Britain’s wealthiest taxpayers could be in for a multi-billion-pound tax raid after the Government’s tax gurus recommended a major overhaul of capital gains tax.
In July, the Office of Tax Simplification was tasked by Chancellor Rishi Sunak to look at whether the levy on asset sales was ‘fit for purpose’ and how it could be simplified.
This week, the OTS published its report, which among other things has called for an increase in capital gains tax so that it is in line with income tax rates and for a massive reduction in the annual tax allowance.
The moves could more than double the amount of people who pay the tax, and mean massive hikes for higher earners.
Here, we look at the new report’s suggestions, how they could affect you and how to protect yourself from a possible raid.
Raid on the wealthy? Chancellor Rishi Sunak desperately wants to raise funds after spending billions in the wake of the pandemic
What is capital gains tax?
It is a tax on the profit of an item sold that has increased in value. It’s the gain that’s taxed, not the amount of money received.
So CGT is levied on gains made from the sale of second homes (but not main residences), inherited properties, shares and investment funds – although the rate charged depends on the asset being sold and whether the seller is a basic, higher or additional rate taxpayer.
On shares, the rate is 10 per cent for basic rate taxpayers and 20 per cent for higher rate and additional rate taxpayers. On sales of second homes, the respective rates are 18 per cent and 28 per cent.
Capital gains on such assets are traditionally taxed at lower levels than income because people are taking a risk – whether an entrepreneurial one, or via their investments.
But there is a vast array of rules and exemptions underlying the system, which has created all sorts of loopholes and incentives that weren’t originally intended by the Government. For example, lottery wins, classic cars and vintage wine are exempt from CGT.
In the current financial year ending on 5 April 2021, the annual exempt amount is £12,300 because of the so-called capital gains tax allowance – which could be lowered under the new proposals.
Who pays it at the moment?
At the moment, it is almost exclusively paid by older, wealthier households, who own assets and properties.
According to the OTS, 97 per cent of CGT tax revenue is paid by over-35s, with most people caught by the tax in their 50s and 60s.
CGT vs income tax: The OTS has called for an increase in capital gains tax so that it is in line with income tax rates
Why is the government looking to it for more revenue?
It desperately wants to raise funds after spending billions of pounds in the wake of the pandemic.
The UK is facing an estimated annual bill of more than £300billion to cover the cost of Government measures, such as the furlough scheme, implemented to help Britain through the recession caused by the coronavirus pandemic.
In light of this, in July the Chancellor asked the OTS, an independent arm of the Treasury, to identify opportunities to simplify capital gains tax in relation to individuals and small businesses.
Rachael Griffin, tax and financial planning expert at Quilter, said the report was produced faster than usual – a sign that a change to CGT is on the cards as the Government looks to counteract the escalating deficit caused by the pandemic.
‘The appeal of changing CGT is clear – only a relatively small number of people pay it,’ she says.
‘Statistics show that over the course of a decade around 1.5million people reported taxable gains, far lower than the numbers paying the biggest taxes like income tax and national insurance. It means the tax can be reformed in order to squeeze asset owners, shareholders and landlords without impacting the majority of people.’
Distortion: Many CGT payers offload assets like shares to ensure they are just under the exempt limit every year
What was in the proposals released this week?
The OTS has suggested a package of reforms in its 135-page report, mostly aimed a simplifying the levy. Here are the main recommendations.
Aligning CGT and income tax: The OTS is proposing to bring CGT in line with income tax, a move which has been talked about for some time and was in Labour’s 2019 election manifesto.
Hiking CGT to match income tax would mean big hikes for higher earners and smaller increases for basic rate taxpayers.
The move could see the tax rate on capital gains rocket from the current 20 per cent on investments such as shares and investment funds to 40 per cent for higher rate taxpayers.
For basic rate taxpayers it would double from 10 per cent to 20 per cent, hitting those with investments held to fund retirement outside of pensions.
On second home and buy-to-let sales, the tax rate would rise from the current 28 per cent to 40 per cent for higher rate tax payers. Basic rate taxpayers would see the rate on residential property that isn’t their main home rise from 18 to 20 per cent.
Those paying the highest 45 per cent rate of tax would see capital gains tax climb to this level.
But the OTS also suggests that there should be two rates of CGT, rather than four, and that these should not be linked to income tax, as taxpayers ‘cannot know their liability to capital gains tax on a particular disposal until they know their total income for that tax year’.
Tax on asset sales: Officials have floated a cut in the annual exempt amount from £12,300 to £2,000
Lowering exempt allowance: The OTS proposes reducing the current ‘relatively high’ £12,300 annual tax-free allowance to as low as £2,000, resulting in more people being taxed.
Their view is that while small gains should still be exempt in order to avoid administrative hassle for the sake of a minor bill, the current allowance results in too many profits being tax-free.
The number of taxpayers that would pay CGT could almost triple if the personal allowance is reduced to £1,000, and double if it is reduced to £5,000.
