CGT: is a change on the horizon?

Capital gains tax: what changes might be coming?

Governments of every stripe feel the need to meddle in our tax system at regular intervals but the biggest changes are often focussed on the taxes that generate relatively little.  The ‘big four’ taxes (income tax, national insurance, VAT and corporation tax) seem to have reached a point where the overall scheme is reasonably settled.  Governments may tinker with the rates and allowances but the principles unpinning these taxes rarely see any significant revisions.  It is taxes such as capital gains tax (or ‘CGT’) that have seen the biggest changes in the rules over the years.

Capital gains tax remains in the limelight in view of recent comments made by well known politicians, which seem to indicate that another rule change could be on the cards.  If you look at the history of capital gains tax, this would seem to make sense:

1965 – Capital gains tax was introduced; if taxpayers could convert income into gains they could avoid tax entirely on the gains until this point.

1982 – Indexation allowance was introduced to give relief against gains made purely because of inflation

1988 – The rate of capital gains tax was aligned with the income tax rate, and rebasing of assets to their value in 1982 was introduced.

1998 – indexation allowance was scrapped (for individuals) and the rate of tax was no longer linked to the income tax rate; instead, ‘taper relief’ gave a reduction in the rate of tax the longer the asset had been held.

2008 – taper relief was abolished and a flat rate of capital gains tax was introduced along with a special rate for business assets (dubbed ‘entrepreneur’s relief’).

On average, until 2008, quite significant changes happened approximately every ten years.  Since 2008 there have been a number of changes to the rates at which capital gains tax is charged, and also some changes to entrepreneur’s relief (which is now called business asset disposal relief) but no significant changes to the basis for calculating the tax.  Based on the history of the tax, a more fundamental change might be overdue.

What changes might we see?

As Chancellor, Rishi Sunak requested a review of CGT by the Office of Tax Simplification in July 2020.  There were four main recommendations in their reports:

Rates – there should be less of a discrepancy between CGT and income tax rates; either the rates should be aligned (and indexation relief reintroduced) or other measures taken to reduce the discrepancy.

Annual exemption – in addition to aligning the rates, the annual exemption should be reduced.

Interaction with inheritance tax – the ‘rebasing’ of assets on death should not apply to assets that have not suffered an inheritance tax charge (e.g. because they pass to a spouse).

Business relief – relief for disposal of business assets should be more focussed on business owners who are retiring e.g. by specifying a minimum age to qualify for relief.

Of these four recommendations, only one (the reduction in the annual exemption) has been implemented to date.

Governments appear to have learned that announcing a fundamental tax change on Budget Day, to take effect immediately, is not the way a responsible government should act.  It is far better to have a proper period of consultation, so that the changes are properly thought out, and to avoid having to make embarrassing U-turns at a later date. Accordingly, any fundamental changes to CGT are likely to be announced some time in advance.

Plus ca change, plus c’est la meme chose

Since the reason for the introduction of CGT in the first place was to remove the incentive for people to make gains instead of receiving income, it clearly makes sense for gains to be taxed at a rate that is close to the income tax rate, assuming relief is also given for inflation.  The removal of indexation relief, and the introduction of taper relief, by Gordon Brown as Chancellor in 1998, was justified in part as a simplification measure.  It was not always easy to calculate the correct amount of indexation relief, particularly for share disposals, where there was a substantial history of acquisitions and part disposals over a lengthy period of time.  These days many more people hold their shares via an online platform that is capable of calculating the gains and losses automatically, and providing a summary for tax purposes.  Accordingly, the reintroduction of indexation relief ought not to complicate matters as much as it once would.

The suggestion that relief for business disposals should be focussed on business owners who are retiring will be a familiar concept for older tax advisers.  Prior to the introduction of taper relief in 1998, there existed a CGT relief called ‘retirement relief’ that provided an exemption from CGT for business owners who were disposing of a business, if they had attained age 55 or were in ill health.

The suggestion that CGT ‘rebasing’ should not always apply on death is new.  It would be seen, possibly, as closing a ‘loophole’.  However, there is an obvious obstacle to be overcome before this rule could be changed.  A change in the law would possibly necessitate people having to calculate their CGT liability with reference to someone else’s acquisition cost, but currently, and for obvious reasons, the law only requires people to keep records of their own affairs in order to calculate their taxes.  It is not clear how this rule could reasonably be changed.

Presumably, before implementing any change, the government would want to know whether the change would result in a greater amount of tax being collected, or not.  This is not a question with an obvious answer in all cases.

Winners and losers

Any changes to the rules will likely produce both winners and losers.  For example, the reintroduction of indexation relief (and alignment of rates to the income tax rates) would broadly benefit those who have owned assets for a lengthy period of time, over those who have made a large gain over a short period of time.  This is particularly the case in view of the fact inflation over recent years has been on the high side.

It is worth reflecting that changes to the rules can sometimes throw up tax saving opportunities for those people who are willing to take advantage of them.  Taxpayers can generally control the date when they dispose of an asset, and so control the date they make the corresponding gain.  If there is a change to the rules, there may be some scope for them to control whether their gain should fall under the existing, or the new rules.

Taxpayers who want to crystallise a gain early, in order to fall under the existing capital gains tax rules, without selling the corresponding asset, can usually do so by making a transfer to a family member, company, or trust.  This was very popular during the run up to the abolition of taper relief in 2008 (and also during the phasing out of retirement relief from 1998).  The main disadvantage of doing this is the necessity, usually, of paying CGT without receiving any proceeds, so it should mainly be done when a sale is planned in the not-too-distant future.

Taxpayers who want to sell an asset, but delay the effective date of sale for tax purposes, may be able to do that using an option agreement.

The lessons for estate planning

Professionals such as ourselves will usually advise their clients based on the law as it currently stands.  There are forever rumours and speculation about forthcoming changes (particularly in the run up to Budget Day) and usually these prove unfounded.  Unfortunately, the media has a vested interest in running scare stories to drive engagement.

That does not mean however that we should never take into account the possibility of future changes in tax rules.  On the contrary, estate planning operates over a long time horizon, so that tax changes of some form or another become almost inevitable.  We must at least try to anticipate changes even though we do not know what those changes might be.

Since we don’t know what changes could happen in future, how can our advice take these changes into account?  From an estate planning perspective the answer is twofold.  First, we ensure that any arrangements we help to put in place should be as flexible as they can be, so preserving the greatest opportunity to adapt to changes in tax rules in the future.  Second, we recommend where possible not to rely too heavily on any single tax planning strategy (‘putting all your eggs in one basket’) since doing so increases the risk that a future change of tax rules could have a disproportionate impact on your overall estate planning arrangements.

Paul Davies

Consultant, Private Client Solicitors