CGT Reform: What could it mean for rates and exemptions?

4 min read 2 Mar 21

Capital gains tax has just seen the biggest independent review in its history. In a two-part series, our M&G colleague Les Cameron, Head of Technical at Prudential, assesses what changes could be on the horizon, starting here with tax rates and boundaries, and the annual exempt amount.

In July 2020, Chancellor Rishi Sunak asked the independent Office for Tax Simplification (OTS) to undertake a review of capital gains tax (CGT) as it applies to individuals and smaller businesses.

Sunak asked for the review to advise on opportunities to simplify the CGT regime – especially where the current rules can distort behaviour. Following calls for evidence, the OTS published its first report reviewing the key principles of CGT in November 2020. A second report this year will explore technical and administrative issues.

OTS recommendations are only advisory. But with around 50% of its recommendations having been adopted by government in the past, it’s important to know what could be in store. In a two-part series, we look at what’s being explored – starting here with CGT rates and boundaries, and the annual exempt amount.

What did the OTS say on rates and boundaries?

One persistent criticism of CGT is that there are different rates of tax for different types of gain, all of which are lower than the equivalent standard rates of income tax – see box.

Income Tax rates vs Capital Gain Tax rates
  Basic Rate Higher Rate Additional Rate
Income Tax 20% 20% 20%
Investment gains 10% 10% 10%
Property gains* 18% 18% 18%
Business gains 10% 10% 10%
*i.e. on property not designated as a main residence

That creates complexity – but, says the OTS, it also creates distortion. The lower rates of CGT incentivise taxpayers to look for ways to turn what would otherwise be income into gains – for example, using share-based remuneration schemes.

The OTS also found that capital gains fall on a relatively small number of taxpayers, who benefit where others do not. If there were greater alignment between income tax and capital gains tax rates, the OTS suggests, there would be less incentive to “turn income into gains”. In turn, there would be less need for complex anti-avoidance rules to police the boundary between the two taxes.

The OTS made four recommendations in this area in its first report. One aspect – “consider more closely aligning Capital Gains Tax rates with Income Tax rates” – was inevitably the headline grabber.

Our thoughts

  • The boundary between income tax and capital gains tax was a key focus of the OTS report. The area where the boundary is most under pressure is around share-based remuneration schemes and the accumulation of earnings in owner-managed companies.
  • Government may well therefore adopt some highly targeted measures to deal with these specific issues but avoid alignment of income tax and CGT rates, which would have a widespread impact on many.
  • In particular, aligning tax rates would not be welcomed by those selling businesses and would make property investing less attractive – another tax nail in the ‘buy-to-let is a better bet for retirement than a pension’ coffin?

And what about the Annual Exempt Amount?

The Annual Exempt Amount (AEA) for capital gains tax can be variously viewed as a de minimis amount to reduce the tax administration burden, a relief akin to the personal allowance for income, or a simple way to allow for a bit of inflation-proofing.

At £12,300 for 2020/21, many consider the AEA to be too high and therefore operating more like a tax relief than an administrative de minimis. Indeed, the OTS notes that in 2017/18 approximately 50,000 individuals reported net gains just below the AEA threshold. That clearly shows that the AEA influences investors’ decision-making (or good tax planning if you’re a planner!).

The OTS has recommended reducing the level of the AEA. But it is acknowledged that a reduction would bring more people into the tax system and therefore create greater administration. It’s been estimated that the number of CGT payers in 2021/22 would double if the AEA were reduced to £5,000 and triple if the AEA was £1,000.

If the government were to reduce the AEA, the OTS makes further recommendations to deal with the increased numbers of taxpayers that would result – specifically:

  • amend the chattels regime to reduce the amount of asset types that are subject to CGT.
  • ensuring the CGT regime operates in “real time” with gains fed into personal tax accounts.
  • ask asset managers to calculate and report gains to Individuals and HMRC, to make tax reporting easier.

Our thoughts

Asking managers to report gains – akin to the insurance bond chargeable event regime – would be welcomed by clients and planners but perhaps not so much by asset managers!

  • It would be interesting to see how much pushback such a move would elicit from asset managers – or how platforms could be harnessed to facilitate reporting.
  • If the AEA is reduced, it will also be interesting to see to what extent investors simply reduce their withdrawals to remain within the lowered allowance.
  • If the AEA remains as is but the recommendation to align income tax and CGT rates is implemented, many investors would largely be unaffected as they could continue to buy and sell investments within their annual exemption.

Coming soon - Part Two: CGT Reform: What could it mean for inheritance tax and business relief?