Techzone

In the current climate it is unsurprising that the government is conducting a review of the tax system. In recent weeks we have seen the launch of a Treasury Select Committee inquiry into 'Tax after Coronavirus' and the commencement of an Office of Tax Simplification review of CGT.

In their call for evidence the OTS stated that CGT brought in £8.8 billion for the exchequer in 2017/18. While it is at the lower end in terms of a revenue earner, close scrutiny is still being given to the rates of tax paid, the range of exemptions,  allowances and reliefs currently available and the interaction with other taxes.

This review is in its early stages and the initial outcome is not expected until sometime in 2021. But this article should give you and your clients an understanding of the relevant areas which may be affected in the future.

Annual Allowance

The annual exemption allows chargeable gains up to £12,300 each year to be taken free of tax. This has the effect of taking many individuals with relatively modest gains out of the need to report or pay tax on them.

But it is also a very effective way of limiting the gains payable on an investment portfolio by ensuring sufficient gains are realised each year to utilise the allowance. It is currently worth up to £2,460 a year for a higher rate taxpayer. And if the exercise is repeated each tax year the tax savings can have a significant impact on the net investment return.

The OTS is looking to understand to what extent the annual exemption is used to reduce tax liabilities and if there is a simpler, more targeted way of exempting small gains.

Rate of capital gains tax

The OTS wish to explore options to simplify the multiple tax rates and whether there should be a difference in treatment between long term and short term gains.

How gains are taxed has changed considerably over time. The full gain (with no adjustment for inflation) is added on top of income to determine the rate of tax which will apply (currently 10% and 20% on non-residential assets and, 18% and 28% on residential property). In 2017/18 the average rate of CGT paid was 15% - well below the income tax rates.

Indexation allowance and taper relief are long gone - having previously been mechanisms to ensure only the gain above inflation was taxed. However, this was at a time when capital gains were taxed at the same rates as income tax.

Interaction with IHT

IHT and CGT are inextricably linked – on death if one of these taxes is chargeable then generally the other does not apply. When the OTS looked at this interaction last year in their review of IHT they concluded it was complex and could affect decision making particularly around how and when to pass on assets to future generations.

But they flagged that where assets benefit from business property relief (BPR), agricultural property relief (APR) or the spousal exemption then neither IHT nor CGT would be payable.

When someone dies, there's no capital gains tax charged on the assets they own, just IHT. The beneficiaries of the estate will acquire assets at market value at the date of death. This is commonly known as 'market uplift'.

The OTS recommended where IHT relief applied there should be no CGT market uplift. This would mean there's still no charge on death but, instead, assets would be transferred on a 'no gain, no loss' basis, similar to the treatment of lifetime transfers between spouses. That's to say that the beneficiaries will acquire the assets at the cost to the deceased.

But there are also situations where both IHT and CGT can apply to the same asset. For example, where someone gifts an asset in the seven years prior to death there will have been a disposal for CGT at the time of the gift, and on death the failed PET may result in IHT becoming due.

In this latest report the OTS are considering what effect the market uplift on death has upon decision making with regard to the timing of passing on wealth to the next generation.

Exemptions & Reliefs

The call for evidence also looks at the effectiveness of the range of exemptions and reliefs available. They are attempting to determine if these continue to meet their policy objective and aren't distorting behaviours.

One relief under the microscope is Entrepreneurs Relief (now known as Business Asset Disposal Relief). In his last Budget the Chancellor cut the lifetime limit on the amount of relief from £10m to £1m. But one area they are now investigating is whether the relief affects business decision making in terms of how much cash a business accumulates on its balance sheet.

Relief is restricted to trading businesses and not investment businesses. This means holding substantial cash and other investments could contribute to a company losing its 'trading' status. The test for entrepreneurs' relief is all or nothing. If cash and investments trigger a loss in relief it affects the full value of the business disposed of, not just the non-trading assets.

One interesting thing to note is that the OTS is exploring the possibility of extending the availability Gift Holdover Relief. This relief allows the donor to make gifts without triggering a disposal for CGT and any gain is deferred until the recipient of the gift disposes of the asset. The relief currently applies to gifts of business assets, including unquoted shares, and also where any asset is gifted to a 'relevant property trust' (i.e. discretionary trust).

The OTS is now is considering the merits of opening this relief up further to encourage the lifetime transfer of assets between generations without an immediate CGT charge. But they are looking to understand if this could lead to possible tax avoidance opportunities.

Losses

Any capital losses on disposal of an asset can be carried forward indefinitely to be offset against future capital gains. However, these losses must be claimed within four years from the end of the tax year which the loss occurred.

The OTS is interested in views on the timescales required to bank losses and also on record keeping issues which can arise. But also whether the current loss regime influences decisions on when investors buy and sell assets.

Summary

The government has commissioned this research but is not obliged to take on any of the recommendations from any subsequent OTS report. It does, however, show how thinking on future legislation may be influenced.