14th December 2020
In recent months the government’s response to the pandemic has created a heavy strain on the Treasury. With the Office for Budget Responsibility confirming that government borrowing will hit £394 billion by the end of 2020, Chancellor Rishi Sunak has been under pressure to find new ways to raise additional revenue.
This prompted the Chancellor to ask the Office of Tax Simplification (OTS) to conduct a review into the way Capital Gains Tax (CGT) is paid and how it could potentially be reformed.
The OTS has recently published this report and has recommended a range of Capital Gains Tax reforms which could impact you. With these potential changes to CGT in mind, read on to find out why now may be the time to act.
Capital Gains Tax is levied on the profits that you make when disposing of assets
Capital Gains Tax is the tax you pay on the profits made by disposing of an asset. The amount of tax you pay is determined by whether you are a basic-rate or a higher-rate taxpayer. You pay CGT on any gains you make above your annual exemption, which for the 2020/21 tax year is £12,300.
There are some assets where gains are not taxed, for example ISAs, UK government gilts, and Premium Bonds.
The cost of the government’s pandemic response has created a large hole in the Treasury’s finances, and this prompted the Chancellor to commission a report into the ways that CGT could be reformed.
Earlier this year, the Chancellor demonstrated his willingness to change CGT when he announced a reduction in Business Asset Disposal Relief, previously known as Entrepreneur’s Relief.
This relief reduces the amount of CGT you would pay if you sold your business, provided that you had owned it for at least two years, down from 20% to just 10%. Previously this relief had a lifetime cap of £10 million, but in March the Chancellor reduced the cap down to just £1 million.
The Chancellor could raise the rate of CGT to be in line with Income Tax
One of the main areas for reform that the report highlighted was the disparity between CGT and Income Tax. According to the report, this disparity was one of the main sources of complexity for CGT and often distorted “family and business decision-making.”
Currently, basic-rate taxpayers pay Capital Gains Tax at 10% when selling assets, or 18% when selling a residential property (note that you don’t normally pay CGT on the sale of your main home). If the Chancellor acts upon the report’s recommendations, this rate could rise to 20% for both assets and property – mirroring the Income Tax rate.
Higher- and additional-rate taxpayers, on the other hand, currently pay Capital Gains Tax at 20% when selling assets and 28% when selling a residential property (again, typically not your main home). This would rise to 40% or 45% if it were to align with Income Tax.
A reduction in the annual exemption
Every year you have a limit on the amount of profit you can make before incurring CGT. This is your annual exempt limit, and you would be taxed on any gains above this limit at the rates mentioned above.
In the 2020/21 tax year, this limit stands at £12,300. However, one recommendation of the report is to lower this limit to between £2,000 and £4,000 annually. This would significantly increase the number of people who would end up paying tax on their gains, potentially raising large sums for the Treasury.
If the Chancellor were to act on this recommendation, the reduction in the limit would mean a significantly larger portion of your gains would be subject to tax, which would eat into your profits.
The report suggested a reduction or outright removal of CGT uplift on death
Another recommendation in the OTS report is to remove Capital Gains Tax Uplift on death.
Typically, when a person dies whilst holding assets that have appreciated in value, the base cost of the assets is uplifted to the market value without any Capital Gains Tax liability arising. When the assets are transferred, they are ‘reset’ for the purposes of CGT.
One issue that the report highlighted was that the current system encourages people to hold onto their assets until they pass away, meaning these can be transferred without incurring any tax.
The report recommends that the Chancellor reduces the uplift significantly or removes it entirely, to encourage wealth transfers to happen earlier.
You can use tax-efficient vehicles, such as ISAs, to reduce your CGT
If you want to minimise the impact that these potential tax reforms will have on you, there are several things you can do.
One of the more obvious solutions is to crystalise your gains before the changes to CGT come into effect. Taking advantage of your annual exemption now, which for the 2020/21 tax year stands at £12,300, would mean you’d pay less tax on profits than if the Chancellor decided to lower the exemption to between £2,000 and £4,000, as the report recommends.
Furthermore, another way to protect yourself from the changes is to maximise your holdings in tax-efficient vehicles, such as ISAs. Since you do not pay tax on interest on cash, or on income or capital gains from investments in an ISA, using your full ISA allowance has the potential to avoid a large amount of tax.
You could also consider the ‘Bed and ISA’ strategy, where you sell investments that you hold outside an ISA and use the proceeds to open or top up your ISA – all with a single instruction. Speak to us if you would benefit from advice in this regard.
Get in touch
If you’re concerned about the changes to CGT and want to ensure you aren’t paying any more tax than you have to, we can help. Email firstname.lastname@example.org or call (0161) 8080200.
Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. The Financial Conduct Authority does not regulate tax planning.