Capital Gains Tax - What’s Changing and What You Need to Know
We take a look at the possible changes coming to CGT as a result of the recent OTS review.
In light of the massive expenses the government has incurred as a result of the COVID-19 pandemic, it’s no surprise they are looking for ways to boost their coffers. Capital gains tax is seen as a relatively easy target, as it is currently only paid by just over a quarter of a million people in the UK, but generating nearly £10bn in revenues.
With this in mind, no doubt, the Chancellor Rishi Sunak asked the Office of Tax Simplification (OTS) to review the capital gains tax system. That was back in July 2020 and the OTS has since released a report, including its recommendations. Another report is due out in early 2021, which we will update you on later.
It’s important to point out, at this stage, that the government won’t necessarily action all or any of the measures outlined in the OTS report. A similar review into the inheritance tax system was carried out in 2019 and none of the recommendations has been applied yet. However, the economic environment has changed pretty drastically since last year and the government has been borrowing like never before to try to keep all of our heads above water. So it pays to be informed and prepared ahead of any major CGT changes
What is CGT and what is it currently applied to?
Capital gains tax is intended to tax the gains made when you dispose of an asset that has increased in value. This doesn’t apply to your main residence or your car, but it applies to most other things, providing they are worth over £6,000. For CGT to apply, gains from the disposal of assets alone, accumulated over a tax year, must also exceed your annual tax-free Capital Gains Allowance, of £12,300.
The gain made on your main property when you sell it can sometimes be liable for CGT under certain circumstances, such as if you have recently rented it out.
Now, CGT isn’t only applied to assets you have sold, but also assets you dispose of in other ways. This includes giving them away as a gift, getting compensation for an asset when it is lost or damaged, or swapping it for another asset.
Assets regularly taxed for capital gains include:
- Any property that’s not your main residence
- Business assets
- Personal possessions
CGT is a complex tax and this is one of the reasons it is seen as a good candidate for sweeping reforms. For example, CGT is applied at a higher rate for property than other assets.
Capital gains tax rates
Basic rate 10%
Higher rate 20%
Basic rate 18%
Higher rate 28%
There are also a number of assets that are exempt from CGT, such as:
- Gifts to close family members or charities
- Gains made on certain investments, such as ISAs and PEPs
- Lottery winnings
- Premium Bond gains
- Gambling winnings
Also, whether you are domiciled in the UK can have a bearing on your CGT liability. Here is more information on this.
What has the OTS recommended?
The introduction of a higher, flat rate of CGT
Fundamentally, the OTS is calling for a simpler CGT system with a higher rate. It has suggested aligning CGT more closely with income tax rates, which could mean rates soaring to double their current level for some taxpayers.
The OTS argues that the fact that CGT is charged at different rates for different kinds of assets affects the way people dispose of these assets. This leaves the door for tax avoidance wide open, reducing the amount of money the government can collect under the current system.
Reducing the four different rates of CGT currently payable, to a single flat rate, as recommended, is likely to result in higher CGT bills for basic rate taxpayers disposing of non-property assets, for example.
Reassessment of CGT relief schemes
The OTS says that changes need to be made to the existing Business Assets Disposal Relief (BADR) and the Investors Relief. The latter of the two reliefs should be abolished entirely, according to the report, while the former needs to be more focused on retirement to better incentivise investment, as it is intended.
A lower CGT tax-free allowance
The OTS also recommends reducing the annual tax-free allowance for CGT to between £2,000 and £4,000, down from the current £12,300. Alongside this should be a reduction in the number of personal items on which you should have to pay CGT. This, they claim, would mean fewer people only making a small amount of profit being caught by the tax, but less distortion in behaviour among those who are liable.
IHT and CGT must work better together
Currently, ‘capital gains uplift’ rules are in place, reducing CGT payable on inherited assets that are later sold at a profit. These rules state that assets inherited and later sold at a gain should have CGT applied to the increase in the value of the asset between the moment it was inherited and the moment it was disposed of, instead of from its value when the deceased first purchased it.
The OTS’s report says that those whose inheritance is exempt from IHT should have to pay CGT on the gains when disposing of an inherited asset based on the value gained between the item first being purchased and the item being sold. This would prevent people from benefiting from both IHT exemptions and CGT uplift rules.
The report recommends that the base rate for valuing items purchased by the deceased should be changed to the year 2000, from the current date of 1982, which would reduce measured gains considerably.
So, from a taxpayer’s perspective, there are positives and negatives to take away from the OTS report. We can all agree that the current CGT system is too complex and needs updating and the recommended changes could bring some much-needed clarity. However, we all need to be aware of how we can take measures right now, to prepare for any future implementation of the OTS’s recommendations.
How to prepare for potential CGT changes and limit your current CGT liability
Dispose of your assets now
It does look likely that the CGT system will be simplified at some point soon, and this is likely to result in larger CGT bills for many. To minimise this, disposing of your assets as soon as you can, i.e. before the changes some into play, may save you thousands.
Dispose of your assets over time
Alternatively, if you cannot dispose of your assets right away, planning ahead can limit your exposure to this tax. If you can limit your taxable gains each tax year to £12,300 by disposing of your assets over a number of years, rather than all at once, you will maximise the value offered by your tax-free allowance.
If this does fall to just a few thousands pounds, spreading your disposals will still be worth doing, but you may need to dispose of assets over an even longer period of time.
Take advantage of tax-efficient investments/savings
Whatever the changes to the CGT system, ISAs and money invested in pensions are likely to remain untouchable and you should be maximising your use of these tools now. Remember, if Sunak applies some of the OTS’s recommendations, higher rate taxpayers could be looking at CGT of 40%+ on any investment gains not held in ISAs and pensions.
Consider other ways to make money from property
If the CGT on property moves in line with income tax, property investors will want to rethink how they make money on their property investments. For example, instead of selling your properties and paying 40% or more in CGT on the gains you’ve made, you could look into borrowing against your property through an equity release scheme for example.
Entrepreneurs may need to borrow more and sell less
As if the replacement of Entrepreneurs’ Relief with the Business Asset Disposal Relief wasn’t enough of a blow to the entrepreneurial spirit of the UK, things could get even worse for those looking to sell their business assets. If the OTS gets its way, there could be no CGT relief for many business owners when they sell their business assets, which all but removes this as a viable means of raising operating cash.
Instead, entrepreneurs will want to look into cheap borrowing as a way to boost cashflow, for example.
In conclusion, these are incredibly uncertain times and there’s no easy way to predict how the government will go about raising the funds needed to pay for 2020’s mammoth rescue effort. However, onlookers and analysts seem pretty convinced that changes to CGT are coming and that the OTS report will play a part in these changes.
CGT is a highly complex area and we would always recommend that you seek out professional advice to help manage your exposure.
When it comes to tax planning, preparation is key and now is the time to review your plans in the context of these likely changes. By doing this, you will most likely reduce your existing CGT exposure, while ensuring your finances won’t fall off a cliff if CGT rates are increased as expected.