15 July 2020
The UK’s Chancellor has commissioned a review of the taxation of chargeable gains in relation to individuals and smaller businesses, including capital gains tax (CGT). Whilst this review is not share plan focused, it could have significant implications for UK taxpayers in share plans, as we explain below.
In a letter released earlier this week (available here) the Chancellor, Rishi Sunak, has directed the Office of Tax Simplification (OTS) (which is an independent office of HM Treasury) to identify simplification opportunities in relation to the taxation of chargeable gains. In particular, the Chancellor has specifically directed the OTS to consider “any proposals…on the regime of allowances, exemptions, reliefs and the treatment of losses within CGT, and the interactions of how gains are taxed compared to other types of income”.
In response to the Chancellor’s direction, the OTS has now published both a survey and a call for evidence to seek views about CGT. The OTS is seeking views from individuals, businesses, professional advisers and representative bodies. The survey has already opened, with the OTS stating this will be open until the end of the summer. The call for evidence has two elements: the first seeks comments on CGT principles and closes on 10 August, and the second seeks comments on practical and technical points, closing on 12 October.
Why is this happening?
The Treasury has said that it is merely following “standard practice” to review taxes regularly. However, the reference by the Chancellor to specifically consider the taxation of chargeable gains compared to other types of income has led to speculation that there could be an alignment of the rates of CGT and income tax, a move likely to be supported by Labour generally and which would increase the Treasury’s tax revenues following this period of increased spending.
What are the current CGT rates?
CGT rates are much lower than UK income tax rates. Currently, CGT is charged at 10% for basic rate taxpayers, rising to 20% for higher and additional rate tax payers (although slightly higher rates apply to residential property). Individuals also currently benefit from an annual CGT exemption (£12,300 for the 2020/21 tax year).
By way of contrast, income tax rates in England and Wales are 20% (basic rate), 40% (higher rate) and 45% (additional rate) and those earning less than £125,000 per year also benefit from an annual income tax exemption (currently up to £12,500).
Whilst simplification is the stated aim of the Chancellor’s review, an alignment of the taxation of chargeable gains with the taxation of other types of income would also serve to increase tax revenues.
The pie chart above (which is prepared based on data from the Institute of Fiscal Studies survey from November 2016) illustrates the stark difference in the government’s revenue from income tax when compared to capital taxes, including CGT (30% compared to just 1%). Whilst employment taxes such as income tax would likely still remain the bigger source of government revenue should rates of income tax and CGT be equalised, it would nevertheless raise much needed funds for the government at a time when public spending has increased rapidly.
The outcome of this review could have significant implications from a share plans perspective. For UK taxpayers participating in share plans, low rates of CGT can help encourage participants to hold onto their shares, knowing that any increase in value is taxed at lower CGT rates (or not taxed at all, if the gain falls within their annual exemption). Any reductions in the CGT annual exemption and/or equalising of rates of income tax and CGT would negatively impact the position of UK taxpayer participants.
Similarly, for those participating in UK tax-advantaged plans (such as Sharesave or the Company Share Option Plan), a gain arising on a tax-qualified exercise is currently subject to the lower CGT rates (subject to the annual exemption), rather than the higher income tax rates. Should the rates be equalised and/or the annual exemption be reduced or cut entirely, this would take away much of the advantage that such plans offer to employees (although the deferral of the tax point until sale may still be valuable to some).
By way of contrast, any increase in CGT rates would serve to make the UK tax-advantaged Share Incentive Plan (SIP) even more attractive to participants, given there are normally income tax savings and there is also no CGT payable on direct sales of shares from a SIP.
Whether Enterprise Management Incentive (EMI) options would still be able to qualify for business asset disposal relief (formerly entrepreneurs’ relief) remains to be seen but could make these options even more attractive. EMI can only normally be offered by small-medium companies but if options qualify for the relief gains are taxed at just 10%.
It is obviously still early in the consultation process and the outcomes of the OTS’s review will hopefully be shaped by the submissions they receive. Tapestry will be keeping a watchful eye for developments and will participate in the consultations. If you have views that you would like us to submit on your behalf, please let us know. The OTS has indicated they may be in a position to publish an interim update once the first of the consultation deadlines has passed, and we will of course update you when we hear more.
If you have any questions about this alert, or if you would like to discuss your remuneration structures, please do let us know.
Sarah Bruce and Emma Parker