How Capital Gains Tax Could Evolve After Covid

The Office of Tax Simplification put forward a number of proposals in November 2020, although changes to the tax system were limited in the 2021 Budget. The government have kept their options open however, with reviews of CGT (and other aspects of the tax system) firmly on the table as part of a future Finance Bill.

Capital Gains Tax (CGT) is one area that may be due for an overhaul in the near future, with the aim of increasing tax revenue.

A Brief Guide to Capital Gains Tax
CGT applies if you dispose of an asset that has increased in value since you acquired it. This is the case whether you sell the asset, give it away, or sell it to a relative or friend for less than it is worth.

CGT works as follows:

• The gain is calculated as the disposal proceeds minus the acquisition cost. The costs can also include any fees, charges, or commissions incurred in the sale. Individuals have an annual exemption of £12,300 for 2021/2022. Gains are only taxed if they are above this exemption.
• For most assets, the rate of tax is 10% for basic rate taxpayers and 20% for higher/additional rate taxpayers.
• Property disposals (other than your main residence) are charged at 18% (basic rate) or 28% (higher rate).
• The gain is added to your other income to determine which rate you should pay.
• Gifts between spouses are ignored for CGT purposes. This means that if you transfer an asset into joint names, you can make use of both annual exemptions.

Part of the problem with CGT is that it is a transactional tax. You can avoid it by simply not selling assets. This means a careful balance needs to be struck between increasing revenue, and keeping the rates at a palatable level so that investors don’t aim to avoid it altogether.

Aligning CGT Rates with Income Tax
One of the proposals involves aligning the tax rates with the income tax system. For example:

• 20% for basic rate taxpayers
• 40% for higher rate taxpayers
• 45% for additional rate taxpayers

The rate of CGT has historically been higher than it is now, and closer to the rates of income tax. The current rates were only introduced in 2016 (with the previous, higher rates being retained for property investments) to encourage investors to buy shares rather than property.

Prior to 2008, CGT rates were in line with income tax rates, so there is certainly a precedent for this.

Reducing Exemptions
At the moment, you can realise gains of up to £12,300 without paying tax or declaring the gain on your tax return.

One method of increasing tax revenues could be to reduce this exemption. A reduction of between £2,000 and £4,000 has been suggested.

This could increase tax revenues on a single disposal by up to £1,120.

Removing Reliefs
There are a number of reliefs available when calculating your CGT liability. For example:

• Private residence relief allows CGT to be avoided when selling your main home. This can be applied to any property you previously lived in, proportionate to your period of residence.
• Spouses can transfer assets to each other without CGT implications.
• CGT can be deferred by reinvesting disposal proceeds in Enterprise Investment Schemes.
• Entrepreneur’s Relief allows business owners to pay CGT of 10% on lifetime gains of up to £1 million when disposing of business assets. This has already been subject to a reduction, as prior to the 2020 Budget the limit was £10 million.
• Hold-over Relief means that no tax is charged on disposal, but the new owner inherits the original acquisition cost from the previous owner. This does not reduce the tax payable, but can defer it indefinitely. This relief is only available in respect of business assets or certain types of trust.
• No CGT is charged on gifts of assets to charity. Any gains realised are usually tax-free in the hands of the charity.
• Any of these reliefs could be removed in the future.

Taxation of Estates
When someone dies, their estate may be subject to Inheritance Tax (IHT). But any capital gains on their assets are effectively wiped out. The estate, and subsequently their beneficiaries, receive the assets with a new base cost, equivalent to the value at the date of death. Gains are only taxable if the assets rise in value after death, prior to being sold.

IHT only applies on estates over £325,000. Couples who are eligible for the Residence Nil Rate Band have an exemption of up to £1 million to set against their joint estate. This means that the majority of estates will avoid IHT altogether.

Removing the CGT uplift on death would not only increase the tax on larger estates. It would also be likely to catch more modest estates, as plenty of people have investments and property, but not all are millionaires.

What Can You Do?
The tax system changes all the time. This is something we have no control over. But there are always things you can do to make your own tax affairs more efficient. For example:

• Make use of your ISA allowance. Any gains realised on your ISA are tax-free.
• Contribute to your pension. You will receive tax relief on contributions and the funds will grow free of most taxes.
• Investment bonds are not free of tax, and are currently subject to higher tax rates than shares or investment accounts. But a bond allows you to withdraw 5% of your original capital without immediate tax liability. Tax only applies if you fully or partially encash the bond. This can make it easier to control if and when the tax is incurred.
• Use your annual exemption (£12,300). You cannot carry this forward, so by generating smaller gains each year, you can avoid large gains accumulating in future years.
• If you need to sell an asset, it can be worth splitting the asset with your spouse and phasing the sale over more than one tax year.
• Check which reliefs are available before you sell an asset.

It’s unlikely that you will be able to avoid tax altogether. But a good financial plan will aim to minimise tax, evolve when legislation changes, and bring you closer to your goals.

Please don’t hesitate to contact a member of the team to find out more about tax planning.

 ¹ The budget deficit: a short guide - House of Commons Library (parliament.uk)