In recent months, the UK government has provided unprecedented support to the economy. Now, rumours are gathering pace concerning how all these measures will be funded. It seems inevitable that some taxes will rise.
The Conservative manifesto said there would be no increase in Income Tax, National Insurance or VAT. However, they were silent on Capital Gains Tax (CGT) and speculation is rife that the one tax at the top of the list for reform is CGT.
The Chancellor announced a review of Capital Gains Tax back in the summer and planned to make the findings of this review available before the delivery of the autumn Budget. However, the Treasury have announced that there will be no Budget this autumn, so the timing of any potential reform is unknown.
Who pays Capital Gains Tax?
Capital Gains Tax is levied on gains made from the sale of assets and investments e.g. second homes, holiday homes, shares, and investment funds.
Broadly speaking, if you dispose of something deemed a ‘chargeable asset’ – i.e. personal possessions worth £6,000 or more (apart from your car and your main residence) – you are likely to trigger a Capital Gains Tax liability.
You only pay Capital Gains Tax on total gains above your annual tax-free allowance (£12,300 in 2020/21). Higher-rate or additional-rate taxpayers pay 28% on gains from residential property and 20% on gains from other chargeable assets. Basic-rate taxpayers pay 18% on residential property and 10% on other gains if the amount of the gain is within their available basic Income Tax band.
What changes could we see?
Labour’s General Election manifesto last year laid down a marker on possible changes. It outlined plans to ‘end the unfairness that sees income from wealth taxed at lower rates than income from work’.
Its proposals included a reduction of the annual Capital Gains Tax allowance to £1,000. It also laid out plans to tax capital gains at the same rate as income. So, a basic-rate taxpayer would pay 20% tax on the disposal of a second property or a share portfolio while higher-rate and additional-rate taxpayers would pay 40% and 45% respectively.
The chances of the current Chancellor basing a reform on the opposition’s manifesto are unlikely, however, it seems inevitable that he will announce some changes.
So, what changes could we see?
Gains taxed in the same way as dividends
A possible way forward would be to tax capital gains at the same rate as that applied to dividend income.
Currently, any annual dividend income above £2,000 is taxed at 7.5%, 32.5% or 38.1%, dependent on whether the shareholder is a basic, higher, or additional-rate taxpayer. While this would see a reduction for a basic-rate taxpayer compared to the current Capital Gains Tax rate, the higher rates sit between current Capital Gains Tax rates and Income Tax rates.
To mirror the taxation of dividends, the annual exemption could also be reduced to £2,000 which would bring more gains within the charge to tax and offset the reduction in the basic tax rate.
Changes to other reliefs
In recent years, the government have reduced reliefs such as Entrepreneurs’ Relief (now called Business Asset Disposal Relief (BADR)) and the lifetime BADR limit is now just £1 million (was previously £10 million). The first £1m of any qualifying gain is taxed at 10%.
This relief is designed to encourage people to be entrepreneurial and to start and run their own businesses. It is debatable whether the Chancellor can reduce it further if it is to remain an effective relief but, in these unprecedented times, we could see an increase to the 10% rate or a further reduction in the lifetime allowance.
Introduction of CGT on primary homes
At present, Capital Gains Tax is not paid when you sell your primary residential property. Given historic increases in property values, removal of this exemption would raise a significant sum.
This is though an unlikely move considering that the government is currently trying to revive the property market with initiatives such as the Stamp Duty Land Tax holiday.
However, the Chancellor may not rule out a Capital Gains Tax charge on the sale of ‘high value’ homes as this would have no impact on first-time buyers or the sale of the ‘average’ family home.
Taxing gains on death
At present, gains are not taxed on death and the base cost of any asset inherited is ‘reset’ to the probate value. This is a valuable relief and there has been much talk of reform. Any tax revenue raised would be contingent on the death of investors and may be more politically palatable.
There is currently a review being carried out into Inheritance Tax and a distinct possibility is that any asset left on death which is not immediately charged to Inheritance Tax could lose the uplift in base cost for Capital Gains Tax.
With the potential for a substantial reform, what can you be doing now?
Use tax-free savings
Capital gains made within tax-friendly savings vehicles such as ISAs and pensions are free from Capital Gains Tax. Also, all withdrawals from ISAs are tax-free. It therefore makes sense to utilise these Capital Gains Tax-free accounts as much as possible to protect your investments from any increase in the rate of Capital Gains Tax.
‘Bed and ISA’
One often overlooked but effective exercise is to ‘bed and ISA’. Here, you can sell shares or investment funds held outside an ISA and then repurchase them within the plan. This means the holdings are then exempt from Capital Gains Tax going forward.
However, the initial sale could trigger a Capital Gains Tax charge. You can avoid this charge by ensuring any gains fall within your £12,300 tax-free capital gains allowance. You can then use the proceeds to fund an ISA or pension.
Transfer assets to a spouse or civil partner
Those who are married or in a civil partnership could transfer assets to the partner who is paying a lower rate of Income Tax.
Such transfers do not trigger Capital Gains Tax, but it means any future gains will incur a lower rate of tax and you could take advantage of two annual exemptions (currently £12,300) when the assets are sold, meaning the first £24,600 of gains is tax-free (based on 2020/21 rates).
Report all losses
Capital losses can currently be carried forward indefinitely and offset against any future capital gains. You must report losses on your tax return within four years of them arising to qualify for carry forward.
If the rate of Capital Gains Tax increases, losses will become more valuable. We therefore recommend that you ensure all capital losses have been reported on a tax return to ensure they remain available.
Get in touch
Changes announced normally take effect from the start of a tax year. However, George Osborne changed CGT rates mid-year in 2010, so there is a precedent for an increase being applied before the end of a tax year.
It is therefore possible that any changes announced could take effect immediately. If this is an issue that could potentially affect you then you should consider your options now.
We encourage you to speak to us before making any major decisions. Everyone’s circumstances are different, and the tax treatment depends on the individual circumstances of each client and is always subject to change.
The above is only our view of what changes the Chancellor could make to Capital Gains Tax. This is a complex area and it is no means certain that any changes will increase the costs of Capital Gains Tax to you, but it is well worth considering what prudent action you might take ahead of any potential reform. Acting now could save you money.
If you would like to discuss how any potential changes to Capital Gains Tax could impact you please contact our Head of Tax, Nick Donohue, or your usual RPG contact.
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