Back in July Rishi Sunak requested a review of the current capital gains tax (CGT) system. The Office of Tax Simplification (OTS) was asked by Sunak to produce a report on whether certain features of CGT distort the behaviour of individuals. The first instalment of the report has now landed and comes with some quite drastic recommendations in respect of aligning CGT with income tax rates, cutting exemptions and binning business reliefs. In this blog we will explore the intricacies of the current CGT scheme, the OTS’s recommendations and how these recommendations may affect your decision to sell your business.
The current CGT system
The report has labelled the current CGT system as ‘counter-intuitive,’ creating ‘odd incentives’ and creating ‘opportunities for tax avoidance.’ Why is this?
Well, the first £12,300 of an individual’s overall gains (the profits an individual gains from the disposal of certain assets) in any given tax year are exempt from CGT. Whilst there is a similar concept within the income tax scheme by way of the personal allowance, the OTS report considers the CGT scheme’s annual allowance as acting more as a relief owing to its high threshold. The report highlights how a large amount of individuals organise the disposal of their assets in such a way as to come under (but very close to) this threshold in order to avoid paying CGT.
Not only this, as it currently stands, there is a wide disparity between the amounts of tax a taxpayer would pay in respect of income in comparison to any capital gains made. By way of an example, the standard income tax rate for a higher rate taxpayer is 40% whereas the standard CGT rate for the same taxpayer is 20%. Therefore, in situations where an individual exceeds the CGT annual allowance they would only need to pay tax on the remainder of any gains at a rate that is half the rate of income tax.
As a founder or investor of a company, you may have been hoping to benefit from certain CGT business reliefs in the event of a sale of your company shares. Under the current CGT scheme, business asset disposal relief allows individuals to pay a reduced rate of 10% tax on the chargeable gains made on the sale of any shares owned (up to the lifetime limit of £1m) as long as certain conditions are met. Investor’s relief under the current CGT system also offers investors the ability to pay a reduced tax rate of 10% on the chargeable gains made on the sale of any shares owned (up to the lifetime limit of £10m) as long as certain conditions are met.
Therefore in its current form the CGT scheme clearly offers investors and founders some key tax benefits on their chargeable gains and it is no wonder that capital gains tax only constitutes a small proportion of the Exchequer’s income. The OTS report explains that it is these very benefits and ‘odd incentives’ that results in taxpayers arranging ‘affairs in ways that effectively re-characterise income as capital gain.’
What has the OTS report recommended?
In light of its review of the current CGT scheme, the OTS has recommended that a simplification of the system is required. The report offers some key recommendations in respect of how this can be achieved. For founders and investors, the following recommendations are of the most interest:
- In order to simplify the tax system and in order to reduce distortions to behaviour, the government should align CGT rates with income tax rates;
- The annual allowance amount of £12,300 should be reduced in order serve its purpose as an administrative allowance and not a relief;
- Investor’s relief should be abolished; and
- Business asset disposal relief should be replaced with a relief that is more in line with retirement so as to narrow the pool of those benefiting from the same.
Whilst the report currently only serves as a list of policy recommendations to Sunak it seems highly likely that the Chancellor will seize the opportunities presented by the proposed changes to the CGT system. The various support systems initiated by the government during the Coronavirus pandemic, such as Eat Out to Help Out, the Bounce Back Loan Scheme, the Coronavirus Business Interruption Scheme etc., have burned a big hole the Exchequer’s pocket by costing billions and billions of pounds. As we have most recently seen, Sunak has tightened his purse strings in respect of public sector salaries to try and address the current deficit. Therefore, the projected additional £14bn worth of taxes the proposed alignment of CGT rates with income tax rates would bring must be quite enticing.
How will these recommendations affect you as a founder or investor?
Whilst nothing has been confirmed by Sunak as of yet, it is likely that at least some of these recommendations will be implemented as government policy. After the unprecedented spending seen over the last year by the government in response to the pandemic, the Exchequer will need to start taking steps to rebuild the UK economy.
Therefore, if you are a founder and have been sitting on the fence over whether to exit your company or not, now might be the time to start seriously considering your options in respect of selling your shares. The same goes for investors and any shareholdings you may have. To do otherwise might result in a higher tax bill than you initially anticipated when you first established your business or first invested in a company. So start taking offers to buy your interest in a company seriously and SELL SELL SELL!