Investors will be adversely affected by recommendations in the Capital Gains Tax Review published last week by the Office of Tax Simplification.
The recommendations are presented as recommendations with some alternatives. It is vital for both investors and business owners that chancellor Rishi Sunak does not make the wrong choices.
The chances of CGT changes in the near future look high. We know the chancellor wants to balance the national books in the long term but without dampening down any recovery in the face of Covid-19 and Brexit.
Raising CGT rates alongside some other tweaks could generate a lot more revenue, with almost no short-term impact on the real economy. The tax is an easy target, affecting relatively few people (1.5 million over a 10-year period).
So, what are some of the recommendations?
Aligning CGT and income tax rates
The idea of aligning CGT rates to income tax rates has grabbed the headlines and elicited a surprising amount of support. Indeed, there is a serious danger it will become the new orthodoxy.
The main accusations are that income and gains are essentially the same and taxing them at different rates distorts taxpayer behaviour, especially by senior business management and business owners. But here are some reasons why CGT rates should be lower than income tax rates, especially for ordinary investors in shares and funds.
A high proportion of gains reflects a reduction in the value of money – inflation – rather than an increase in the value of investments. With this in mind, the OTS recommends there be some relief for inflation if the government decides to align gains and income tax rates.
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But inflation-linking leads to lots more complexity, especially with collectives-based saving schemes. Taper relief may be a bit simpler but it distorts behaviour and doesn’t really do the job.
Most disposals of assets – businesses and property – are lumpy, even though the gains typically accrue over many years. So people who are normally basic rate taxpayers tend to be pushed well into higher rates, even though they would pay those rates if the gain had been spread over the years of ownership. Top-slicing relief on life assurance bonds reflects this need up to a point.
Most of the distortions the OTS has identified refer to the activities of highly paid employees benefiting from certain share incentive schemes and some other supposed behaviours of business owners. It seems perverse to introduce changes that will affect many ordinary investors in funds and shares because of the behaviour of a separate group of taxpayers. Surely it would be better to look at the specific issues with share schemes and business owners.
Cutting the annual exempt amount
Raising the rates of CGT and cutting the annual exempt amount – another recommendation – is sure to make investors even more reluctant to shift out of poorly-performing portfolios that don’t reflect their risk profile or objectives.
CGT is a barrier to good investment management and an encouragement to maintain the status quo. For instance, it wouldn’t encourage investors to switch into more sustainable investments.
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Higher rates of CGT would also encourage funds and other tax shelters over individual shares. The report gives the example of the potential tax efficiency of a family investment company. The shareholders would aim to build up their assets in the family company to take advantage of lower rates that apply to capital gains.
The report omits to say this would be even more true of investors’ behaviour towards collectives like funds and offshore bonds, which can be kept for years, with trading going on under their shelter. But the disincentive from switching to new and perhaps cheaper and better providers would be even greater – with a stultifying effect on the innovation and competitiveness of the market.
Change position on death
Another recommendation is to change the CGT position on death – broadly meaning the inheritor of an asset would take it over at the deceased’s base acquisition value. The interplay with inheritance tax might make this a step too far. But the proposal to bring forward base values from March 1982 to 2000 would be welcome.
It would be a pity if the chancellor were to think there is a consensus in favour of aligning CGT and income tax rates. Why not write to him and to your MP to suggest it would be a very bad plan?
Danby Bloch is chairman of Helm Godfrey and head of editorial strategy at Platforum
Would have been interesting if the article explained all of the recommendations.
If not this, then what?.
Fair point, though there’s only so much space. I was focusing on the case against alignment of the two taxes. Some of the appropriate strategies are implicit in the article: use of collective investments like OEICs, unit trusts and life assurance bonds as well as family investment companies. ISAs and pensions are even more obvious vehicles.
I covered several more suggestions in my article on CGT in Money Marketing of 8 September 2020. They are pretty obvious: use the annual exempt amount, consider realising gains taxed at 10% or 20%. And maybe think about doing this before the autumn statement / spending review on 25 November – otherwise the next action point is the Spring Budget 2021.