OTS’s capital gains tax review: more tax on disposal of the family farm?

Many of us will have had mixed feelings while watching Rishi Sunak, the Chancellor of the Exchequer, announcing the furlough scheme and help for the self-employed including some foreboding about the massive amount of money being spent, and how it is to be recouped.
Consequently, the request in July from the Chancellor to the Office for Tax Simplification (OTS) for a review of possible measures to simplify capital gains tax (CGT) has been met with some scepticism as to whether the intention is just to reform and simplify CGT or whether it is also to increase the tax take.

A minor tax

CGT was introduced in April 1965. Before that date asset gains were free of tax, inevitably encouraging schemes to convert taxable income into untaxable gains. The tax has undergone various manifestations over the years, for example, an indexation allowance to counter the gains caused by inflation could be claimed at one point. CGT rates have also oscillated over the years with a flat 30% rate (once equivalent to the basic rate of income tax) applying until 1988.

In terms of the amount of money it contributes to the public purse, CGT exceeds inheritance tax (IHT) but is very much a minor player behind the big beasts of income tax, VAT and national insurance. It is interesting to note that the sums raised are contributed by a relatively small number of taxpayers on quite high gains, and that this trend has accelerated over the past year. In the last year for which we have figures, 40% of all CGT came from those who had made gains of £5 million or more. Individuals with CGT liabilities therefore form a relatively small, and comparatively wealthy, proportion of taxpayers.

The OTS’s recommendations

Rate alignments

For several years there have been four different rates of CGT depending on whether the person liable to pay it is a higher rate or basic rate income taxpayer, and on whether the asset disposed of is property or another type of asset. The rates are lower than income tax rates which the OTS believes is “one of the main sources of complexity”. Aligning CGT rates with income tax rates would raise substantial extra tax revenue and, according to the OTS, remove the incentive to try to reclassify income as capital gains.

If CGT and income tax rates are more closely aligned the OTS recommends re-introducing a form of indexation allowance to take gains caused by inflation out of the charge to tax.

Annual exemption

This currently amounts to £12300 per individual. The OTS recommends that this should be reduced (perhaps to between £2000-£4000) so that it operates “as an administrative de minimus threshold.” The OTS suggests that this could be done in conjunction with a reform of the chattels exemption which applies on the disposal of personal effects.

Business Asset Disposal Relief (BADR)

The OTS makes some recommendations about further tightening of BADR (formerly Entrepreneurs’ Relief) proposing three possible changes: increasing the minimum shareholding from 5% to 25%, increasing the holding period to ten years and re-introducing a qualifying age (as was the case with the former CGT retirement relief). The abolition of investors’ relief is also suggested. The changes to BADR would be on top of the recent reduction in the amount of relievable gains from £10 million to a lifetime allowance of £1 million.

CGT and business and agricultural assets

One of the OTS’s recommendations is that assets subject to business property relief and agricultural property relief (APR), which often reduce to nil the amount of inheritance tax payable on death, should not benefit from a CGT uplift on death enabling beneficiaries to receive assets IHT free and dispose of them with lower CGT bills than would otherwise be payable.

This could substantially increase the potential tax bill of someone inheriting a family farm. For example, George leaves his dairy farm to his son John. The farm is valued at £1.5 million but no IHT is payable as APR applies. Two years later John sells the farm. At present he is only liable to pay CGT on the difference between the value at George’s death and the sale proceeds.

If the changes mentioned in this report go ahead, John would be liable to CGT on the difference between the value of the farm when George acquired it (or possibly its value in 2000 as outlined below) and its sale proceeds. In addition, Business Asset Disposal Relief might not be available to John ,and the gain may be taxed at his marginal income tax rates rather than the currently lower CGT rates so potentially significantly increasing his tax bill.

The OTS suggests this increase in tax could be offset by rebasing the acquisition date of assets to the year 2000 and reintroducing a wider form of CGT holdover relief for gifts.

Implementation

A number of recommendations have been made by the OTS in recent years (including simplification of IHT) and so far none appear to have been translated into policy or into legislation. In view of the huge bill arising from the pandemic some of the revenue raising measures in the OTS’s report may find favour with the Chancellor, if not in this forthcoming budget then in the ones to come once the pandemic has receded.