We are all acutely aware that the Government needs to find a way to fund the deficit caused by Coronavirus, and recognise that tax changes will form part of the solution. The Chancellor wrote to the Office of Tax Simplification (OTS) in July asking for a review of capital gains tax (CGT) and aspects of the taxation of chargeable gains in relation to individuals and smaller businesses. This is a clear signpost that changes to CGT may be heading our way. What changes are we likely to see and what other areas of taxation will the Chancellor be thinking about?
Various reports have been published that shed light on how the tax system in the UK could develop and put forward suggestions for change. These include reports from the OTS and an All-Party Parliamentary Group (APPG) on inheritance tax, an independent review of wealth tax, and a Treasury Committee inquiry into ‘tax after coronavirus’.
Nobody knows what changes will be made or when they will be introduced; particularly given the impact tax rises could have on individuals and businesses during this very delicate and challenging time. It may, however, be an appropriate time for individuals and small businesses to consider how they may be affected by potential tax changes, and to start discussing this with their advisers. It would not be surprising to see some of these changes at the Autumn Budget.
CGT appears to be towards the top of the list and the Chancellor has asked for the review to identify areas where the present rules do not meet their policy intent. Proposals were specifically requested on the regime of allowances, exemptions, reliefs and the treatment of losses within CGT, and on how gains are taxed compared to other types of income. An increase in the rate of CGT would be an unsurprising outcome. Restrictions or reductions to reliefs could also be expected.
Given these potential changes, we are regularly asked what taxpayers should do now to put themselves in the best tax position. While actions should be driven by commercial factors, if you are looking to dispose of assets in the near future, some are considering whether or not those plans can be accelerated. This may lock in the current CGT rate, but may mean that tax is payable sooner. Bear in mind anti-forestalling rules could also be introduced to counter any such tax planning.
The interaction between IHT and CGT may also be scrutinised. The APPG report proposed radical IHT reform, including a lower flat rate of tax on lifetime and death transfers with virtually no reliefs available. There have also been calls for changes to the Potentially Exempt Transfer (PET) regime; either scrapping it completely or reducing the relevant period from 7 years to 5 years with no tapering. For some, this has prompted a review of succession planning or the acceleration of gifts to children.
The recently released ‘tax after coronavirus’ inquiry from the Treasury Select Committee further increases the likelihood of change. The inquiry will examine the entire tax system, given the need to reconstruct the economy after the economic fallout of the Coronavirus crisis. Further speculation on what may change is below. If you are considering how potential tax changes may impact you, please speak to your professional adviser to understand the full implications.
Increase in rate of CGT
CGT remains a very complex tax and generates very little for the exchequer; around £9 billion, or around 1% of the total tax take. It is also paid by a very small percentage of the population; fewer than 300,000 people paid CGT in 2017/18. Some are calling for CGT to be scrapped altogether; others for gains to be taxed at income tax rates. What does seem clear is that if the Government wishes for CGT to help fund the deficit, some significant changes would be needed for it to make a difference.
If the rates of CGT were aligned with those for income tax, an increase in tax revenues and simplification of the rules could be achieved. It may, however, affect reliefs such as business asset disposal relief and EMI schemes. Any increase in the rate of CGT may also run the risk of discouraging some entrepreneurs from starting their own businesses and generating growth and job creation.
Removing capital gains uplift on death
Generally, there is no CGT on death as the person inheriting an asset is treated as acquiring it at its market value on the date of death. This is known as the ‘capital gains uplift’. The APPG recommended the Government should consider removing the capital gains uplift and instead treat the recipient as acquiring the asset at the historic base cost of the person who has died. Their rationale is that the capital gains uplift can deter people from passing on assets to the next generation during their lifetime. This is especially the case where other IHT reliefs are available, such as Business Property Relief (BPR) or spouse exemption, which mean that the asset could pass to the next generation on death and be sold shortly afterwards without either CGT or IHT being payable.
Removal of the capital gains uplift would effectively counter some of the tax savings people may otherwise make if the rate of IHT is reduced; essentially a shift of some of the tax liability from IHT into CGT.
Changes to employee share schemes
The OTS report may consider issues arising from the boundary between income tax and capital gains tax in relation to employees.
It is possible that the OTS could consider changes to the taxation of “growth” or “flowering” shares. Broadly, these are shares of a special class that allow employees to invest a small amount in their employer company, or a group company, and realise capital gains if the company grows in value. Shares of this type generally have limited value on issue, so that employees can acquire the shares for low or nominal consideration without liabilities to income tax arising. However, the taxation of shares of this type has been considered by the Government in the relatively recent past and no change has been made.
A more radical change would be to align CGT rates with income tax rates for all share gains realised by employees or directors, save possibly for “Government-approved” employee incentives. This would have a significant effect on the tax treatment of share schemes.
If such changes are made, your employer solutions specialist can help you understand the implications and suggest alternative approaches that might be more suitable.
Restrictions on capital losses
It is currently possible to carry forward capital losses without restriction, to set against future capital gains. Although a generous aspect of the tax system, it can create issues relating to record keeping and valuations. If CGT rates are to increase, the value of any carried forward losses also increases. If restrictions are imposed to limit the period over which losses can be carried forward, taxpayers may be encouraged to make earlier disposals of other assets in order to utilise such brought forward losses.
