In 2020 the Chancellor of the Exchequer, Rishi Sunak, asked the Office of Tax Simplification (OTS) to undertake a review of Capital Gains Tax (CGT) including aspects of the taxation of chargeable gains in relation to individuals and smaller businesses. The aim seemingly was to identify opportunities relating to administrative and technical issues as well as areas where the present rules can distort behaviour or do not meet their policy intent.
Some commentators have speculated that CGT rates may have been set to increase as part of the UK Government’s Covid-19 crisis response and it was expected that the Chancellor’s focus would be on structural matters such as exemptions, reliefs and treatment of losses. However, there was no certainty that either the OTS would recommend changes to the CGT regime or increases in the CGT rate. With no Autumn budget having taken place, it has been left until after a third national lockdown and Spring 2021 has arrived for changes to CGT to be confirmed or implemented.
Nearly a year after the COVID-19 crisis spread throughout the world, topped off by the final exit of the UK from the EU, the need to raise additional revenue, to plug a fiscal deficit that could pass £400bn, is evident. Rishi Sunak’s now looks likely to cover two key areas of note; CGT and Corporation tax (CT), allowing the Chancellor to begin repairing the fiscal fallout of COVID-19.
What are the rates of CGT and CT, and how might they change?
There are currently four separate rates of CGT. Broadly, the 18% and 28% rates apply to residential property, and the 10% and 20% rates apply to most other asset classes. These are relatively low rates in comparison to Income tax (up to 45%). One suggestion made is to align Income Tax (IT) and CGT rates, so that investors pay tax at their highest rate on disposal of assets. There is history to support this as IT and CGT rates were aligned between 1988 and 2008.
In addition, the long awaited final reduction in CT to 17% was scrapped in 2020 and has been replaced with a new suggestion to increase the CT rate above the current 19% in the March 2021 budget.
What does this mean for investors?
Setting aside the question of whether now is the right time to consider tax rate increases, it is important for individuals and their advisers to think of the prospective changes that are coming over the hill and what to do to mitigate the impact. For those taxpayers who currently sit on large accumulated CGT gains, there may be a concern about if, or when, to bank the current CGT rate against those gains as post-budget day, that may not be possible.
For taxpayers who currently structure their wealth through corporate entities, a CT rate increase means an increase in taxation on investments within those structures. Individuals will be considering how to preserve the current tax efficiency those corporate income and gains have become accustomed to.
What can be done?
An onshore or offshore bond can facilitate the investment of capital with accumulation of income and gains while allowing tax efficient access to the original capital over time (eg. Cumulative tax deferred access up to 5% of the original premium per policy year). The income and gains are then subject to Income tax, as opposed to CGT on realisation. Should CGT and Income tax align or become more aligned, the added value of an onshore or offshore bond is the deferral of that income tax impact until sums are withdrawn from it, allowing individuals to ride out fluctuations in tax rates until they stabilise or reduce again. In addition, allowing compound growth of investments can be very effective for returns, particularly when faced with a high tax environment.
One option is to dispose of currently held assets or investments at a lower CGT rate (this could also be done via an in-specie transfer, so the assets are not sold but transferred instead) and contribute crystallised gains into an onshore or offshore bond, allowing the future gains and income to accrue without an immediate tax impact.
A major advantage of onshore or offshore bonds is the ability to assign segments to others like your children when they are over 18 without an immediate tax consequence, as they can subsequently sell those segments and fully utilise their personal income tax allowances.
Gains realised are taxed at the investors highest rate of Income tax (up to 45%), assuming the investor is UK resident for tax purposes. No “exit tax” is raised if the investor leaves the UK, and any taxable gains are mitigated by:
a) Top-Slicing relief – where, for example, the investor is a basic rate taxpayer before the gain is added to income. Investors who limit other sources of income in a particular tax year can benefit, with potential to limit tax to the basic rate, and
b) Time apportionment relief – where the investor’s taxable gain is reduced to reflect an ownership period while non-UK resident.