As we approach 27 October and our second Budget of 2021, questions will inevitably emerge over the future of capital taxation. Apart from the frozen inheritance tax (IHT) thresholds and the frozen capital gains tax (CGT) exemption there has been very little change proposed. And yet both IHT and CGT have been reviewed and reported on (two reports for each tax) by the Office of Tax Simplification (OTS). The last of those reports, on ‘simplifying practical, technical and administrative issues’ related to CGT was published in May 2021, two months after the Spring Budget. It is CGT that we will examine in this bulletin.
Ahead of that last Budget, on 3 March, many advisers received questions from clients concerned about the future of CGT and what, if any, advice should be considered and/or action be taken. A repeat of this pre-Budget pattern is likely – especially as no material changes to capital taxation were announced in March.
So, what is the advice and recommended action this time around? A tough question – but we’ll try to answer. First let’s consider some background and context:
- The proposals from the first and second OTS reports on CGT that gave rise to the greatest concerns were:
a. Capital gains rates should be ‘aligned more closely with Income Tax’ but with a reintroduction of some form of inflationary relief so that only “real” gains are taxed and with a possible “rebasing” of acquisition value to an appropriate date to help diminish possible “tax pain” for long held assets;
b. A reduction in the annual exempt amount to ‘a true de minimis level …in the range between £2,000 and £4,000’;
c. A review of Business Asset Disposal Relief (formerly entrepreneurs’ relief); and
d. Removal of the tax-free re-basing of acquisition value on death for all chargeable assets.
- Total receipts for CGT in 2020/21 were £10.6bn – so not huge, but double the level of IHT for the same period.
- The numbers of individuals who paid CGT in 2019/20 were not large either- around 250,000. In addition, 18,000 trusts paid the tax.
- The Conservative Government is coming under strong pressure from the backbenches over the tax and national insurance (NIC) increases they have already proposed. Many in the party are keen that the Conservatives are clearly identified as the Party that stands for fiscal responsibility and low taxation, not obvious traits of their leader.
So, what might all of this mean for the likelihood of material CGT reform being introduced in the upcoming Budget? As the above context demonstrates there are plenty of “moving parts” and “contributory factors” to consider.
Here’s what we think supports CGT changes (pros) and also what makes change less likely (cons):
- The perception of fairness in selecting who bears the largest burden of tax increases is politically important. Those who pay CGT are likely to be the richer members of society with the ‘broadest shoulders’.
- Relatively few people pay CGT and so making the tax tougher and increasing the yield might not have a high political cost. 2019/20 data show that just 11,000 individuals accounted for two thirds of all taxable capital gains, with an average gain of about £3.8m.
- The current Chancellor specifically asked the OTS to review and report on CGT.
- Taxing capital gains as income is nothing new – we have “been there before” so to speak. It was generally the “way of it” up until 2008 and was last introduced by a Conservative Chancellor (Nigel Lawson). Taxing gains as income has also been a popular proposal from many think tanks for some years.
- If the yield from the tax were doubled by charging gains at closer to income tax rates, then an extra £10bn a year would be helpful.
- The likelihood that there will be no “one-off” or annual “wealth tax” or “covid recovery” tax maybe makes a more fundamental review of CGT (and IHT) more likely. It has the political benefit for the Chancellor of also appearing to be tax on wealth. CGT can be changed almost instantly (remember June 2010 – please see below) and legislation does not have to be built from scratch, as would be the case with a wealth tax.
- The Treasury Select Committee stated recently that there is a “compelling case for a review of capital taxation”.
- The concern over backbench and conservative voter “revolt/anger” which would be damaging for unity.
- The relatively low yield that the OTS-proposed CGT changes would generate.
- Behavioural factors would have a considerable impact on the extra tax raised. Gains only attract tax on disposals, so these may be deferred, and, for example, loans taken instead. The OTS noted that ‘alignment of Capital Gains Tax rates with Income Tax rates could theoretically raise an additional £14 billion a year …[but]… it is clear that nothing like this amount would be raised in practice, due to behavioural effects.’
- The lesson of additional rate tax would doubtless be exhumed.
- The additional yield (apart from the likely behavioural changes) is strongly linked to potentially volatile values – so inherently uncertain. For example, CGT receipts fell by nearly 70% between 2008/09 and 2009/10 in the wake of the financial crash.
