Neil MacGillivray: Are we about to wake up to new CGT nightmares?

With capital gains tax (CGT) being the latest tax to go under the potential reform spotlight, Neil MacGillivray suspects further CGT changes could lead to more tax nightmares

The Institute for Public Policy Research (IPPR) issued a report in September, Just tax: Reforming the taxation of income from wealth and work, just in time for the start of what turned out to be a much-shortened conference season.

Part of the reform proposed by the IPPR included that capital gains should be taxed at the same rates as income, and consideration given to introduce some form of indexation relief in order that gains equivalent to the rate of inflation are not taxed. Got a feeling of déjà vu?

Gains were first tied to the rates of income tax more than 30 years ago and that regime remained in place for 20 years, in conjunction with an allowance for indexation. Hopefully taper relief will not be making a comeback because the calculations were inextricably more complicated than they are today.

If that does not send a shudder down your spine, then take a deep breath. The new rates of tax applying to all income and capital gains would be a combination of both income tax and national insurance. The concept of merging income tax and national insurance in regard to earned income is nothing new.

The bringing together of the two regimes under the one set of rules provides not only a degree of simplification, but the current national insurance scheme is deemed to be out-dated and not fit for modern working practices. The Office of Tax Simplification (OTS) has been considering similar changes since as far back as 2010. However, the revolutionary step with this proposal is the idea it will cover not just earned income, but capital gains, interest, dividends, and pensions.

The proposed combined rate of tax would start at a lowly 2% for income and gains over £8,600 (just below the current primary NIC threshold), rising gradually to 50% at £100,000. Under this structure, for income alone, the IPPR estimate that 80% of taxpayers would be better off, but the remaining 20% – those with income of over £44,800 – would be the losers. This is a somewhat dramatic difference to Boris Johnston’s promise of no higher rate tax until income exceeds £80,000.

‘Adding to the gloom’

As part of the proposals the annual exemption for capital gains, currently £12,000, would be scrapped, though a de minus allowance (suggested as £1,000) would be put in place in an attempt to reduce reporting requirements to a practical and manageable level.

Adding to the gloom, gains on all fixed interest bonds would be included, thus the current exemption on qualifying bonds and gilts would be lost. Additionally, the likes of Entrepreneurs’ relief and Enterprise Investment Scheme relief would be abolished.

The final nail in the coffin is that the capital gains tax exemption on death would be removed. This recommendation is again nothing new, with the OTS report published in July titled ‘Simplifying the design of Inheritance Tax’ concluding that the interaction between inheritance tax (IHT) and CGT is complex and can distort decision making.

Under current rules, where an exemption or relief applies from IHT (for example, business relief, or agricultural property relief, or where the spouse exemption applies), any capital gain is wiped out on death of the owner of the asset, and it could be sold just after death without either IHT or CGT arising.

The OTS takes the view that this deters people from passing on assets during their lifetime. The ability to wipe out any CGT on death may be a motivator to retain an asset, such as a business, rather than gift it during an individual’s lifetime.

The OTS has concluded that this distortion would be best addressed by amending the CGT rules so that, where a relief or exemption applies to an asset for IHT, the person who inherits that asset gets it at its original base cost. Although not as dramatic a change as recommended by the IPPR, it does emphasise that the CGT uplift of value on death is under intense scrutiny.

To finish on a brighter note, there is one bit of positive news and that is the IPPR consider that the principle private residence relief should remain.

It is abundantly clear we will have a general election in the coming months. Based on recent opinion polls it is unlikely that any one party will have an outright majority, resulting potentially in another coalition government. The Liberal Democrats have already come out in support of changes along lines similar to those proposed by the IPPR, so it is looking less likely that we will experience an “it was all just a dream” plot twist.

Neil MacGillivray is head of technical support at James Hay