Overview
A new report by Centre for the Analysis of Taxation (CenTax) finds that few UK policies have faced as turbulent a history over recent decades as Capital Gains Tax (CGT). They find the current CGT regime is the product of a series of contradictory reforms that have rendered the rules needlessly complex, inefficient, and unfair. Laying out a roadmap for much-need change, this report recommends a comprehensive package of CGT reforms going beyond changes to the tax rate. They use de-identified tax data accessed via His Majesty’s Revenue and Customs (HMRC) to provide estimates of the revenue and distributional impacts of these recommendations. Importantly, their policy proposals include changes to the tax base that will shut down opportunities for tax avoidance and improve investment incentives and growth. The report emphasises that these measures are essential alongside any increases in the tax rate in order for CGT reform to be effective.
The report finds that a comprehensive reform would raise an additional £14bn in total revenues, whilst simultaneously taking over 100,000 people out of CGT altogether. It would also remove many existing opportunities for avoidance and improve incentives for capital investment.
Key findings
The report proposes a package of five reforms:
1) Equalise CGT rates with tax rates on income
Differential tax rates on income and gains cause distortions to real economic activity and create strong incentives for tax planning and avoidance. The preferential tax treatment of capital gains leads to both vertical and horizontal inequity in the tax system and has sparked a complex array of anti-avoidance rules to police the boundary between income and gains. Under a system where the tax rates on income and gains are equalised, most of these rules would cease to be necessary, bringing major advantages in simplifying the tax system and making it easier to understand. We recommend equalising CGT rates with Income Tax rates. This entails a rate of 20% (Basic Rate), 40% (Higher Rate) or 45% (Additional Rate) on taxable gains, depending on the taxpayer’s Income Tax band after aggregating their income and gains.
2) Introduce an ‘investment allowance’
The current CGT system subjects the entire nominal gain to tax. This raises clear concerns on both fairness and efficiency grounds. We propose (re)introducing an investment allowance that is deducted from the tax base when calculating taxable gains. Administratively, the allowance would operate in the same way as Nigel Lawson’s ‘Indexation Allowance’, which applied to disposals by individuals from 1987 until 1998. Our central modelling is based on an allowance for the (risk-free) rate of return, in line with the recommendations of the Institute for Fiscal Studies in the Mirrlees Review, though we also provide estimates using an allowance for inflation.
3) Remove death uplift
There is currently no CGT on assets held until death, as inheritors acquire assets with the base cost ‘uplifted’ to their market value at that date. This creates a significant incentive to indefinitely defer disposals of assets with substantial accrued gains. It similarly disincentivises additional investment in business assets shortly prior to death, since the credit for that investment is wiped out on death. If CGT rates are equalised with Income Tax rates it is therefore crucial that the existing death uplift is also removed. Our favoured approach is to ‘carry over’ the original base cost of the asset to the inheritor, such that when eventually sold, the inheritor pays CGT on the full gain since the asset was acquired by the deceased. To address concerns over double taxation, we recommend giving the inheritor a deduction against CGT (on a subsequent disposal) in respect of the IHT already paid on the asset.
4) Rebasing on arrival and deemed disposal on departure (ROA-DDD)
Currently, if individuals emigrate prior to disposing of assets, they can escape UK CGT on the gains they made whilst living in the UK. This results in lost revenue even if the emigration was not directly tax motivated, although there is evidence to suggest that the destinations of individuals holding large business gains are disproportionately low-tax jurisdictions. We recommend the introduction of rebasing on arrival with deemed disposal on departure (‘ROA-DDD’) for CGT. This policy would ensure that gains made by an individual whilst UK resident are taxed in the UK, even if they subsequently move abroad. It also removes from UK CGT any gains that individuals made before they arrived in the UK, which ensures that the resulting tax treatment is fair and symmetrical.
5) Improve tax treatment of losses
There are currently several restrictions on using capital losses to offset other gains or income. This results in an asymmetry whereby gains on successful investments are taxed in full but losses on unsuccessful investments are not given full relief, which discourages risk-taking and entrepreneurship. We think that reforms to the tax treatment of losses should be subject to consultation and further evidence-gathering to ensure an appropriate balance between economic objectives and administrative feasibility. However, we recommend that some of the revenue generated from the other measures in our package should be set aside to fund a more generous loss regime.
Further reading