Apart from the inherent uncertainty (foolhardiness even!) of predicting anything ahead of a Budget, where does this context and these pros and cons leave us? Well, call it sitting on the fence, but the matter seems very finely balanced. Too close to call even. On balance though, there is enough to lead to a conclusion that whilst change is not inevitable, it absolutely can’t be ruled out. In other words, it would be difficult, in all consciousness, to argue capital taxation will remain as it is.
So, with that in mind, what if any, action should be considered ahead of the Budget?
Before considering that, though, could any change, say to tax capital gains as income, be implemented other than at the beginning of a new tax year, e.g. from midnight on 26 October? The better view is that it could: George Osborne increased the CGT rate by 10% for higher and additional rate taxpayers at midnight on Budget Day in June 2010. Would, there be a need for consultation? That is certainly possible, especially if radical capital tax reform incorporating CGT and IHT is the chosen way forward – don’t forget those OTS reports!
If that were the case then, even though the final shape of the tax would not be known, anti-forestalling provisions could be announced so that any changes are applied to certain transactions (most obviously disposals) after the date of the announced consultation.
It’s not easy is it?
So, against this unavoidable uncertainty, the one certainty is that change can’t be categorically and confidently ruled out.
So, what action then? Should there be any action?
Now it gets tricky!
There are “knowns” and there are “unknowns” in relation to the consequences of both action and inaction.
Let’s deal with an easy one first. In relation to a possible removing of “rebasing” on death, it’s unlikely that we are going to see deliberate pre-Budget action (i.e. deaths!) to “forestall” this process and trigger a pre-Budget rebasing!
So, how about pre-Budget disposals to “bank” a gain taxed at 10% or 20%?
That’s the dilemma some individuals found themselves in ahead of the last Budget.
The stronger the perceived likelihood of taxing capital gains as income, and the bigger the unrealised gain, the more appealing a pre-Budget realisation would seem. And there’s the rub. There is no certainty and so “perception” and the nature of the individual will be the key drivers. An optimist or a pessimist? No sane adviser could give a formal recommendation. You can only state the facts (please see above). The “win” if the feared changes come to pass could be material if the gains realised are significant – a potential halving of the tax. If you felt it right to divest on economic, commercial, investment grounds (i.e. you were going to do it anyway) then that will absolutely be the likely way you will go. The main reason for the disposal decision would not be tax-motivated, even if it may yield a tax advantage. In making the decision to disinvest on this basis you will have factored in the tax cost based on the current tax rates. So, two absolute “knowns”. You “know” you want to divest on commercial/investment grounds and you “know” and accept the tax consequences under the current rules. And you may secure a supplementary benefit by divesting and realising a gain before the rates go up.
Where the only reason for considering divestment is the fear of a future tax increase and the “chance” of a “tax win” then you also have to factor in the cost. The “unknown” benefit and the “known” cost. In relation to the latter you have the commercial cost of sale and reinvestment. It is, however, more than arguable that the current “bed and breakfast” anti-avoidance provisions would appear to be capable (as the legislation stands) of getting you “out of a hole” by repurchase within 30 days, so the sale is identified with the recent purchase, minimising the gain or creating a small loss. Interesting.
And then there is the tax cost at the current rates payable in January 2023 (assuming we are not talking about residential property). Harry Callaghan springs to mind. “Do you feel lucky …punk?” Against the knowns and unknowns the decision will be subjective and substantially founded on FOMO (fear of missing out) – one way or another. The adviser can only clarify the context (based on facts) and give the client all they need to make the decision. Of course, if any further “hard” information on the likelihood of change becomes available ahead of the Budget this will need to be factored in. Don’t hold your breath on that though. Leaks have been frequent but not dependable ahead of recent Budgets.
Banking a gain subject to 18% or 28% tax – which primarily applies to residential property – ahead of 27 October, is largely theoretical unless the sales process is already underway. One point to remember in such an instance is that it is generally the exchange date, not the completion date, which determines when the disposal occurs for CGT purposes.
And, to close, on Business Asset Disposal Relief, as for ordinary chargeable assets, if you are going to make a disposal anyway, on commercial/economic grounds and if it’s logistically possible, absolutely complete before the Budget. If you are not in this “advanced” position then manufacturing a solely “tax fear” motivated disposal is probably not practically possible anyway. As for complex contingent disposals, the 2020 Budget provided a warning in the anti-forestalling measures that accompanied the rebranding of entrepreneurs’ relief.
So, there we are. As many of the key facts as we could recall and some thoughts on the thought process that could be adopted before taking or refraining from taking any pre-Budget action.
We hope you found it of use.