The Office of Tax Simplification (OTS) has published its first report following its review of certain aspects of the UK’s capital gains tax regime requested by the Chancellor in July this year with the specific purpose of identifying opportunities relating to technical and administrative issues as well as areas where the present rules can distort behaviour or do not meet their policy intent. This report is the first of two. The second will focus on key technical and administrative issues and is expected to follow early in 2021. The report contains a number of recommendations for the government to consider.
The report makes a number of recommendations to the government, including:
- Aligning the capital gains tax and income tax rates more closely, since the OTS considers that the current disparity can distort decision-making, delay business sales for tax-motivated reasons and create an incentive for taxpayers to arrange their affairs in ways to try to recharacterise income as capital gains. In connection with this, the OTS recommends that the government considers reintroducing reliefs for inflationary gains and allowing more flexibility in the use of capital losses, as well as looking at how such changes will interact with taxation of capital gains for companies.
- Alternatively, if the capital gains tax and income tax rates are not more closely aligned:
- looking to reduce the number of “boundary issues” between capital gains and income. Specifically, the report examines rewards from personal labour as the driver behind capital growth in the value of an asset (or a business) and whether such amounts are taxed consistently. The report places particular focus on the question of whether more employee share-based rewards should be taxed at income tax rates; and
- considering reducing the number of capital gains tax rates from four to two (the four existing because of the higher rates applied to certain gains). The report does not expressly set out which rates might be abolished, but the context suggests that the two basic rates might be removed.
- Reducing the annual exempt amount to ensure that it operates effectively as an “administrative de minimis” rather than as a form of relief.
- Removing the capital gains uplift on death and instead providing that the recipient is treated as acquiring the relevant assets at the historic base cost of the deceased. This particular recommendation relates to the interaction between capital gains tax and inheritance tax and how it can mean that business owners are encouraged to hold onto their businesses until death rather than selling them (something also raised in the OTS inheritance tax report from July 2019).
- Considering how effective certain reliefs are, including Business Asset Disposal Relief (previously known as Entrepreneurs’ Relief) and Investors’ Relief and whether such reliefs should be amended and/or abolished.
While the report can be considered a part of the government’s and OTS’s long running process of reviewing the UK’s tax system, the particular discrepancy between capital gains tax and income tax rates for individuals and the government’s likely focus on ways to fill the hole in public finances caused by the ongoing Covid-19 pandemic mean that certain recommendations that could lead to increasing the tax take (rather than, say, just simplifying and focusing the capital gains tax regime) might be attractive and lead to change. Having said this, the publication of this initial report gives little insight into the reality of any future changes to the capital gains tax regime in the UK as the government must now review the OTS’s input, wait for its further recommendations and consider which, if any, of its recommendations it will look to implement. Any proposal to make changes to the rules would then be likely to be subject to a detailed consultation process.
The sensitivity of making wholesale changes to the capital gains tax regime is highlighted by the immediate response of Lord Leigh of Hurley, senior treasurer of the Conservative Party (and a senior partner at Cavendish Corporate Finance), who is reported to have said that “Proposals to simplify tax by equating income and capital don’t reflect the differences between the two. Capital gains are rewards for a risk taken by investing in an asset which might become worthless. Income involves no risk at all. If you want people to move from a comfortable salary to invest in a new business, take a risk, employ people, as I did, they have to feel that tax on any success reflects that risk”. Other commentators have warned against increasing tax rates with the effect of discouraging business development, employment and so, ultimately, the overall tax take to the Exchequer.