Policy paper

OTS Capital Gains Tax Review: Simplifying by design

This new report highlights ways Capital Gains Tax can distort behaviour, and sets out a framework of policy choice about the design of the tax for government.

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Capital Gains Tax review - first report: Simplifying by design (web copy)

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This new report, written in response to the Chancellor’s request in July 2020, is the first that the Office of Tax Simplification (OTS) has devoted to Capital Gains Tax.

The Chancellor asked the OTS, in particular, 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.’

The OTS’s extensive consultation revealed a range of areas in which Capital Gains Tax is counter-intuitive and creates odd incentives. Some respondents argued that Capital Gains Tax is a barrier to economic growth, others that it is a barrier to a more equitable society.

The stated principles and role of Capital Gains Tax have varied over the last 50 years as political priorities, economic conditions and the needs of the Exchequer have changed.

This report draws on a range of economic perspectives, nearly 100 written responses to the Call for Evidence and analysis of taxpayer data commissioned by the OTS.

The report goes on to set out a framework of policy choice within which government could consider simplifying the design of Capital Gains Tax, to smooth out bigger picture distortions, improve administrative efficiency and make the tax easier to understand and predict, across four interlinked areas:

Rates and boundaries

The disparity in rates between Capital Gains Tax and Income Tax can distort business and family decision-making and creates an incentive for taxpayers to arrange their affairs in ways that effectively re-characterise income as capital gains.

Bill Dodwell, Tax Director, Office of Tax Simplification said:

If the government considers the simplification priority is to reduce distortions to behaviour, it should consider either more closely aligning Capital Gains Tax rates with Income Tax rates, or addressing boundary issues as between Capital Gains Tax and Income Tax. The report covers a range of other issues relevant to each policy choice, including relief for inflation.

Annual Exempt Amount

The relatively high level of the Annual Exempt Amount can distort investment decisions. In tax year 2017-18, around 50,000 people reported net gains just below the threshold. If the government’s policy is that the Annual Exempt Amount is intended mainly to operate as an administrative de minimis, it should consider reducing its level.

Bill Dodwell, Tax Director, Office of Tax Simplification said:

If the government were to reduce the Annual Exempt Amount, it should do so in conjunction with considering reforms to the current chattels exemption and improving the real time capital gain service, including linking these returns to the Personal Tax Account. It should also explore requiring investment managers and others to report Capital Gains Tax information to taxpayers and HMRC, to make tax compliance easier for individuals.

Interaction with lifetime gifts and Inheritance Tax

Capital Gains Tax incentivises owners to transfer business and personal assets to others on death rather than during their lifetime. This may not be best for the business, the individuals or families involved, or the wider economy.

The OTS’s second Inheritance Tax Report recommended that where a relief or exemption from Inheritance Tax applies, the government should consider removing the capital gains uplift on death, and instead provide that the recipient is treated as acquiring the assets at the historic base cost of the person who has died. This would not affect those who retained the assets, but would lead to a tax charge for those who sell recently-inherited assets.

This report considers the policy issues should the government look more widely at removing the capital gains uplift on death, and instead provide that the person inheriting the asset is treated as acquiring the assets at the historic base cost of the person who has died.

Bill Dodwell, Tax Director, Office of Tax Simplification said:

If the government were to look more widely at removing the capital gains uplift on death, it should consider a rebasing of all assets, perhaps to the year 2000, and consider extending Gift Holdover Relief to a broader range of assets, making it easier for individuals to give assets away during their lifetime.

Business reliefs

There is a policy judgement for government to make about the extent to which Capital Gains Tax reliefs should be used to seek to stimulate business investment and risk-taking.

Bill Dodwell, Tax Director, Office of Tax Simplification said:

The OTS considers that Business Asset Disposal Relief is mistargeted if its objective is to stimulate business investment and risk-taking. The government should, having regard to pensions policy more broadly, consider replacing Business Asset Disposal Relief with a relief more focused on retirement.

The government should abolish Investors Relief.

Kathryn Cearns, OBE, OTS Chairman said:

The report highlights many features of Capital Gains Tax which can distort behaviour. This report breaks new ground for the OTS, setting out a framework of policy choice about the design of the tax for government to consider. The OTS work has been informed by a wide range of input from the public, academics, think tanks and professional bodies and firms. There are 11 recommendations across four interlinked areas, where there are policy choices for governments to make.

Notes for editors

In the 2017-18 tax year, £8.3 billion of Capital Gains Tax was paid, and £55.4 billion of net gains (after deduction of losses) reported by 265,000 individual UK taxpayers. This compares with £180 billion of Income Tax paid in that tax year by 31.2 million individual taxpayers.

The OTS is the independent adviser to government on simplifying the UK tax system. The OTS makes recommendations for the government to consider. It does not implement changes – these are a matter for government and for Parliament.

The OTS works to improve the experience of all who interact with the tax system. It aims to reduce the administrative burden - which is what people encounter in practice - as well as looking to simplify the rules. Simplification of the technical and administrative aspects of tax are important, both to taxpayers and to HMRC.

During this review, which was requested by the Chancellor, the OTS consulted with a wide range of individuals and businesses, receiving very strong engagement with its call for evidence from individuals, advisers and the general public.

The OTS has received were over 1,000 responses to an online survey, 96 emails and submissions from individuals and experts, and held 22 consultation meetings.

Given the wide scope of the review, the OTS will produce two reports. This report is on the policy design and principles underpinning the tax; the second which will follow early next year will explore key technical and administrative issues.

The report also contains HMRC data that has never been published before, to inform debate and discussion about the costs and trade-offs inherent in the design of Capital Gains Tax.

Press Enquiries only please contact Julie Gillespie, OTS Press Officer 03000 585028

Published 11 November 2020