Will the Chancellor’s review result in a policy change? Jason Hollands analyses different scenarios
The Chancellor has asked the Office of Tax Simplification to review the UK’s Capital Gains Tax (CGT) regime. This has – understandably – set the cat among the pigeons in the current environment where Government spending has skyrocketed as it grapples with the Covid-19 pandemic, but there is no appetite for a return of austerity.
On the surface, CGT (alongside pensions tax reliefs) looks relatively a low-hanging fruit for policymakers and civil servants reviewing tax raising options, especially given the Conservatives have a manifesto commitment not to raise Income Tax, VAT or National Insurance during this parliament. Politically, CGT directly impacts a relatively small number of wealthier people and so may be palatable to many voters.
Yet a move to hike CGT receipts is a not a magic bullet and would have significant implications for private investment in the UK and for entrepreneurs in particular, at a time when investment and new job creation are going to be critical to the post-pandemic recovery. In the event that CGT rates were to be materially hiked, this could prompt a rush to sell businesses and assets. Business sales are typically followed by the extraction of cost efficiencies, often involving layoffs, so a move to hike CGT is not without risk.
It is important to flag that nothing may ultimately come of this review; a similar exercise looking at the UK’s inheritance and gifting regimes has – thus far – resulted in no policy changes. Some options that could be considered were the Government to decide to raise CGT receipts could include:
Reducing or scrapping the annual capital gains exemption (currently £12,300 per individual). Such a policy formed part of the Labour’s tax programme under Jeremy Corbyn and would have implications for a wide cross section of investors looking to dispose of shares or funds held outside of tax-wrappers such as ISAs and pensions, with potential ramifications for making basic switches of investments within portfolios costly. That could result in investors being reluctant to transfer out of pedestrian funds.
Abolishing Business Asset Disposal Relief (formerly Entrepreneurs Relief). This relief is applicable to business owners and significant shareholders (over 5%) and results in an effective CGT rate of 10% on lifetime gains of up to £1 million. A wholesale scrapping of this allowance would seem unlikely as it has just been cut down from £10 million, but there could be some raising of the threshold around who is eligible.
Increasing CGT rates. On most assets (except property) these are currently 10% for basic rate taxpayers and 20% for higher and additional rate taxpayers on gains that exceed their annual exemption. On property assets, other than a main residence, CGT is payable at 18% for basic rate taxpayers and 28% for higher and additional rate tax-payers. Speculation has focused on aligning CGT rates with Income Tax rates – another Labour manifesto policy at the last election – which are currently 20%, 40% and 45%. This would have major implications for private investors with non-tax-wrapped investments, including those owning buy-to-let properties. Advocates of this approach see capital gains as another form of income and therefore argue that the tax treatment of income and capital returns should be agnostic. However, unlike most income (e.g. salary), capital returns are the result of risk taking and CGT is effectively a form of double taxation as invested capital will typically have originated from income that has previously been taxed.
There are of course other options should the Chancellor at some point seek to increase CGT rates: aligning these with dividend tax rates (which are higher than current CGT rates but lower than Income Tax rates), or selectively raising them on certain assets such as buy-to-let properties. Another option would be to introduce some form of tapering based on the time an asset has been held or the size of the gain. The latter could, in theory, include introducing CGT on the disposal of main residences for a slice of the return above a certain threshold.
Add additional types of assets into the universe of capital gains. CGT covers most assets, including properties that are not a main residence (e.g. buy-to-let, holiday homes), shares and funds and antiques. However, certain other assets that have become increasingly popular with wealthier investors, such as classic cars, are usually exempt as they are classified as “wasting assets”.
End CGT deferrals or change the rules on loss relief. Other possibilities for tinkering could include overhauling the mechanism for deferring CGT or offsetting gains with losses made elsewhere. Gains made on the disposal of an asset can be deferred by investing in Enterprise Investment Schemes (EIS). While the liability recrystallizes when the EIS is sold, continually rolling over the original capital gain into new schemes can enable the gain to be deferred until death when the tax liability disappears altogether. At this point the EIS shares would also qualify for Business Relief if owned for at least two years, meaning they would not be included in the investors’ estate for Inheritance Tax purposes. Likewise, investors can offset capital losses against capital gains made in the same year. Unused losses can currently be carried forward indefinitely.
So what might the consequences be should the Chancellor decide to tinker with CGT? With so many options (including no changes), the devil will be in the detail and it is important not to act too hastily.
However, there are some important points to make.
