In July 2020, the Chancellor asked the Office of Tax Simplification (OTS) to carry out a review of capital gains tax (CGT), to ‘identify opportunities relating to administrative and technical issues as well as areas where the present rules can distort behaviour or do not meet their policy intent’.
Given the wide scope of the review, the OTS will produce two reports. The first report was published on 11 November and covers the policy design and principles underpinning the tax; the second, which will follow early next year, will explore key technical and administrative issues.
The main thrust of the report is to highlight many features of CGT which can distort behaviour, including its boundary with income tax and interconnections with inheritance tax (IHT).
- The Government should either consider (i) aligning the CGT rates with income tax OUCH (as it has been in the past) or (ii) deal with the “boundary issues between CGT and income tax
- If there is to be alignment with income tax rates i.e. taxing capital gains in the same way as income, then there should also be some measures to deal with (i.e. not tax) inflationary gains, e.g. re-introduction of indexation relief
- If the CGT rates are not aligned to income tax then there should be fewer rates. And, with no reliance on the taxpayer’s income in determining what the rate should be, measures should be introduced to prevent the disparity in treatment between capital gains and income. In particular, they should consider: whether employees and owner-managers’ rewards from personal labour (as distinct from capital investment) are treated consistently; and taxing more of the share-based rewards arising from employment and more of the accumulated retained earnings in smaller companies, at income tax rates. Currently, of course, SME owners can build up cash in their businesses and, on sale or liquidation, extract funds subject only to lower rates of CGT.
Entrepreneur’s Relief (re-named Business Asset Disposal Relief in this year’s Finance Act) was reviewed in the Budget of March 11 this year and the cumulative limit for disposals qualifying for the relief was reduced from £10m to £1m. The excess is then taxed at typically 20% – the current higher rate for CGT on the sale of business assets. (if linked to income tax this could rise to 45%. The OTS has put forward a challenge to the appropriateness of the relief in its current format. They believe that there is a policy judgement for Government to make about the extent to which CGT reliefs on disposal should be used to seek to stimulate business investment and risk-taking.
The OTS considers that Business Asset Disposal Relief is mistargeted if stimulation of risk taking is its objective. It seems that several respondents told the OTS that the rate of tax on an eventual disposal of an investment is an ineffective incentive, and that incentives for investment, if required, should apply at the time the investment decision is made. This is an idea that has had some “airtime” in the professional press.
The OTS (doing its “history “) note that Business Asset Disposal Relief and its predecessors have also long been understood as having another objective – as a specific relief when business owners retire. This was originally in recognition that a person’s business can be an alternative to a pension, representing many years of constant reinvestment. In the past, “Retirement Relief” was a recognition of this.
If this were the objective, the Government could, alongside having regard to the wider objectives of the pension system, consider:
- increasing the minimum shareholding to perhaps 25%, so that the relief goes to owner-managers rather than to a broader class of employees;
- increasing the qualifying holding period to perhaps 10 years, to ensure the relief only goes to people who have built up their businesses over time; and/or
- reintroducing an age limit, perhaps linked to the age limits in pension freedoms, to reflect the intention that it mainly benefits those who are retiring.
The OTS also recommended that the Government should abolish Investors’ Relief.
Accepting the economic impact of Covid has to be paid for, and admitting to self-interest, this could be a massive kick in the teeth for business owners seeking to sell, with much of their value as a result hard work in building their businesses going to the Exchequer.
Credit : Techlink