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.

Most Popular

The MoneyWeek Podcast: Asia, financial repression and the nature of capitalism

The MoneyWeek Podcast: Asia, financial repression and the nature of capitalism

Russell Napier talks to Merryn about financial repression – or "stealing money from old people slowly" – plus how Asian capitalism is taking over in t…
16 Jul 2021
Commodity supercycle or not, here’s a metal that’ll still be in demand – tin
Industrial metals

Commodity supercycle or not, here’s a metal that’ll still be in demand – tin

Commodity prices may have come off the boil recently. But for tin, the only way is up. Dominic Frisby picks the best ways to invest.
7 Jul 2021
Three companies that are reaping the rewards of investment
Share tips

Three companies that are reaping the rewards of investment

Professional investor Edward Wielechowski of the Odyssean Investment Trust highlights three stocks that have have invested well – and are able to deal…
19 Jul 2021