Align UK income tax and CGT more closely, says OTS

Thursday, 12 November 2020
A report from HM Treasury's Office of Tax Simplification (OTS) suggests that the government should consider aligning capital gains tax (CGT) rates more closely with income tax rates, or address the boundary issues between the two taxes to discourage taxpayers from disguising income as capital gains.
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The Treasury asked the OTS to write the report on CGT in July 2020, with the aim of identifying administrative and technical simplifications as well as areas where the present rules distort taxpayer behaviour or fail to meet their policy.

The OTS's call for evidence drew more than 1,000 responses, including from STEP. The OTS found that the disparity in rates between CGT and income tax creates an incentive for some taxpayers, notably family businesses, to arrange their affairs to reclassify income as capital gains, which is generally taxed at a lower rate.

However, rather than make specific recommendations, the OTS offers several alternative suggestions, leaving it up to the government to decide which meets its priorities. It notes that other issues, such as inflation relief for gains accumulated over several years, should also be considered.

It also notes that the relatively high level of the annual exempt amount, currently GBP12,300, can ‘distort investment decisions’, demonstrated by the fact that 50,000 people reported net gains just below the threshold in the 2017/18 tax year. The government should consider reducing the exempt amount if its policy is simply to provide administrative de minimis level, the OTS noted, highlighting that a 'true' de minimis level would be in the range of GBP2,000 to GBP4,000; reducing it below that level would have the drawback of bringing many more taxpayers into the self-assessment system.

OTS Tax Director Bill Dodwell added, ‘If the government were to reduce the Annual Exempt Amount, it should do so in conjunction with considering reforms to the current chattels exemption and improving the real time capital gain service, including linking these returns to the Personal Tax Account.’

The report also deals with the complex and sensitive issue of CGT interaction with lifetime gifts, inheritance tax, and reliefs given on business assets. The OTS has already suggested that the government should consider removing the existing capital gains uplift on death, and instead provide that the person inheriting the asset is treated as acquiring the assets at the historic base cost of the deceased. This would not affect those who retained the assets, but would lead to a tax charge for those who sell recently inherited assets and could be accompanied by a general rebasing of all assets, with an extension of gift holdover relief to a broader range of assets, making it easier for individuals to give assets away during their lifetime. 'Taken as a package these proposals could potentially raise money for the Exchequer over the long term', the report notes.

The OTS also recommends the abolition of investors' relief, and the introduction of a new relief focused on retirement to replace business asset disposal relief, which it considers does not achieve the aim of stimulating business investment and risk-taking.

Further, it recommends that the government consider taxing accrued profits of owner-managed companies at income tax rates.

Commenting on the report, Robin Vos TEP, Chair of STEP’s UK Technical Committee, said: ‘The Chancellor put the OTS in a difficult position by asking it to consider ways in which the existing rules might distort behaviour or do not meet their policy intent. Inevitably, therefore, the report strays into areas of policy and deals with matters that have nothing to do with simplification such as rates of tax. The government is of course looking for ways to raise tax revenue in a way that is politically acceptable, and CGT is one of the ways in which that can be done without breaking any manifesto commitments.’

Vos added that a modest increase to CGT seems likely, although aligning it with rates of income tax are ‘much less likely to be pursued.’

‘The real purpose of the Chancellor in asking the OTS to review CGT was to see what the public and political appetite was for raising more money from it,’ he noted. ‘The answer seems to be that modest increases might be accepted, but that more radical reform would not be tolerated.’

The Institute of Chartered Accountants in England and Wales (ICAEW) has urged a cautious approach, claiming that the CGT regime as it stands is 'fit for purpose'. The system largely achieves its policy intent of discouraging schemes that seek to convert income into a capital gain for tax purposes, although the way in which it is administered could be improved, it said.


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