25 Sep Capital gains tax – Reform on the horizon?Read Time: 4 minutes
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With Chancellor Sunak facing a £300bn hole in the public finances due to a combination of the various Coronavirus support measures introduced earlier in the year and reduced tax inflows, speculation about how he will fund it is inevitably moving to consideration of the tax system. Governments only have two basic ways to raise money, taxation and borrowing.
It is worth noting that the latter is not currently unaffordably expensive and can be serviced, so it’s not an urgent issue and too much tax-raising at this stage could be dangerous to the nascent recovery. Still, in the longer term, measures to increase the tax haul look like a distinct possibility.
One of two questions that arose in a recent meeting with a trust client was whether further changes to capital gains tax might be in the offing. Although trusts pay tax at the same rates as a basic rate taxpayer, the value of gains that they are allowed to realise before paying it is lower, at between £6,150 and £1,230 depending on the number of trusts that the settlor created, so their concern was unsurprising.
The current situation
Data source: www.gov.uk
As the chart shows, CGT rates in the UK are currently at historic low levels – 10% for basic rate taxpayers and 20% for higher rate taxpayers, rising to 18 and 28% respectively for realised gains from residential property. CGT is currently subject to a review by the Office of Tax Simplification (OTS), although since the consultation does not close until 9th November there is still time to contribute suggestions. For a politician, an additional attraction of reform (particularly if it involves increasing the amount of tax received) is that a relatively small proportion of taxpayers (i.e. voters) actually pays much of it.
In 2018/19, under 1% of income taxpayers paid CGT at all and under 1% of those (fewer than 3,000 people, likely to be mainly people selling businesses or investment properties) paid it on gains in excess of £5m. Deducting those, and the 46,000 people who claimed entrepreneur’s relief on their £27.7bn of gains (an average of £600,000 each) leaves us with around £10bn of CGT being raised from 227,000 individuals, so around £4,400 each.
Of course the Chancellor has already made some changes to CGT in March, having reduced the limit for entrepreneur’s relief from £10m to £1m.
In any event, CGT only raised around £10bn in 2018/19. Half of that was paid by a mere 10,000 people. Given such a modest total, even doubling it is hardly going to make much of a dent in the deficit. Furthermore, CGT is paid in arrears in most cases, so gains realised in the current tax year will not bring in any revenue until January 2022. That assumes that there are many gains to be realised in 2020/21; based on the year to date, there is a good chance that the market impact of the pandemic will reduce the incidence of realised gains and thus the tax take on them. In fact the Office of Budget Responsibility is suggesting a reduction of around a quarter compared to the previous year.
Perhaps unsurprisingly, the concept of taxing ‘the wealthy’ more is popular with voters. Given the evidence of the small proportion which pays CGT, many of those in favour would seem to be justified in assuming that they would be unaffected by increases in it. It’s always more popular to increase taxes for someone else!
What could be changed?
One option would be to remove or reduce the uplifting of CGT base costs on death. This may encourage people to hold taxable assets as long as possible in the knowledge that what may be large gains will be effectively eliminated on death. However, unless accompanied by a mass culling of investors (likely to prove politically difficult in a democracy), it is something of a slow burn in terms of pulling in revenue. Still, with CGT and inheritance tax both subject to reviews by the OTS, there is scope for the two to be combined in some way.
Perhaps more likely is to return to taxing gains as an additional slice of income, as was originally introduced under Nigel Lawson and remained in place for another 20 years. If also made subject to national insurance contributions (there is a logical, if not necessarily popular, argument that as both are income taxes, they should be combined), it would reduce even further the distinction between capital and income.
The current CGT exemption (£12,300 in 2020/21) could also be either reduced or abolished. However, this would drag more people into self-assessment (often for relatively trivial gains which would be expensive to collect). Furthermore, in many cases they would be unaware of their liability, which could give rise to (unpopular) penalties for granny who’s “never filled out a tax return and just gave a few shares that she’s had for years to little Johnny for his birthday”.
In theory, there is always the option to tax gains on the principal private residence. However this is likely to be what the fictional Sir Humphrey Appleby would describe as ‘courageous’, quite apart from the impact on activity in the housing market after its complete suspension earlier in the year.
Is pre-emptive action worthwhile?
Tax changes are generally difficult to forecast accurately (reductions in the tax relief on pension contributions have been predicted in advance of just about every Budget I can recall). Governments must tread a fine line between collecting enough cash now to fund its expenditure plans and keeping the economy trundling along to sustain that in the longer term. At the same time they need to keep at least one eye on public (and party) opinion so that they can get the measures through parliament and – ideally – stay in power at the next election. Most tax changes result in winners and losers, even if in a relative sense, but with rises on the cards it may be more a case of minimising the loss of, rather than trying to win, votes.
While it may be tempting to seek to gain a short-term advantage by realising some gains at current rates, there is no guarantee that doing so will confer an advantage (and the opposite may apply). In the long term, the effect may be minimal anyway. Either way, tax is a poor starting point for planning an investment strategy – the most tax-efficient one only ever makes losses.
Next time I’ll consider the trustees’ second question, which is what wider impact the potential changes might have on the stockmarket.