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The annual allocation on capital gains tax in the UK would be drastically lowered and CGT rates would come closer to those of income tax according to a far-reaching review commissioned by Rishi Sunak, the chancellor, which has potential to raise billions of pounds for the Treasury.
The Tax Simplification Office, a legal body, released a long-awaited report in CGT on Wednesday that concluded that the current rules were “counterintuitive” and created “strange incentives” in several areas.
The losers of the proposals would be wealthy individuals who have second homes or assets outside of tax-favored vehicles, such as individual savings accounts. It would also affect small business owner-directors, who often have cash inside their businesses to use as a pension when they retire.
The chancellor commissioned the review in July and is desperate to raise money to fill the fiscal hole left by the Covid-19 crisis, but he is expected to act very carefully: any dramatic reform of the CGT would hit central conservative voters hard.
Differences between the CGT and income tax rates, and the CGT’s “relatively high level” of annual exemption – currently £ 12,300 – were the main incentives for taxpayers to change their behavior to lower their tax bill, according to the OTS.
“The disparity in rates between capital gains tax and income tax can distort business and family decision-making and creates an incentive for taxpayers to arrange their affairs in ways that effectively re-characterize income. as capital gains, ”the report said.
The OET said most of the gains were made by relatively few taxpayers, who often had flexibility on when to dispose of assets. “This may mean they pay proportionally less tax on their overall income and profits than others,” the OTS said.
Bringing the two rates into ‘greater alignment’ could narrow these gaps and raise up to £ 14bn for the Treasury, according to an estimate by HM Revenue & Customs, cited by the OTS. However, he acknowledged that in practice the amount collected would be less as people would change their behavior.
Tax revenue could be further constrained if investors realize their gains early in the event that the Treasury adopts the OET recommendations.
Sunak is currently focused on containing the economic effects of the coronavirus crisis, but next year is expected to signal how it will begin to fill the fiscal hole it has created.
But the chancellor’s allies distanced him from the OTS report’s findings, noting that it had not adopted its previous recommendations on inheritance tax and income tax reforms.
“Your job is to review these taxes, but essentially these are a bunch of experts doing this job,” said a colleague of the chancellor.
The CGT is charged on earnings at 10 percent for base rate taxpayers and 20 percent for higher and additional rate taxpayers, or 18 percent and 28 percent respectively when earnings relate to residential property . In contrast, income tax is charged at a base rate of 20 percent, which increases to 40 percent and 45 percent for higher and additional taxpayers.
In fiscal year 2017-18, 265,000 individual taxpayers paid £ 8.3 billion to CGT which reported £ 55.4 billion of net profit (after deduction of losses). This compares with £ 180 billion of income taxes paid in the same tax year by 31.2 million individual taxpayers.
The OET did not suggest a specific rate to which the CGT should be raised. Bill Dodwell, the agency’s chief tax officer, said: “We are unelected people, working in the background. How can we suggest that? Must be [made by policymakers]. Taxes are a political option. “
An alternative to bringing the two tax rates closer together would be for the government to focus on areas where individuals were more likely to re-categorize earned income into capital gains. The OTS said this could include taxing income, share-based compensation and earnings retained in businesses by owner-managers.
The OET said the annual exemption could also “distort investment decisions.” Data from fiscal year 2017-18 showed that 50,000 people reported net earnings just below the threshold. The report suggested that the government consider lowering the £ 12,300 threshold, possibly between £ 2,000 and £ 4,000.
Other recommendations included changing the Entrepreneur Relief, recently renamed “Business Asset Disposal Relief,” with an allocation focused on retiring business owners. The policy was subject to reform in March, after Sunak reduced the lifetime allowance from £ 10 million to £ 1 million.
The OET also suggested eliminating the “capital gains increase,” which allows beneficiaries to inherit an asset at its market value on the date of death rather than its value on the date of purchase.
The Treasury said it did not comment on future fiscal policy outside of fiscal events and that it would consider the OET report in due course. “The government’s priority at the moment is to support employment and the economy,” the Treasury added.
Wednesday’s report was the first of two OTS reviews of the CGT system and focused on the policy design and principles underpinning the tax. The second will look at key technical and administrative issues and will be published next year.
