Is capital gains tax (CGT) going to rise dramatically as the government attempts to claw back the cost of extra spending during the coronavirus pandemic? A surprise review of CGT unveiled on Tuesday by chancellor Rishi Sunak opens the door to higher taxes on the wealthy and possibly middle income earners, too.
What is CGT?
CGT is a tax on the profit when you sell (or ‘dispose of’) something (an ‘asset’) that’s increased in value. It’s only the gain that is taxed. Mostly it applies to gains made on property and shares, but also applies to things such as art works. The Office for Budget Responsibility forecast that in 2019/20 CGT would raise around £9.1bn, which is about 1.1% of all tax paid in the UK.
There are lots of allowances which mean few people with average incomes pay CGT. Private homes are exempted, which means there is no CGT to pay if you make a profit when selling your home. You are also only liable for CGT on gains of more than £12,300 for the current tax year. So you could make £10,000 profit from share dealing and still not pay any CGT.
When you are liable for CGT, if you are a basic rate income tax payer, then the CGT levy is 18% on second homes and buy to lets, and 10% on other assets. If you are a higher rate taxpayer, the rates are 28% and 20% respectively.
Why is it being reviewed?
The chancellor has asked the Office of Tax Simplification (OTS) to report on how CGT rates compare with other taxes, and how the present rules may distort behaviour. The Treasury played down expectations of any major policy change. But there are fears that with the manifesto vow not to raise income tax, National Insurance or VAT, there are few other places left for Sunak to find desperately needed income.
There is also the long-term problem that tax on unearned and inherited wealth is generally lower than the tax employees have to pay from working. This means the wealthy often have an effective tax rate that is lower than a working person.
What changes could come in?
The chancellor has three main options: raise the rates levied (say from a maximum of 28% to 45%); reduce the allowances (possibly abolishing the current £12,300 annual CGT-free band); and levying it on other assets – such as private homes and classic cars.
How will it affect homeowners?
So-called ‘private residence relief’ means you don’t pay any CGT on the gains made when you sell your home. If it were abolished, the tax take in 2019/20 would have been £26.5bn, according to Treasury estimates – but is unthinkable under a Tory government. Labour has also rejected ending the CGT exemption, preferring instead to consider higher annual property taxes.
That doesn’t mean property is untouchable from a CGT standpoint. An easier target will be second homes and buy-to-lets; the CGT rate could be aligned with income tax rates – at 20%, 40% and 45% – meaning that the tax take on buy-to-let disposals would rise sharply. The problem for the Treasury is that it can’t force landlords to sell, and they might choose to hold on to property for longer without disposing of it.
What other CGT changes could come into effect?
The OTS is likely to consider a lot of tinkering around the edges. It could reduce Business Asset Disposal Relief which effectively means business owners and significant shareholders (over 5%) pay an effective CGT rate of just 10% on lifetime gains of up to £1m.
Or it could overhaul the various mechanisms used by accountants to defer CGT or offset gains with losses made elsewhere.
What other taxes might the government consider?
A broader wealth tax, although anathema to many in the Conservative party, is gaining some support. It already exists in a number of European countries; Norway has had one since 1892, with individuals paying a total rate of 0.85% on net wealth above the value of about £126,000. It raises around 1% of Norwegian tax revenue. In Switzerland, it is set at between 0.3% and 1% of a taxpayers’ net worth, depending on the canton they live in. Spain imposes a tax of 0.2% on assets over €700,000, rising to 2.5% on fortunes over €10.7m, although as each region is allowed to set their own allowances, it is considered an ineffective tax.
Another option would be to increase inheritance taxes, or reduce IHT allowances, but this is also regarded as politically risky for Tories.