By Nimesh Patel, Senior Tax Manager at Grunberg & Co
The cost of COVID-19 must be met by the nation and the Government has already begun to turn its attention to new approaches to increasing revenue to support the public purse.
The latest report from the Office for Tax Simplification (OTS), which was recently released, is just one way in which the Chancellor may take action in his next Budget.
Although it contains several points, the main aim of the recommendations is to bring the rates of Capital Gains Tax (CGT) in line with Income Tax.
The extensive report, also intended to simplify and improve the CGT system, recommends reductions in reliefs and allowances, less generous treatment of gains resulting from inherited assets and reducing the CGT threshold to just £5,000.
What has been outlined can only be described as a major reform to CGT and, if implemented in full, would represent the most significant change to the tax since April 2008. These changes would have a huge impact on those individuals that own assets.
Under the proposed removal of the annual exemption, many more individuals will be brought within the charge of CGT. Even those not to be considered very wealthy, which seems to be the main target of the reforms, who only make modest capital gains on assets they dispose of are going to face heftier CGT charges, which may result in them receiving very little in the way of gains after paying the tax.
Whilst the move to tax those with considerable assets of value may at first seem progressive, it is likely to mean that even small gains are taxed at the same effective rate as larger gains.
Taxpayers have already seen plenty of reforms in relation to CGT. For example, In March 2020, the conditions for Business Asset Disposal Relief (previously known as Entrepreneurs’ Relief) changed to restrict the ability of individuals to exploit this relief.
There have also been changes to the treatment of disposals of residential properties by reducing the final period exemption for main residence relief from 18 months to 9 months and removing letting relief for the vast majority of taxpayers.
In addition, the maximum rate of CGT on residential properties is already at 28 per cent, eight per cent higher than the regular rate of CGT for higher and additional rate taxpayers.
It is understandable why the treasury is targeting CGT, but thought should be given to the fact that many reforms have already taken place that increase CGT.
A different approach
A more progressive CGT system where the effective rate of tax increases with the size of capital gain would be fairer.
Perhaps the annual exemption should be aimed at those with smaller gains but not those making a significant level of capital gains.
This would also help to reduce the administrative burden on those with many low-value transactions, who may not be able to afford the use of a tax adviser.
Of course, CGT is only payable on disposals of assets and, therefore, the frequency at which an individual has to pay capital gains tax is low.
Because of this, an individual is usually in a position to decide on when to dispose of an asset. Raising CGT is, therefore, unlikely to significantly increase revenue in the short term, especially when considering many assets have fallen in value due to the COVID-19 pandemic.
But what about alternatives?
The rates of Income Tax, Inheritance Tax and VAT are already at relatively high levels. Increasing these taxes is unlikely to be effective as it will encourage individuals to behave differently.
Continuing to put more resources to tackle those using tax avoidance schemes and increasing compliance by taxpayers in reporting their income under Self-Assessment would be more beneficial. There would be no question of fairness.
The impact of reform
Taxpayers will have to appraise investments differently to before as the CGT payable on a future sale, should these proposals go ahead, is likely to be much higher. There may even be a fall in investments in certain businesses.
Those with highly geared assets will be adversely impacted as they will receive much less after a sale, as the combination of paying off a loan and increased amount of CGT takes away much of their proceeds.
This makes a sale of an investment a lot less attractive and income-producing investments may end up being held for longer.
EIS investments may become more favourable as they can be used to defer capital gains. Using EIS investments to defer capital gains chargeable at much higher rates than in previous years will be considered by more individuals.
Many individuals are aware of the income tax relief on EIS investments but not the ability to defer capital gains. Therefore, individuals considering EIS investments need to be made aware of this.
More individuals could be brought into Self-Assessment who would normally not be. This will cause an unwanted administrative burden.
Taxpayers should be wary of the potential changes and consider their strategy for disposing of assets. They may look to utilise annual exemptions whilst they still are available at the current level.
If an individual has plans to dispose of an asset, they will need to consider the potential benefit of bringing forward a sale.
Individuals with multiple assets will need to consider their portfolio in terms of which assets have accrued the most gains. It may, therefore, be beneficial from a CGT perspective to dispose of assets standing at larger gains before a potential increase in CGT is introduced.
While the proposals put forward by the OTS certainly give an indication of future direction for the Chancellor’s policies on tax in 2021, they are by no means set in stone and are only intended as a suggestion.
Consensus suggests that the Government is likely to target tax related to wealth such as CGT and Inheritance Tax in future Budgets, so it is highly recommended that taxpayers seek out advice once more is known so that they can protect their financial interests and remain compliant.