In July 2020, the Chancellor asked the Office of Tax Simplification to investigate Capital Gains Tax and to ‘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’.
Simplifying by design is the first of two reports to be produced by OTS and sets out recommendations to help the government to consider simplifying the design of CGT and make the tax easier to understand and predict, across four areas:
- Rates and boundaries
- The annual exempt amount
- Interaction with lifetime gifts and Inheritance Tax
- Business reliefs
The second report next year will further explore technical and administrative issues.
This CPD article intends to summarise the current position and outline the key findings and eleven recommendations of the OTS under each of the four areas above.
Headlines and commentary
The immediate press coverage has been around a “CGT raid” with rates quoted as doubling.
While the Treasury has confirmed “the government’s priority right now is supporting jobs and the economy…” the report does raise some interesting, if not radical, talking points with the potential to raise revenues over the long term.
It is important to remember that although the OTS were requested to carry out this work by the Chancellor, there is no obligation for this, or any other, government to make changes based on the recommendations.
The report seeks to fulfil its commission by highlighting how the present position distorts behaviour or makes things complex in practice and by providing potential solutions for the government to consider once they have decided on a direction for policy.
Areas of review and recommendations
1) Rates and boundaries
The rate of CGT that applies to a gain depends on the level of the individual’s taxable income and the type of asset that has been sold or gifted.
The below table compares the current tax rates for income and gains above the respective personal allowance and annual exempt amount.
Income tax status | Income tax rate | Standard CGT rate | Residential property CGT rate | Business Asset Disposal/ Investor’s Relief rates |
Basic rate | 20% | 10% | 18% | 10% |
Higher rates | 40%/45% | 20% | 28% | 10% |
The report tells us that CGT raises £8.3bn a year from 265,000 people with an average (mean) liability to tax of £32,000. Although income tax raises 20 times as much revenue (£180bn per year) than CGT, the mean tax liability per taxpayer is more than five times less, at £5,800.
The OTS believes that the difference between the rates of tax on income and capital gains can distort decision-making and can create an incentive for families and businesses to arrange their affairs so that income can be classed as capital gains and accordingly taxed at lower rates.
They also believe that the boundary between income and capital gains is under pressure from the use of share-based remuneration and the accumulation of retained earnings in smaller owner-managed companies.
So the direction of travel depends on what the government wants to achieve with the tax policy itself and any potential simplification. Does it want to change the behaviour of people and businesses? Or make the tax and any potential liability easier for taxpayers to understand and predict?
OTS Recommendations
- If the government wants simplification to reduce any distortions in behaviour, the OTS recommends it consider
- aligning the rates of CGT and income tax; or
- addressing boundary issues between the two
If rates were more closely aligned, it would greatly reduce the need for complex rules to monitor the boundary between income and capital gains as the way ‘income’ is classified would not have such an effect on its tax position.