Labour had also proposed to slash the annual exempt CGT allowance to £1,000, if it had won the last election.
Rachael Griffin of Quilter points out that in their new proposals, tax gurus have not acknowledged assets that are free of CGT such as lottery wins, classic cars and vintage wine.
‘This may raise some eyebrows as they seem like easy areas to target the wealthy if that is indeed the government’s goal,’ she added.
Ending the death ‘uplift’: The OTS is proposing to scrap this – having already recommended getting rid of it in a review of inheritance tax.
The ‘uplift’ means someone inheriting an asset is treated as acquiring it at its market value on the date of death, rather than the amount it was bought for. This means the beneficiary can sell it shortly after the death without paying CGT.
If the asset is a farm or business, and therefore exempted or relieved from inheritance tax, it can be sold without that being due either.
But the OTS is recommending that ‘a taxpayer should not get both an inheritance tax exemption and a capital gains tax death uplift’.
It also recognises that the ‘uplift’ means that people are often holding onto assets until they die for the tax benefits.
‘Removing or limiting this relief could be seen as a way to encourage wealth transfers to happen earlier, as well as raising significant funds,’ Griffin said.
However, she also warned that such changes could have far reaching consequences.
‘One of the biggest challenges of tinkering with the CGT system is its interaction with several other parts of the tax system, in particular inheritance tax, so many changes can be complex and have knock-on consequences for other parts of the tax system,’ Griffin said.
Scrapping the business asset disposal relief: The OTS said the Government should consider replacing this tax relief aimed at ‘stimulating business investment’ with a relief more focused on retirement as it found that it was an ‘ineffective’ incentive.
It proposes instead to create a new, as yet unspecified, relief more targeted at those who plan to use their business to fund their retirement. The OTS also said investors’ relief should be abolished.
Who would be hit in a new CGT regime?
Landlords, savers and entrepreneurs could be in the firing line if the Chancellor follows through on the recommendations.
Tom Selby, senior analyst at AJ Bell, says: ‘Landlords would be among the biggest losers from a CGT hike, as second properties are subject to CGT when they are sold. The same would be true for anyone who wants to sell a holiday home.
‘Because second homes can’t be held in a pension or Isa and are difficult to sell in small chunks to take advantage of the annual exemption, a disposal is more likely to generate a significant CGT bill.’
As we’ve seen, the paper could also pave the way for a CGT raid on those who inherit assets if the Government scraps the ‘uplift’.
Selby said: ‘If the Chancellor were to shift the base cost to the original purchase price, this would inevitably pull more people into the CGT net.’
Plans to scrap the business asset disposal relief could potentially hit entrepreneurs, who are currently able to pay tax at just 10 per cent on all gains on qualifying assets.
Selby adds: ‘People who use Save As You Earn schemes – which are designed to help employees buy shares in the company they work for – could also be negatively affected, particularly if they plan to cash in large chunks of shares.’
How to protect yourself against a CGT raid
Use your allowances: Saving in a pension or Isa are the most common ways to build up a pot of money while keeping it sheltered from the taxman.
Your Isa allowance is £20,000 per year, and if you have investments any assets in Isas are exempt from CGT, so you should ensure these are fully funded each year.
‘Both (pension and Isa) benefit from tax-free investment growth, with pensions offering tax relief on contributions and 25 per cent tax-free cash from age 55 (rising to 57 in 2028),’ Selby says.
‘Pensions are also free from inheritance tax and can be passed on tax-free to your nominated beneficiaries if you die before your 75th birthday,’ he adds.
Keep a note of your losses: If you have suffered any losses with any assets, make sure HM Revenue & Customs are aware.
‘Any capital losses that you have ever made can be carried forward and offset against any gains, but this isn’t an automatic process,’ says Graeme Dreghorn, financial planner at Charles Stanley.
Transfer assets between spouses: Spousal transfers are free of CGT.
‘If you are married or in a civil partnership and have assets with a large profit, transferring or sharing ownership of an asset you are going to sell can be a good idea so that both allowances can be used,’ says Dreghorn.
Donate to charity: If you are planning to leave a legacy to a charity you could consider gifting the assets now, as these do not incur CGT.
‘Transfers to a charity are free of CGT, so gifting the assets promptly not only gives charities a benefit at a time when the third sector is struggling because of the implications of the pandemic, it also reduces your tax burden,’ says Dreghorn.
Understand where you have gains and plan accordingly: Make sure you have a clear picture of any assets that are liable to CGT.
‘If you have a rental property you are thinking about selling in the future, and money to invest now, consider investments that aren’t taxed against CGT, such as Isa, pensions and bonds,’ says Dreghorn.
Time your disposals: ‘If you need to sell, if you can try to spread sales across tax years, this will double up the exemption allowance used. When done across a couple, for jointly owned assets, this quadruples the allowance,’ says Dreghorn.