Rishi Sunak has kept his plans for the March Budget, which is now just a month away, under wraps. However, if the recommendations of a government-ordered report are taken into consideration, we could see huge changes to the current Capital Gains Tax (CGT) rates.

What is the report and what does it say?

In November 2020, the Office of Tax Simplification (OTS) published a report in response to the Chancellor’s request for a review into CGT. The report recommends aligning CGT rates with Income Tax rates, which would signify a major reform to CGT.

This change would see CGT rates more than double in certain cases, with a possible increase in the top CGT rate from 20% to as much as 45%.

The report, which is intended to simplify and improve the CGT system also recommends reducing the CGT allowance threshold, as well as reductions in reliefs and allowances.

In a recent debate on CGT and new businesses, peers in the House of Lords discussed how this proposed change to CGT rates could affect entrepreneurs, particularly in light of the impact of the COVID-19 pandemic, and Brexit. Here, we take a look at some of their comments and what the changes could mean for your business:

The UK tax system needs to support a competitive economy

Peers raised concerns that raising taxes via CGT in the current climate would be detrimental to economic recovery. Peers suggested that instead, we need to encourage inward investment by encouraging entrepreneurs to start new businesses in the UK. This will do more to develop and support the UK economy, making it more dynamic and competitive, rather than raising taxes.

Dan Bowtell, Smith Cooper Corporate Finance Partner comments:

“Given the scale and challenge that the UK has faced and continues to face during this pandemic it is reasonably likely we will see tax rises in the future.”

“However, the vast majority of employment in this country is created from SMEs which have typically been started by entrepreneurs, in most cases risking their own capital in the process. Removing the financial incentives by increasing or even aligning CGT rates with income tax effectively neutralises the desire for people to take risks, create employment and add to the economic recovery and success of the UK. Yes, we need to recoup the Coronavirus induced Government spending that has been necessary, but aligning CGT rates with Income Tax is not a sustainable solution. In the longer term it will have a more detrimental effect on the UK economy than its short-term fillip now”.

The impact on employee owners and owner-managed businesses

Currently, owner-managed businesses can benefit from the tax-advantages of accrued profits, by realising value on a sale or exit. Business owners can therefore benefit from lower CGT rates, rather than higher income rates that would be due if profits were paid regularly through dividends.

The OTS report recommends that tax on accrued value should be paid at income tax rates rather than CGT, as accrued value should be taxed in line with other rewards of labour such as salary and bonuses.

In the peer debate, it was raised that, CGT rewards owners in these businesses who put their capital at risk, and the changes as suggested by the OTS would represent a significant shift in the tax treatment of owner-managed and employee-owned businesses. Entrepreneurs could be taxed more highly than employees, with concerns that this could discourage entrepreneurship.

Adam Rollason, Smith Cooper Tax Director adds:

“Based on where we are currently in the global fight against this virus, my personal opinion is that the timing couldn’t be any worse for Mr Sunak to announce tax hikes on the very people that are attempting to keep the wheels of our economy turning (and their employees in jobs).”

“To do so would be a proverbial kick in the teeth, and as such, I do not expect any full alignment of Capital Gains Tax and Income Tax to take place in this budget.

It is however noted that the current rates are historically low, so perhaps a more reasonable increase to take us back to the pre-2016 rates of 18% and 28% might be more palatable? Either way, there are some difficult decisions to be made by Rishi next month and it is imperative that business owners understand the impact that these may have on their plans for the future”.

Business Assets Disposal Relief

In the 2020 Budget, Entrepreneurs’ Relief, (a £10m lifetime allowance), was altered to become Business Asset Disposal Relief (BADR), a much less valuable relief with a £1m lifetime allowance. This was changed due to concerns that it was not achieving its aim of encouraging entrepreneurial activity.

The OTS has expressed concerns that despite this change, BADR still fails to benefit the economy, and has suggested further restrictions to those introduced in April 2020.

These proposed restrictions will introduce a more restrictive scheme focussed around retirement.

The OTS also recommends the removal of Investor’s Relief, which provides a 10% rate on certain gains made by external investors, up to a lifetime limit of £10m.

Conversely, peers suggested that in order to encourage entrepreneurial investment, the government should consider increasing BADR, rather than restricting it.

Adam Rollason added:

“Whilst there is no suggestion that these wide-reaching changes will be rushed through, particularly whilst we are still in a global pandemic, those looking to benefit from existing rates and reliefs may, where appropriate, look to bring forward a disposal so that it is made before the Budget.”

We would always recommend speaking to your tax advisor to ensure specific and timely advice is given. If you require any assistance with tax matters, get in touch with our team today.