What the chancellor’s OTS review of Capital Gains Tax likely means for contractors
It was last week that a review into Capital Gains Tax was announced but it’s from this autumn that the move by the chancellor could spell big, unwelcome changes for contractor limited company workers, writes Leila Ghazzali, trainee solicitor at WTT Legal.
In fact, on July 14th Rishi Sunak called for the Office of Tax Simplification (OTS) to review the purpose, product, and effectiveness of Capital Gains Tax (CGT) on individual gains and the impact on small businesses.
The scope of this review is directed at identifying simplification opportunities relating to administrative and technical issues, as well as areas where the (existing) rules could distort taxpayer behaviour or do not correspond to what policy intended.
What Sunak says
There are more clues in the chancellor’s wording as to what contractors and other taxpayers should expect.
He said: “I would like this review to identify and offer advice about opportunities to simplify the taxation of chargeable gains, to ensure the system is fit for purpose and makes the experience of those who interact with it as smooth as possible.
“In particular, I would be interested in any proposals from the OTS 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.”
‘Selling’ reform of the selling tax
While it is being ‘sold’ as a simplification exercise, it is likely the chancellor is really looking for the green light to align capital gains with income tax and in the process, raise revenue to counterbalance the spending amid the current coronavirus pandemic.
This alignment idea is not new however, as around 10 years ago a report (The Mirrlees review) raised some fundamental questions, notably “whether government should continue with different rates of tax for different types of income derived through capital gains”. At the time, the recommendation was not accepted, but in these unprecedented times of covid-19, it may be that an opportunity has arisen to ‘sell’ such an idea to the public.
Today, CGT rates are significantly lower than the current income tax rates. CGT’s higher rates are 28% and 20% for residential homes and for other chargeable assets, respectively, whereas the higher income tax rate is 40% and the additional rate 45%. It is clear that this significant difference will not go unnoticed by the OTS.
What is Capital Gains Tax?
In its simplest terms, CGT assesses the difference between a sale of the asset and its original purchase price.
The rate charged on the gain is either 10% or 20% for non-property assets and 18% or 28% for residential property, depending on the extent of the gain and the amount of taxable income earned by the individual.
Capital gains can also be reduced by deducting capital losses that may occur when the asset is sold less than the original purchase price or by benefiting from reliefs that may be available.
How contractor limited companies and other freelance professionals could be hit
The focus of the OTS review is limited to individual gains and gains of individuals small businesses i.e. when they may be disposed of so this may affect which reliefs that are available. This comes after the new Entrepreneurs’ Relief reforms (now known as Business Asset Disposal Relief), which came into effect on March 11th 2020 and has the effect of reducing the individual’s Lifetime Allowance of claims from relevant gains significantly, from £10 million to £1 million.
With the review of CGT, not only could business asset relief be affected, but so could many other aspects of the tax, such as Private Residence Relief (when the main residence is sold) or Investors’ Relief. (N.B. This relief for investors is for individuals who realise chargeable gains upon the disposal of ‘qualifying shares’ or of an interest in shares and will have 10% of CGT applied to such gains with a lifetime limit of £10 million).
The availability of CGT’s Annual Allowance (currently £12,300) could also be impacted and reduced after the review concludes.
With IR35 reform already, is the CGT review yet more writing on the wall for PSCs?
So, these are all considerations that should be taken into account and monitored. These CGT considerations are especially relevant for contractors who have been compelled to change their working practices due to new IR35 tax reforms coming into force in the private sector in April 2021.
As more contractors consider the prospect of full-time employment either by working through an umbrella, moving to PAYE as the end-client’s employee or on their agency’s payroll, their PSC may no longer be as necessary.
Currently, if a PSC has more than £25,000 ‘cash’ in the company, then the closing down of the company by way of Members Voluntary Liquidation (MVL) allows for the extraction of the assets as capital rather than income, making it subject to CGT, rather than the higher income tax rate, depending on whether or not the relevant requirements are met. In some instances, Entrepreneurs’ Relief will be available, serving to reduce the tax liability significantly.
Other CGT planning may also need to be considered, such as taking advantage of the Annual Allowance’s £12,300, by crystallising gains from investments or otherwise.
Plan for a rainy autumn day
As Mr Sunak’s Autumn Budget 2020 approaches, it would be wise to expect an announcement on changes to the CGT regime. And crucially, these changes could potentially be implemented and take place on the very same day as the chancellor’s statement. Therefore, it is important to assess your current situation and consider if you will be impacted by any potential CGT changes that may be on the horizon, because it is almost impossible to conceive these changes being anything other than adverse, as far as contractors are concerned.