors’ relief which currently provides relief on up to £10m of gains at a CGT rate of 10% where the conditions are met.
How are individuals especially in family owned SME’s likely to be affected?
Owners in SME’s could be impacted significantly if all or some of the recommendations were to be enacted in legislation.
In the life cycle of a family business a number of transactions typically take place which could include all or some of the following:
- Transferring of shares between family members
- Sale of shares/goodwill to management or external purchasers, and deferred consideration
- Death of shareholders and inheritance by family members
- Liquidation of the company at the end of its life
- Sale of personally owned investment property
- Certain share schemes which are currently taxed under the CGT regime
Potentially all such situations will be impacted by the proposed changes.
Clearly if there were to be an alignment of CGT and income tax rates then on a sale of shares or goodwill in the SME there is likely to be a significantly increased tax charge. This would be exacerbated if BADR is focused on retirement and many people who currently qualify for that relief would no longer do so. Removing the uplift of share values to probate value on the death of the shareholder could materially affect the options open to legatees and may restrict options for the future.
The OTS recommendations are just that – recommendations. It is for the government to decide tax policy so it is not possible to predict which, if any, of the recommendations may be enacted and when this would happen.
Currently we know the 2020/2021 CGT rates and this enables the tax cost of a transaction to be calculated and planned. We also know that there is going to be a Spring 2021 Budget and that this may see announcements enacted either from that date or the start of the next tax year.
Individuals may wish to look at the following:
- Take advantage of the CGT annual exemption of £12,300 per person in 2020/2021.
- Consider investing in ISA’s and maximising pension allowances to ensure that future gains within the ISA and pension scheme are outside the scope of CGT.
- Consider the most effective use of capital losses.
- Consider bringing forward contemplated actions to benefit from current rates (such as MBO’s/company sales/solvent liquidations and gifts to family members or trusts (IHT and other legal matters will need consideration).
- Review buy to let portfolios and how they are held. Would joint ownership or incorporation be beneficial?
- Consider furnished holiday let properties and whether there is scope of gifting in the family or selling to take advantage of BADR and current CGT rates (IHT, SDLT and other taxes would need consideration).
- To consider the use of a family investment company and the transfer of assets to it for intergenerational planning (various other legal and tax issues need to be considered).
- Consider offshore trusts and whether distributions of stockpiled gains would be beneficial (this is very complex and specialist tax advice is recommended).
Given the high profile of the OTS recommendations tailored advice should always be taken based on your circumstances and the above is just an overview of possibilities and is not exhaustive. As with the case of changes to entrepreneurs’ relief in March 2020, the government could legislate anti forestalling provisions which remove the benefit of any actions undertaken, therefore caution is required.
The OTS has highlighted specific options by which Chancellor can raise significant tax revenue through a reform of the CGT rules. Some changes may be enacted in the 2021 budget. We await a date for the Chancellor’s UK budget although The Scottish government has announced that its budget for 2021/2022 will be published on 28 January 2021.
Get in touch
Now is the time to review your affairs, to consider your options and to move forward with strategic wealth protection and planning.
To enquire about any aspects of the OTS report please get in touch with your local Azets contact. We are here to help.
Please note: This note is based on the law as at 11 November 2020 and the OTS first report into Capital Gains Tax published on 11 November 2020. This note does not cover all aspects of the subject.