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In November 2020, the Office of Tax Simplification (OTS) published its report on Capital Gains Tax on the different tax rates available under CGT, the amount of taxes collected and how the tax affects people’s behaviour in order to give recommendations for simplification.
Below we look at some of the different tax rates currently, as at 2020-21, available to CGT and the report’s key points which might initiate future changes.
Capital Gains Tax rates vary from as little as 0% up to 28% but with a lot of allowances and relief that affect these basic rates. Every UK tax resident or UK national automatically gets a tax-free personal allowance, currently £12,300, where total gains in a tax year under this allowance is tax-free. You can also use current year losses or brought forwards losses before calculating your taxable gains in the year.
CGT is taxed on disposals of assets which generally appreciate in value and is unlike income tax. A disposal occurs when selling it, giving it away, swapping it or being compensated for its loss like an insurance payout, for example.
The CGT rate for a disposal of residential property is 18% or 28% with the exception that the primary residence that you live in does not pay any CGT when you sell it. Instead, you pay stamp duty land tax (SDLT) on the purchase. These rates, therefore, affect only property owners with more than one property whether rented out or not. The rate depends on your overall income and whether you earn above or below the ‘basic threshold’ of income, see below, currently £50,000.
The next important CGT rates on most other disposals of personal possessions or business assets like shares is either 10% or 20%. The rate depends on what tax band your total income is being taxed at. If you are a basic rate taxpayer, paying income tax on your salary or income at the current 20% rate, then you will pay CGT on the gains above your CGT personal allowance at just 10%. If your income is already taxed at the higher 40% or additional 45% tax rates then any taxable gains will be taxed at 20%. The gain is added to your other income and part of the gain could be taxed at 10% while the remainder taxed at 20%.
While most people do not sell personal possessions for more than they paid for them, the most common asset that individuals tend to dispose of, or at least aim to dispose of for a gain, are shares in companies. The rules above hold true on the general tax rates but then there are a number of reliefs available for investing in shares. These are due to the government wishing to encourage investors to fund businesses which ultimately transact the most amount of tax-raising activities.
This used to be known as Entrepreneurs’ Relief until 6 April 2020 and allows up to £1m of lifetime gains on share disposals to be taxed at just 10% even if you are a higher or additional rate taxpayer. Qualifying conditions means that you need to have at least 5% of both the shares and voting rights. You must also be entitled to at least 5% of either profits that are available for distribution and assets on winding up the company or disposal proceeds if the company is sold. Also, for at least 2 years up to the date you sell your shares you need to be an employee or officeholder of the company and the company’s main activities must be trading (i.e. not non-trading activities like investment).
Shares from an Enterprise Management Incentive (EMI) have different rules.
This is very similar to BADR above and came into effect from 6 April 2019. These shares need to have been held for at least three years, you or someone connected to you cannot have been an employee of the company, and you can have up to £10m of lifetime gains taxed at this rate under this relief. The employee rule effectively rules our business owners as directors.
The shares need to be fully paid up in cash, for ordinary shares, the company has to be trading, the shares cannot be listed on certain stock exchanges and they cannot have been issued to you before 16 March 2016.
These very generous government schemes allow for a number of reliefs not just for CGT. If you invest under one of these schemes then any future gains will be taxed at 0% on disposal. There is no cap on the amount of gains you can get with this relief. The qualifying conditions are that you and your connected parties cannot own or control more than 30% of the investee company.
At the point of investing in SEIS, which has a maximum £100,000 annual investment limit, the amount invested can also reduce any gains made in the same tax year by 50% of the invested sum. For example, if you make a £100,000 gain in the year and invest all that into SEIS then only 50%, £50,000, will be taxed to CGT under the rules above. So, if you were to pay CGT at the 10% rate above through one of the reliefs, now your effective tax rate would be just 5%.
The same applies for EIS investments except that you do not get CGT relief when reinvesting gains in the same ear but instead you get a deferral of 100% of the gain until these EIS investments are disposed. At the future point of disposal the originally deferred CGT becomes payable.
One important but little-known tax relief available to SEIS and EIS shares is that you can convert what is normally a capital loss into an income tax loss through S.131 ITA 2007. Under this section, a loss of a share investment can be claimed against income which is more likely to result in tax relief. Normally a negligible value claim is made at the same time in order to crystalise the loss if a formal liquidation has not happened.
Spouses, charities and other investments
There are exemptions for asset transfers between spouses or civil partners since they can be treated collectively within this tax or gifting items to charities. Couples who are separating or divorcing there are further complicated rules relating to the timing of the transfers and the degree of informal or formal separation at the time of the transfer. Tax advise should always be sought by separating couples to avoid unnecessary CGT.
The OTS said that there are too many rates of CGT and recommends removing some. Most noticeably, the Investor Relief and Business Asset Disposal Relief could be overhauled to a more retirement-only relief. CGT has been in the media a lot recently as a target tax to change as a response to looking at ways to recover taxes after COVID. However, further reliefs may then be put in place, such as a return of indexation to ensure that the effects of inflation are not taxed.
The tax-free personal allowance, presently £12,300, is quite large considering income tax is £12,500 but very few taxpayers have taxable gains in any given tax year. The OTS has proven that a lot of transactions are made each year to only use up the personal allowance but not more.
The interaction between IHT and CGT could change whereby business assets which are currently tax-exempt through Agricultural/Business Property Relief are not rebased to the current market value being looked at. This clearly removes a lot of historical gains from CGT.
Other proposals are to assess more transactions under income tax instead of CGT. One example could be that cash remaining on a liquidation or sale of a company that HMRC could tax some or all of the retained earnings distributed at dividend rates instead.
Share-based remuneration is a complex area and the OTS has noted that tax-advantaged share schemes such as the EMI Scheme have a policy justification for being taxed in a different way but nothing further has been suggested yet.
As with all potentially taxable transactions, it is better to get advice beforehand to ensure no tax planning options are missed.