Make use of ISAs and pensions. Capital gains made within ISAs and pensions are free from Capital Gains Tax and any withdrawals from ISAs are tax free. It therefore makes sense to make as much use of these valuable allowances as possible, migrating as much of your investments as you can within them. ISAs are particularly flexible and should be core to most long-term financial plans. Selling shares or funds you own outside of an ISA, taking care not to exceed your annual capital gains allowance in doing so, and then repurchasing them within an ISA is a process known as ‘Bed and ISA’. This will help ring fence any future returns from them from potential changes to CGT or dividend taxes.
Use your annual capital gains exemption. This annual allowance, which is £12,300 for the 2020/21 tax year, is widely overlooked by many investors, but doing so does mean that over time they may become exposed to a large future Capital Gains Tax liability. Selling shares or funds held outside of ISAs and pensions regularly to utilise this allowance can reduce that liability building up over time. Crystallised gains can be used for numerous purposes including to fund an ISA, a Pension or, for higher risk investors, Venture Capital Trusts (which provides both a 30% Income Tax credit and tax-free gains and dividends – see Important information below for the risks of investing in VCTs*). Crystallised gains could also be used to purchase new taxable investments or even repurchase the same fund or shares that have been sold providing a period of six months has elapsed since the sale.
Use inter-spousal transfers. Married couples and civil partners can transfer assets between themselves without incurring a tax event. Where investments are owned by one partner and their ISA allowances are already being maximised, switching investments between spouses can ensure utilisation of two sets of annual capital gains allowances, both sets of ISA allowances and, where CGT will be due, the potential to reduce this by ensuring some or all of the gain is realised by whichever partner might be subject to a lower rate of tax.
Optimise structures. In a tougher CGT environment and where an investor is investing beyond ISA and pension allowances, it is important to think about the tax implications of managing a portfolio: simple fund switches for example, that might reflect a change of view on a market, fund or share and could clock up tax liabilities. In such a situation, use of a number of structures would bring advantages.
OEICs and unit trusts. Transactions within funds such as OEICs and unit trusts are not subject to Capital Gains Tax. A potential liability to the latter only occurs when the investor sells shares or units in the fund itself. In a more hostile CGT environment, the case for holding non-ISA and non-pension investment portfolios within fund structures become more compelling. For many people this could be via multi-manager or multi-asset funds, such as the Tilney Active Portfolios, or for ultra-high-net-worth investors that might involve establishing a private OEIC with a bespoke portfolio within it.
Set up a personal investment company. Another option is to set up a limited personal investment company structure for the purposes of owning investments on you and your family’s behalf as the shareholders. This might be an option for those subject to the higher rates of taxes, already maximising ISAs and Pensions and with significant additional cash to invest in a long-term portfolio where gains are likely to exceed annual exemptions. Business taxes rates are generally lower than personal taxes. Any dividends received on investments owned by the company will generally be exempt from tax and gains are typically taxed at 19% with inflation taken into account. This option should be discussed with a professional tax adviser before embarking on such a course. The running costs of a private investment company are likely to be lower than establishing your own OEIC.
Offshore bonds. Gains from offshore bonds are assessed as income rather than Capital Gains Tax. Up to 5% of the original sum invested can be taken each year for up to a total of 20 years (or accrued) and not be treated as income. Any tax liability will occur following a ‘chargeable event’, i.e. when the money is brought back onshore with only the increase in value (including any previously withdrawn 5% allowances) subject to an Income Tax charge. Investments held within the offshore bond grow free of UK tax, with switches within a portfolio held in an offshore bond not triggering tax. This structure enables investors to exercise control over the timing as to when they choose to incur tax, i.e. at a future point when they have retired and may be subject to lower rates of Income Tax. However, it does not remove a tax liability, but merely defers it, and future tax rules and rates of taxation may change.
Tilney’s nationwide team of financial planners can help you make the most of tax allowances and reliefs. Why not speak to us to find out more? We offer free consultations with no obligation to take any of our services.
The value of an investment may go down as well as up, and you may get back less than you originally invested.
*VCTs should be regarded as higher risk investments. They are only suitable for UK resident taxpayers who can tolerate higher risk and have a time horizon of greater than five years. Past performance is not an indication of future performance. Share values and income from them may go down as well as up and you may not get back the amount originally invested. Owing to the nature of their underlying assets, VCTs are highly illiquid. Investors should be aware that they may have difficulty, or be unable to realise their shares at levels close to that that reflect the value of the underlying assets.
Tax levels and reliefs may change and the availability of tax reliefs will depend on individual circumstances.