CGT Reform: What could it mean for IHT and business relief?

In the second of our two-part series on the recent CGT reform recommendations, our M&G colleague Les Cameron, Head of Technical at Prudential, assesses what might be the impact on inheritance tax and business relief.

As we explained in Part One of this two-parter, the Office of Tax Simplification (OTS) – at the behest of Chancellor Rishi Sunak – has undertaken the biggest independent review of capital gains tax in its history. The aim is to see how the CGT regime can be simplified and the rules improved to achieve their intended outcome and avoid distortive behaviour by asset owners.

Two OTS recommendations to garner attention have been the advice to align capital gains tax rates with income tax rates (to deter investors using the currently more favourable CGT regime to supplement income) and to reduce the annual exempt amount.

Here we look at what the review has suggested for inheritance tax (IHT) and business reliefs.

Interaction between CGT and IHT

Transferring capital, whether by lifetime gifting or on death, has both IHT and CGT implications.  Both taxes have their own rules and policy rationales but there is also a fair amount of overlap. The current rules aren’t coherent and are creating distortion. 

A few examples illustrate this:

  • Bob dies with assets qualifying for business relief: There is no IHT and no CGT to pay on death.
  • Sarah dies leaving her OEIC portfolio to her husband: There is no IHT to pay, Sarah’s gain dies with her, and her husband inherits the portfolio at its current value.
  • Roy makes a lifetime gift of investments to his children: The gift is a disposal for CGT purposes AND if he dies within seven years, it may also be subject to IHT.

In its first report, the OTS has recommended amending the treatment of gains on death. Where an IHT relief or exemption applies, the OTS recommends that the CGT uplift on death (i.e. ‘your gain dying with you’) should not apply. Instead, the asset is transferred on a “no gain/no loss” basis.  It has also suggested removing the CGT uplift entirely.

If there is widespread removal of the CGT uplift, the OTS recommends a rebasing of asset values to make base costs better known (it suggests rebasing to the year 2000) and looking at widening the availability of gift holdover relief. 

Our thoughts

  • The overlap between CGT and IHT is no doubt a complex area that could be simplified. In particular, it does seem strange to allow a capital gain to die with an individual rather than passing it on to the new asset owner.
  • Changes to CGT/IHT treatment could have a major impact on mainstream financial planning. With a £5.5 trillion intergenerational wealth transfer forecast to take place in the next few decades, it’s an area that planners need to watch closely for any change. 

Potential changes to business relief

Entrepreneurs’ Relief is a business relief that levies a tax rate of just 10% on qualifying gains when a sole trader or business partner disposes of a business, subject to a lifetime limit of £1 million.

It’s now known as Business Asset Disposal Relief and the OTS think it’s mistargeted and doesn’t stimulate business investment or risk taking – its original purpose.

The OTS has said this relief should instead be targeted at those retiring. This could involve introducing a qualifying holding period of 10 years (currently, business owners only need to have owned a business for two years to qualify for relief). An age limit could also be introduced to target retirees.

The OTS also recommends that Investors Relief – which reduces the CGT rate paid on the disposal of unlisted company shares by individual investors to 10% – is simply abandoned because of low uptake and interest.

Our thoughts

  • These changes will clearly affect SME business owner clients. But they are perhaps more of a concern for accountants with an indirect impact for planners involved in corporate investments or helping owners to extract profits from their business. 
  • Reducing CGT relief may incentivise business owners to extract value from their businesses as they grow instead of waiting until retirement.
  • Investors Relief is relatively new, unpopular and, we agree, should be abolished.

High time to simplify CGT?

It remains to be seen which, if any, of the OTS recommendations the Chancellor chooses to enact, and whether business owners, property/buy-to-let investors or ordinary investors will be affected.

The Chartered Institute of Taxation is warning that piecemeal changes are unlikely to lead to a more coherent system. So is the time ripe to see a wholesale overhaul of the CGT regime on a par with the pension tax simplification announced 18 years ago?

There are pros and cons. CGT simplification would be welcome but with the scale of public spending during the pandemic, and the need to increase the tax take, it may also bring tax increases.

However, it could at least send out a message that the anomalies, inequities and counter-intuitiveness that have dogged this part of the tax system for so many years are finally being addressed.

Part 1: CGT Reform: What could it mean for rates and exemptions?

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