Rishi Sunak's multibillion-pound tax raid

Rishi Sunak is seeking to fill a £300bn-sized hole in the public books. Investors beware, says Emily Hohler

Britain’s wealthiest citizens could be in for a “multibillion-pound tax raid” after the Office of Tax Simplification (OTS) recommended a “major overhaul” of capital gains tax (CGT), says Camilla Canocchi in the Daily Mail. The review by the Treasury body, which estimates that the changes could raise the CGT haul from £9.6bn to £14bn, assuming taxpayers don’t alter their behaviour, was commissioned by the chancellor, Rishi Sunak, in July as the government considers options to repair the economic damage coming in the wake of Covid-19 (the bill currently stands at £300bn). The recommendations, detailed in a 135-page report, can be “broadly summarised” as aligning CGT rates with income tax and cutting the annual amount that is currently exempt from CGT, says Ian King on Sky News.  

Less than a year ago, Boris Johnson was elected on a promise not to raise “any of the ‘big three’ taxes – income tax, national insurance or VAT”. The appeal of targeting CGT is that only 276,000 households paid the tax in 2018-2019 and therefore any change would affect “fewer than one in 100 taxpayers – albeit many of them older, wealthier and conservative-voting”. CGT applies to assets that can increase in value, including property, businesses, art and shares. Above an annual exemption of £12,300, CGT is charged on gains at 10% for basic-rate taxpayers and 20% for higher- and additional-rate taxpayers, says Emma Agyemang in the Financial Times. This rises to 18% and 28% respectively if the gains relate to residential property. Income tax is charged at a basic rate of 20%, rising to 40% and 45% for higher- and additional-rate taxpayers. 

The considerable difference between income tax and CGT creates an incentive to classify income as profit and to realise annual capital gains of just below £12,300 (the OTS found a “bunching of claims” at this level, notes Carol Lewis in The Sunday Times). The OTS has proposed cutting the CGT allowance to £2,000-£4,000, as well as reducing the number of CGT rates from four to two.  

One benefit, if these changes became law, is that it will correct an “anomaly” that has benefited private-equity groups, creating a “generation of buyout billionaires”, says the Financial Times. Central to how private equity is taxed is the treatment of “carried interest” (defined in the box on page 20). This is currently taxed as capital gains, although it does not reflect a genuine level of personal risk taken on behalf of buyout executives. More broadly, the changes could have a particularly negative impact for investors, business owners, landlords and heirs (see below). 

They could also complicate rather than simplify the tax system, say Robin Vos and Edward Reed on the Macfarlanes website. To mitigate some of the consequences, the OTS accepts that other changes will have to be introduced; for example, allowing basic-rate taxpayers to average gains over the holding period of an asset to ensure they don’t have to pay tax at higher rates for realising a large gain in one year. Another issue recognised by the OTS is that increasing CGT rates will encourage people to hold on to assets, interfering with the efficient allocation of capital as well as reducing CGT revenue. CGT is “ripe for reform” and tax rises are inevitable, but we should tread carefully, says James Coney in The Times. “It’s easy to say tax the rich. It is much harder to do it without destroying the incentive to create businesses and invest in the future.” 

The effect on business owners 

The question posed by the OTS is whether someone who accumulates trading profits in a company and then sells the company, paying CGT on the sale, should be better off than someone who receives profits regularly by way of salary or dividends, say Vos and Reed. Since the OTS acknowledges that there may be many good reasons to accumulate trading profits; that “knowing where to draw the line is very difficult” (it was focusing on personal service companies); and that there is “significant risk” of creating further distortions, we believe that “singling out owners of small companies in this way” will prove hard to justify. Shalini Khemka, CEO of entrepreneurs’ group E2E and a government adviser, told The Times’ James Hurley that the timing was “all wrong” as business owners already faced the “enormous challenges” posed by Covid-19 and Brexit, adding “people will try to offshore or sell up to get ahead of such a change”.  

Investors will pay more 

Reducing the annual CGT exemption to £2,000-£5,000 would reportedly increase revenues by £500m-£900m, dragging up to 400,000 more individuals into the CGT net. In cash terms, it is “insignificant for the very wealthy” and likely to affect the modestly wealthy, making it an “attractive” proposition politically, say Vos and Reed.  

Landlords brace for another squeeze

Aneisha Beveridge of Hamptons calculates that if the CGT allowance were reduced to £5,000 and the CGT rate bumped up, the tax bill for a higher-rate-paying landlord selling for a gain of £69,000 would rise 61% from £15,880 to £25,600. David Alexander, CEO of Apropos property platform, says the changes would “stifle growth, discourage investment and depress the housing market” as landlords raced to sell ahead of any change. 

Will heirs lose out too?

At present, the CGT base cost of an asset is raised to market value at death, without any CGT liability arising. This means the beneficiary can then sell it, without paying CGT, regardless of whether inheritance tax is payable. This encourages people to delay transfers until death. The OTS’s primary recommendation is to scrap the “capital gains uplift” rule if the asset is not subject to inheritance tax (eg, owing to agricultural or business property relief), but it goes on to suggest that the change should be extended to all assets. If it becomes law, it means that capital gains could accrue across generations, making assets “unsaleable due to the astronomical tax liability”, Tim Stovold of Moore Kingston Smith tells the FT. It would also produce the “surprising result” of allowing people to transfer lifetime gifts of any asset without any immediate tax charge, add Vos and Reed. The change is unlikely as it is politically sensitive, doesn’t simplify the tax system and is “close to” revenue neutral.

Recommended

When investors get over-excited, it’s time to worry – but we’re not there yet
Sponsored

When investors get over-excited, it’s time to worry – but we’re not there yet

When investors are pouring money into markets, it can be a warning sign of impending disaster, writes Max King. So how are fund flows looking right no…
26 Oct 2021
An investment trust that gives exposure to frontier markets
Investment trusts

An investment trust that gives exposure to frontier markets

An investment trust investing in small, illiquid emerging markets has disappointed, but deserves another chance, says Max King
26 Oct 2021
What does Rishi Sunak have in store for investors this Wednesday?
Budget

What does Rishi Sunak have in store for investors this Wednesday?

Rishi Sunak is unveiling his spending plans for the economy this week. John Stepek analyses areas which may be most hit by the budget.
25 Oct 2021
How rising interest rates could hurt big tech stocks
Tech stocks

How rising interest rates could hurt big tech stocks

Low interest rates have helped the biggest companies to entrench their positions. But what if rates rise?
25 Oct 2021

Most Popular

Properties for sale for around £1m
Houses for sale

Properties for sale for around £1m

From a stone-built farmhouse in the Snowdonia National Park, to a Victorian terraced house close to London’s Regent’s Canal, eight of the best propert…
15 Oct 2021
How to invest as we move to a hydrogen economy
Energy

How to invest as we move to a hydrogen economy

The government has started to roll out its plans for switching us over from fossil fuels to hydrogen and renewable energy. Should investors buy in? St…
8 Oct 2021
Emerging markets: the Brics never lived up to their promise – but is now the time to buy?
Emerging markets

Emerging markets: the Brics never lived up to their promise – but is now the time to buy?

Twenty years ago hopes were high for Brazil, Russia, India and China – the “Brics” emerging-market economies. But only China has beaten expectations. …
18 Oct 2021