The Budget didn’t have much to say about capital gains tax (CGT).
HM Revenue & Customs' Budget policy paper covered the tax in four brief lines:
“The value of gains that a taxpayer can realise before paying CGT, the annual exempt amount (AEA), will be maintained at the present level until April 2026.
“It will remain at £12,300 for individuals, personal representatives and some types of trusts and £6,150 for most trusts.”
CGT has been with us since 1965. In 2018/19 (the last year for which detailed statistics are available), it raised £9.5bn from 276,000 taxpayers.
The chargeable gains giving rise to this liability amounted to £62.8bn.
Most CGT comes from the small number of taxpayers who make the largest gains.
In 2018/19, 40 per cent of CGT came from those who made gains of £5m or more. This group represents less than 1 per cent of CGT taxpayers.
The case for reform
Last July chancellor Rishi Sunak wrote to the Office of Tax Simplification (OTS) asking for a review of CGT, saying:
“I would like this review to identify and offer advice about opportunities to simplify the taxation of chargeable gains, to ensure the system is fit for purpose and makes the experience of those who interact with it as smooth as possible, as set out in the agreed terms of reference.
“This review should identify opportunities relating to administrative and technical issues, as well as areas where the present rules can distort behaviour or do not meet their policy intent.
“In particular, I would be interested in any proposals from the OTS on the regime of allowances, exemptions, reliefs and the treatment of losses within CGT, and the interactions of how gains are taxed compared to other types of income.”
The OTS reported back in November and a second report exploring “key technical and administrative issues” has been scheduled for around now.
There are many aspects of the CGT code which could be reformed or redesigned.
Three policy issues worth consideration are:
1. The treatment of inflationary gains
2. The rate of tax to be applied
3. The treatment of business assets
Let's look at each of these in turn.
Addressing the problems
It's always been seen as unfair that gains arising solely from inflation should be taxed.
Indexation relief and taper relief were incorporated (at different times) into the CGT legislation to address this problem.
Neither proved particularly popular, and both were ultimately withdrawn.
According to most economic forecasts, the UK will see mild inflation over the coming years, and the government has set the Bank of England a 2 per cent inflation target.
Arguably the inflationary gain issue is not a major concern.
The chancellor will enjoy the benefits of ‘fiscal drag’ due to the freezing of the AEA.
The OTS has noted that what it sees as the relatively high level of AEA, could be seen as “a rough and ready way to compensate for inflation”. Perhaps the chancellor will let sleeping dogs lie.
However, deciding on the rate of tax to be applied to gains poses a much more thorny problem.
When first introduced, CGT was levied at a flat 30 per cent. This was well below the standard rate of income tax in the second half of the 1960s.
It's generally accepted that the rate of CGT should be below the rate of income tax. Otherwise it's argued CGT would operate as a disincentive to invest.
CGT rates are currently 10 per cent and 20 per cent, with 18 per cent and 28 per cent applying to gains on residential property.
So why are gains on residential property taxed at a higher rate than others? Is this a feature that could be simplified?
The OTS is of the tentative view that there should be a closer alignment of income tax rates and CGT rates. The question is, how far is Rishi Sunak prepared to go down that road?
Then we come to business assets.
Business assets have always enjoyed preferential treatment in the CGT legislative code. The rationale behind this is that low CGT rates encourage investment.
The nature of this preferential treatment has varied over time. Sales of businesses have always enjoyed a measure of relief - from ‘retirement relief’ through to ‘business assets disposal relief’.
Given the chancellor’s willingness to encourage investment, it seems unlikely there will be significant change in this area.
What should advisers be doing in 2021/22?
It could be argued that any CGT changes over the coming years will increase rather than decrease the tax ‘take’.
As a result, planning to reduce the impact of future gains should start now. We are in a period of low CGT rates and one in which useful reliefs are available.
The OTS reports that in 2017/18, around 50,000 people reported net gains close to the threshold and so used up the AEA.
AEA planning is straightforward for clients with portfolios of shares, unit trusts and with holdings in open-ended investment companies, but more difficult where other less liquid assets are held.
Spouse exemption can also help in planning strategies, as both spouses have an AEA.
Reinvestment in pensions and/or ISAs can maintain the client’s risk profile, or alternatively disposals could form part of an inheritance tax planning strategy.
The certainty of treatment available in 2021/22 should act as a spur to sensible planning. Who knows what changes lie in store after that?