Changes to incorporation relief
The OTS survey hints at some form of tax transparency and getting rid of double layers of tax. At the moment, relatively low rates of corporation tax make the use of companies for holding investments an attractive prospect. The investment returns are taxed at a low rate and the individual only suffers the potentially higher rates of income tax a dividend is taken.
One increasingly common scenario in recent times has been for those with property investments to transfer their properties into a company. By doing this, capital gains and rental income are subject to 19% corporation tax rather than as much as 28% and 45%, respectively, for personally-held property investments. Furthermore, a company can claim tax relief for all interest incurred on related borrowing, whereas tax relief for individual owners can be restricted.
A transfer of property into a company usually triggers a CGT charge where the properties are standing at a gain. However, where incorporation relief applies, there is no such CGT charge and the properties receive a capital gains uplift which generally results in a lower gain to be taxed on a subsequent sale by the company.
One option the Chancellor might consider is removing incorporation relief, especially for property investments and the like. This would discourage the use of companies for established individually held property portfolios, thus ensuring the revenue on returns is maximised through the application of personal tax rates. The government may also consider making certain companies tax transparent so that any gains arising within such companies are taxed on the individual shareholders as though they held the assets directly.
Changes to CGT on homes
For most taxpayers, the biggest gain they will ever realise is on their main residence. Currently, this is normally free from tax due to Private Residence Relief (PRR). After a recent review, the Government decided to keep PRR. Because of this recent review, and because and CGT on the sale of main residences would almost certainly disrupt the housing market for the majority of homeowners, our view is that PRR is more likely only to change than disappear.
Suggestions have included the time apportionment of gains subject to PRR, or relief up to a certain value. The relief could also be made simpler by removing the ability to nominate which property is a main residence, which can result in people “flipping” between properties to obtain relief on the sale of two properties. There are various complications with such suggestions. Given the inherent cash-flow issue with funding tax liabilities from the sale of a main residence, if changes result in more chargeable disposals, it may be that the tax due can only be collected at some future point, perhaps on death or if the homeowner downsizes and therefore releases cash.
One alternative option would be for the relief calculation to be based on the market value of the property at the relevant times. There would then be no CGT payable where a person moved out of a property, which had otherwise been the main residence at all times, and it fell in value before sale. This would be regardless of the length of time between leaving the property and sale and would deal with issues faced in a falling market.
Treatment of distributions on winding up
At the moment, where a company has served its purpose, it can be liquidated and, provided certain conditions are fulfilled, the remaining contents of the company can be extracted subject to lower rates of CGT rather than income tax; the rate of tax sometimes being as low as 10%.
Consequently, where a business owner does not require all of the profits of company to fund personal living expenses, there can be advantages to retaining the profits in the company and then extracting them at lower tax rates upon retirement by liquidating the company.
It is possible that such scenarios could be subject to review, perhaps with a restriction on the ability to qualify for CGT treatment rather than income tax treatment.
If rates of CGT are aligned with income tax rates, then the method of extraction from the company is of less relevance.
Changes to exemptions
There are certain assets that do not attract CGT, such as chattels sold for less than £6,000, vintage wine and classic cars. The OTS could make the case to remove these exemptions and simply state that any asset sold for a capital gain should be subject to taxation.
This might be an attractive option for HMRC, especially if some restrictions to how capital losses could be used or carried forward were also introduced.
Under the current regime, where an individual makes a gift of an asset standing at a gain to, say, a family member other than spouse or civil partner, there can be a CGT charge on the gain. In some circumstances, it is possible to ’holdover’ or defer that gain so that CGT is only payable on a subsequent disposal by the recipient. Specific elections need to be made and, as a holdover election may have been made many years before an actual disposal, the maintenance of historical records is vital and there can be significant complexity associated with such situations. As one of the objectives of the CGT review is to simplify, we may see some adjustments to this regime. Those considering making gifts of assets to which a holdover election may prove useful may consider accelerating their plans.
Radical changes to IHT regime
The APPG report called for the introduction of a ‘flat-rate gift tax’, which would replace the current IHT system’s multitude of reliefs and exemptions, such as Business Property Relief (“BPR”). These proposals would tax lifetime and death transfers of wealth at maybe 10% or 20%. Although this would be a major reform and possibly has a lower probability of being introduced, now more than ever, the Government has a reason to make significant changes. It Is possible we may see elements of the APPG’s suggestions being introduced sooner rather than later, such as changes to the ability to make Potentially Exempt Transfers, which avoid IHT if the donor survives by seven years.
The OTS scoping document also references aligning different definitions for similar transactions or events. For example, there are currently different tests used to define a business asset for the purposes of capital gains tax and inheritance tax. Could we see these aligned so that a number of companies and businesses cease to qualify for Business Property Relief?
Subject to investment decisions, thought might be given to accelerating planned disposals or gifts whilst the CGT rates are known and remain low. If the capital gains uplift also becomes unavailable, there is less incentive to defer making gifts.
It is essential to be alert to the fact that any action taken in anticipation of changes involves significant risk. For example, CGT rates may not change as you expected or action taken before the next Budget could be caught by a subsequent change.
What form any changes may take, and when they may be introduced, is of course unknown, but the possibility that all this focus on the tax system results in no changes seems remote. We should expect any new tax regime, understandably, to impose a higher burden on taxpayers than the current one. The costs of the Coronavirus pandemic will, after all, have to be paid for somehow.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of publication.