Are big changes afoot for capital gains tax?

Significant changes to capital gains tax could be in the pipeline next spring, following a report from the Office for Tax Simplification (OTS).

Chancellor Rishi Sunak commissioned the report back in July 2020, asking the OTS to consider the scope of the tax and the rates which apply as well as the reliefs, exemptions and allowances.

The Chancellor is looking for ways to claw back a £210 billion hole in public finances after loosening the purse strings to protect jobs and businesses amid the COVID-19 pandemic this year. Sunak is, however, under no obligation to accept the recommendations.

Capital gains tax in the UK is currently charged at 10% and 20% for most taxable assets, or 18% and 28% for residential property that is not a main home.

The levy raised more than £9.5bn for the Treasury in 2018/19, and is on course to fetch roughly the same figure in 2019/20, but the OTS suggested ways that could triple the number of people liable for the tax.

Align capital gains tax with income tax rates

The current capital gains tax rates are lower than the 2020/21 income tax rates around the UK. Income tax in England, Northern Ireland and Wales is charged at rates of 20%, 40% and 45%, with different rates and bands applying in Scotland.

“This disparity is one of the main sources of complexity”, the report found, often “distorting business and family decision-making and creating a tax incentive for people to recharacterise income and capital gains”.

The OTS suggested aligning capital gains tax rates with income tax rates could raise an estimated £14bn a year for the Treasury, with higher and additional-rate taxpayers footing most of the bill.

More than 275,000 people paid capital gains tax in 2018/19, with 40% of those payments coming from wealthy individuals who made gains of £5 million or more.

Cutting the tax-free allowance

The report also recommended slashing the annual capital gains tax-free allowance – £12,300 in 2020/21 – and replacing it so that it only covers asset price increases that are equivalent to inflation.

This threshold is expected to increase to £12,500 for 2021/22 as things stand, but a reduction from next year’s figure to £12,000 is estimated to affect around 50,000 taxpayers who reported net gains close to the threshold and effectively used up the allowance.

The OTS said lowering this allowance to £5,000 would double the amount of people who pay capital gains tax, while reducing it to £1,000 would almost treble the number of taxpayers.

Should the Chancellor drastically lower the annual capital gains tax-free allowance, many more people would have to file annual personal tax returns through self-assessment.

Capital transfers

The report also highlighted a “practical overlap” between capital gains tax and inheritance tax – “as most of the assets liable for capital gains tax can also attract inheritance tax”.

For example, if someone inherits a £300,000 investment portfolio which was once £90,000, the £210,000 gain is wiped and the £300,000 figure used as the base value if they then go on to sell the portfolio.

To go some way to rectify this, the report urged the Treasury to remove this capital gains ‘uplift’ on death and instead treat the inherited assets at the historic base cost of the asset.

Steps to consider now

The subliminal message from the OTS is pretty clear: use your allowances before 5 April 2021 or potentially lose them for good, but it would be unwise to act solely on policy conjecture.

Due to the financial effects of the virus, we know tax changes are afoot and it is worthwhile to review any assets, in light of what will inevitably be a harsher tax environment in the future.

Speak to us about capital gains tax.