Thursday, 19 November 2020

Capital gains tax should be fairer and simpler


Charging CGT at income tax rates is not that controversial — it’s been done before

“Taxes should be simpler and fairer” is the common mantra of better off people and tax commentators.

Even accountants who make their living wrestling into submission some of the more arcane rules of HM Revenue & Customs tell us the UK tax code is the longest in the world and should be simplified. This is usually when opposing yet another attempt to close a loophole they sell to their clients.

So I was shocked to read the numerous objections to the latest report by the Office for Tax Simplification which proposed making capital gains tax (CGT) simpler and fairer. It proposes:

  • Chucking out the separate rates of tax for gains and income.
  • Slashing the annual £12,300 gains allowance to as low as £2,000.
  • Scrapping highly complex reliefs intended to encourage entrepreneurs, but which do not do that.
  • Taxing equally the products of our labour whether we are paid in wages, dividends, or share options (adding the word “options” allows tax to be avoided). 

What could be fairer? Or simpler?

No, no, no, said one credulity-stretching comment to the OTS. “Without a lower rate of tax on its eventual sale [I] would not have worked nearly so hard to expand the business.” Really? You work to pay less tax on money you have not even made yet?

Perhaps the key to all the objections is this sentence in the review: “If gains were taxed at income tax rates some taxpayers could face a substantial increase in their overall tax liability,” the OTS said, citing HMRC estimates that aligning rates of CGT and income tax could raise £14bn. Objectors seem to think that simplicity and fairness is fine as long as it doesn’t mean more tax is paid by the well off.

And the people who pay CGT are well off. If you inherit a home and keep it for a few years and then sell it the CGT will be modest, only being calculated on the difference between its value at inheritance and price at sale (CGT death uplift prevents it being valued when the deceased acquired it, though the OTS also recommends scrapping this uplift). But you are better off than most because you have a second home and when it is sold you have the value of it.

In fact, charging CGT at income tax rates is not that controversial. At the end of its report, the OTS notes that for the 20 years to 2007-08, that is how it was charged. Nigel Lawson, the Conservative chancellor, believed there was “little economic difference between income and capital gains” so they should be treated along similar lines.

He echoed the principle of Labour’s James Callaghan, who introduced CGT in 1965 and told Parliament: “Gains confer much the same kind of benefit on the recipient as taxed earnings . . . the present immunity from tax of capital gains has given a powerful incentive to the skilful manipulator.”

The OTS report has many examples of the way skilful manipulators have got to work to minimise the effect of CGT on share and business owners. Two examples in the report (cases 8 and 9) show the advantage for self-employed people to set up a company, pay themselves largely in dividends, store excess money in the business, and then liquidate the company and claim business asset disposal relief to slash the tax on the gain to 10 per cent. Thus director Rose pays £108,817 less tax over five years than self-employed Geoff doing the same job for the same income. Rules that distort behaviour to pay less tax are found throughout the review. But the OTS loses its nerve when it comes to scrapping them.

Stupid Geoff, you might say. No. Stupid tax system that includes rules which the OTS says “distort behaviour, pushing taxpayers towards incorporation”. In the last tax year, this business asset disposal relief gave £58,700 each to 46,000 people at a cost of £2.7bn — even though OTS says it does not “stimulate investment and risk-taking by business owners”.

Rules that distort behaviour to pay less tax are found throughout the review. But the OTS loses its nerve when it comes to scrapping them. It tries to find fairness by tinkering with the dog’s breakfast rather than starting again with the basic tin of Chum, in the form of the principles of Callaghan and Lawson. It should ignore the special pleading of the better off that “it’s not fair”.

Fairness is being fair to all taxpayers, not just the few who pay CGT. A truly fair and simple system would tax a capital gain like income in the year it is received. Just as a bonus at work or a pension withdrawal is added to income and taxed that year, so should a capital gain.

The right level for the annual exemption is not a de minimis £2,500 but zero. Scrap relief for enterprise investment schemes, social investment relief, venture capital trusts shares, investor relief, rollover relief, death uplift, holdover relief and losses relief. Get rid of anything that gives scope for well-paid advisers to help wealthy people game the system.

Tax the 265,000 people lucky enough to have taxable capital gains (which would rise to 1m after the changes) at the same rates as the 32m who pay income tax, with no choice and before they even see it. And prevent the manipulators by applying the change from Budget Day afternoon.

Simpler and fairer. Who could possibly object?

This piece first appeared in the Financial Times 19 November 2020.