How to beat the potential capital gains tax hike
Chancellor Rishi Sunak has signalled he is looking to shake up how capital gains tax (CGT) is paid, which could leave taxpayers with a higher tax bill.
Sunak has asked the Office for Tax Simplification to look at how CGT is structured, whether the tax can be simplified and if more help can be given to individuals in the administration of the tax.
While he doesn’t explicitly say so, many people assume that the timing of the review indicates the Chancellor could be looking at changing the tax as one way to raise money in order to pay for the Government’s cost of the current Covid-19 pandemic.
The Government has spent a large amount of money on helping the country to stay afloat during the current crisis and everyone expects this year’s Autumn Statement to reveal how it plans to pay for this support. While additional Government borrowing is one solution, tax hikes may also be on the agenda.
The review will look at the differences between the CGT system and the income tax system, how private residence relief works and the reliefs and exemptions on offer.
The move might not be entirely unpopular with the British public. Research from AJ Bell showed that two thirds of people think we have a responsibility to contribute towards the cost of the recent measures.
When questioned, the most popular tax to increase was either dividend taxes or CGT, with 37% of respondents thinking it was acceptable to raise those taxes. This was followed by a third of people who said income tax and 22% who said inheritance tax.
WHAT COULD CHANGE?
Changing tax rates: One area that may change is the rates charged on CGT (see below for current rates). There is a big difference between the rates charged for income tax and CGT.
An additional rate taxpayer, for example, would pay 45% tax on any income they make over their personal allowance, but only 20% on their investment gains. One thing the Government could do is bring these rates in line with each other.
Cutting allowances: In a similar vein to above, individuals have a tax-free rate for their income and for their capital gains – currently £12,500 before income tax kicks in and £12,300 for CGT.
These allowances could be brought together, so someone only has one lot of £12,500, for example, before they incur tax. This would bring lots more people into the bracket of having to pay CGT.
Scrapping main home relief: At the moment you pay no CGT on the gains you make on your main home – in part this is offset by the fact that you have to pay stamp duty tax when you buy a new home.
However, one suggestion has been that the Government could remove or limit this relief. This would mean lots of people who had made a gain on their property would face a large tax bill, but in turn could raise a lot of money for the Government. It would be an odd move to make just as the Government has put in other measures to try to get the housing market moving.
HOW CAN YOU BEAT THE HIKE?
If you’re worried about any rise in the tax rates or cuts to allowances, you could think about locking in gains now. Remember, anything in an ISA or SIPP is exempt from CGT, so you don’t need to worry about those gains. But outside of these tax wrappers your investments could face CGT.
You can choose to cash in gains up to your annual allowance this year, in order to lock in some gains and make use of that allowance. If your gains are higher than your allowance, you could transfer assets to your spouse so they can use their allowance.
Transfers to spouses are exempt from CGT, but if they then sell the assets they’ll face CGT on any profit between the price you bought the investment and the price at which they are selling. If you transfer assets to them, they can then cash in the gains and use their annual allowance to avoid a large tax bill.
For example, let’s assume Mrs Smith has investments that have a £25,000 gain on them, and she is a higher-rate taxpayer. If she sold those investments in one tax year, she’d use her £12,300 allowance but still pay tax at 20% on the remaining £12,700 gain – which would equal a £2,540 tax bill.
However, if she transferred the investments with the remaining £12,700 gain on them to her husband, who is a basic-rate taxpayer, he could use his £12,300 tax free allowance – leaving just £400 of gains to pay tax on. At his lower 10% CGT rate this would mean a tax bill of just £40 – saving £2,500.
Another option is cashing in the gain and rebuying the asset in your ISA, assuming you have some of your annual ISA allowance remaining. This is called ‘bed and ISA’ and means you can use your annual allowance, keep hold of the investment and future gains will be exempt from CGT.
HOW DOES CAPITAL GAINS TAX WORK?
You pay capital gains tax on any profit you make when you sell an asset that has risen in value.
Some assets are tax free, including your main home. Everyone gets a tax-free allowance each year, which is currently £12,300 per person.
Beyond this level any gains are taxed depending on your income tax rate, so basic-rate taxpayers pay 10% (or 18% on property) while higher and additional-rate payers pay 20% (or 28% on property).
If you give money to your spouse you don’t have to pay CGT, nor on assets including land, property or shares you gift to charity. If you make a loss on an asset you can offset that against any gains you make on other assets in order to reduce your tax bill – and you can carry forward losses into future years.