Weekly Spotlight: Capital Gains Tax
A new report from the Office of Tax Simplification (OTS) this month1 suggests that the rules around Capital Gains Tax might be changing. Many people might end up paying more of it, however, this can potentially be mitigated by changing the structure of our assets.
With this in mind, it is worth taking a look at how the tax works and what can be done now to prepare for changes to come.
What is Capital Gains Tax, and who pays it?
Sometimes known as CGT, this is a tax paid when you dispose of an asset for more than you bought it for. You pay tax on the gain you have made, not on the entire profit you have made from the sale, but even so, the amounts involved can be high.
The OTS report says that the mean average amount of capital gains tax paid now is £32,000, which is five times more than the equivalent figure for income tax. Far fewer people pay CGT, however; it raises £8.3 billion for the Treasury from 265,000 people, compared with £180 billion a year from 32million people paying £5,800 each.
CGT tends to be paid by older people, with those between 45 and 74 accounting for nearly 80 per cent of gains, with a small number of business owners paying most of it.
What rate is it paid at?
Confusingly, CGT has several rates, depending on the asset being disposed of, and the tax band of the person who is disposing of it. If you are making a gain by selling shares and you are a basic rate taxpayer, you will pay 10 per cent of the gain in CGT, while those who pay higher and additional rate tax pay 20 per cent. If you are selling a second home or buy-to-let investment (your main residence is exempt from CGT), you will pay 18 per cent of the gain you make, or 28 per cent if you are a higher and additional rate tax payer.
When don’t you need to pay CGT?
CGT is quite confusing, and there are some assets that are exempt from the tax, including vintage wines and classic cars. There is also an annual exempt allowance of £12,300 this financial year - meaning you can make gains of this amount without paying CGT.2
In some cases, you can reduce the amount you pay by offsetting losses made in the same tax year or in a previous tax year, or by claiming a specific relief.
Gains inside ISAs and SIPPS (self-invested personal pensions) are also tax free, and you can transfer assets to a civil partner or spouse without incurring CGT.
What might the government change?
The OTS report has fuelled a suggestion that the government might want to boost their tax income to pay for the pandemic by ensuring that more people pay CGT. They could do this by lowering the annual exempt amount, or by aligning the rates with income tax rates, so that those who benefit from capital gains pay more.
They may also remove a clause known as the ‘uplift on death’. This quirk of CGT policy means that when someone dies there is no CGT charge on the asset and the clock is reset on the value of the asset. It can then be passed on to a family member at the current market value, and, if sold, any gain is calculated from the time at which it is transferred.
Any of these policy changes would result in many more people paying CGT, and paying larger amounts of it, so it makes sense to act now if you think you might be affected.
What can I do?
Some of the things you can do to mitigate these possible changes are quite simple, such as making use of ISA or pension allowances and selling assets in annual tranches where you can to make use of your exempt allowances.
Others are more complex, such as making use of losses elsewhere and selling some assets and allowing a spouse to buy them back within an ISA, to use up allowances. There are also specific investment schemes that are free from CGT.
However, everyone’s situation and risk tolerance is different and not all of these solutions will be suitable for everyone, so you should speak to an expert financial adviser in order to ensure you understand the best options for you.
This article is for information purposes only and is not suggesting a suitable investment strategy. Always seek financial advice before taking any action.