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BRIEFING PAPER

Number 5572, 12 June 2020

Capital gains tax : recent developments

By Antony Seely

Inside: 1. The origins of the current tax

structure 2. CGT and the new 50p rate of

income tax 3. Debate on CGT reform after

the 2010 Election 4. The Coalition Government’s

reforms 5. The Conservative

Government’s reforms 6. Annex: CGT statistics

Number 5572, 12 June 2020 2

Contents Summary 3

1. The origins of the current tax structure 6

2. CGT and the new 50p rate of income tax 9

3. Debate on CGT reform after the 2010 Election 12

4. The Coalition Government’s reforms 18 4.1 The June 2010 Budget 18 4.2 Subsequent debate 27

5. The Conservative Government’s reforms 36 5.1 The Summer 2015 Budget 36 5.2 The 2016 Budget 39 5.3 Subsequent developments 41 5.4 Budget 2018 47 5.5 Budget 2020 54

6. Annex: CGT statistics 64

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3 Capital gains tax : recent developments

Summary Capital gains tax (CGT) was first introduced in 1965 on capital gains made on the disposal of assets by individuals, personal representatives and trustees. It is charged on gains in excess of the annual exempt amount, set at £12,300 for 2020/21.1 The tax is forecast to raise £11.4 billion in 2020/21.2

Over the last thirty years, CGT has been substantially reformed three times, as successive governments have sought to meet a number of different concerns: that the tax be charged on real, rather than inflationary gains; that the tax should promote long-term investment and entrepreneurship; and that the tax should not act as an incentive for individuals to avoid income tax, by converting their earnings or profits into capital gains.

In the 1980s the Conservative Government’s concern was that savers and investors were being taxed on paper gains, arising from severe price inflation over the previous decade. Successive Conservative Chancellors introduced an allowance to take account of inflation, ‘rebased’ assets so that only gains made since 1982 would be taxed, and aligned the rates of tax with the rates of income tax. In the late 1990s the Labour Government’s priorities were to use CGT to encourage business growth, and in a time of low inflation, it replaced indexation allowance with a relief which tapered chargeable gains by reference to the length of time assets were held. The taper was more generous for business assets.

By 2007 it was apparent that this relief for business assets was being exploited by executives in private equity funds – some of the most highly-paid individuals in the country – to pay CGT on their gains at 10%, rather than income tax at 40%. In October that year the then Labour Chancellor, Alistair Darling, proposed removing this incentive by abolishing taper relief, and setting a single rate of tax at 18%. Concerns that this would penalise the owners of small business lead to the Government introducing a new ‘Entrepreneurs Relief’ alongside these changes from April 2008. In its 2009 Budget the Labour Government confirmed that from April 2010 a new 50% higher rate of income tax would apply on incomes over £150,000. In turn this led to concerns that the structure of CGT might provide too great an incentive for the very wealthy to avoid tax.

In May 2010 the new Conservative-Liberal Coalition Government announced that it would “seek ways of taxing non-business capital gains at rates similar or close to those applied to income, with generous exemptions for entrepreneurial business activities.”3 On 22 June the Chancellor, George Osborne, presented the Government’s first Budget. In his Budget speech Mr Osborne said that in reforming CGT, “my concern has been to balance the competing demands of fairness, simplicity and competitiveness.” A new 28% rate would apply, from midnight on Budget day, to gains made by higher rate taxpayers. The 18% rate would remain for basic rate taxpayers. Entrepreneurs’ Relief would be substantially increased to “protect the incentives to succeed in business and to innovate”, but there would not be a new relief for the length of time an asset had been held, as “the complexity and administration involved [in tapers or indexation allowances] would have been self-defeating.”4

Over the remainder of the 2010-15 Parliament the Coalition Government did not make any other major changes to the tax. Some commentators suggested that the higher rate

1 HM Treasury, Overview of Tax Legislation & Rates, March 2020 (Annex A) 2 OBR, Economic & Fiscal Outlook, CP 230, March 2020 (Table 3.3). This compares with forecast receipts from

income tax of just under £208 billion in the same year. 3 HM Government, The Coalition: our programme for government, 20 May 2010 p30 4 HC Deb 22 June 2010 cc178-9

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of 28% continued to provide an incentive for the wealthiest to avoid paying income tax by obtaining remuneration in the form of capital gains rather than income.5 Arguably this incentive was reduced by the cut in the top rate of income tax from 50% to 45%, which was announced in Budget 2012 and took effect from April 2013.6

In March 2016 the then Chancellor, George Osborne, presented the Conservative Government’s second Budget, following the 2015 General Election, and as part of this, announced that both rates of CGT would be cut, with effect from 6 April 2016: the higher rate would be cut from 28% to 20%, and the basic rate cut from 18% to 10%. Gains from carried interest and from the sale of residential property would continue to be charged the existing rates of tax.7 It was forecast that this change would cost £630m in 2017/18, rising to £735m in 2020/21.8

Generally receipts from CGT are quite cyclical, though these reforms have made revenues a good deal more volatile in recent years.9 As the Institute for Fiscal Studies has noted, the tax is highly progressive, disproportionately paid by a small number of taxpayers realising very large gains. This reflects the structure of the tax – the level of the annual exemption, and the fact that both gains made on the sale of one’s main residence and on assets held in pension funds or ISAs are tax-exempt.10 In 2017/18 more than half of all individuals’ CGT liabilities came from 9,000 people who realised gains more than £1m.11

In the next three Budgets the Conservative Government did not announce any further major reforms to CGT, although over this period there was considerable speculation that the Government might restrict or abolish Entrepreneurs’ Relief.12 The cost of this relief has risen considerably faster than initial projections,13 and by 2015/16 its annual cost had reached £4.3 billion. The estimated annual cost fell by around 50% the next year, a change that HMRC attribute to the 2016 Budget changes in CGT rates; HMRC estimate that the relief cost £2.1 billion in 2019/20.14

In July 2019 the Office for Budget Responsibility published its detailed assessment of the various risks to the public finances over the medium term, and, as part of its analysis of the risks for Government tax revenues, looked at tax expenditures and tax reliefs. The OBR argued that Entrepreneurs’ Relief met “many characteristics of a relief that poses a fiscal risk” as it had “increased significantly in cost, and the reasons for the rise (and recent fall) are largely unknown, raising the possibility that the assumptions underpinning our forecast fail to factor in something that has affected its cost in the past.”15 The report also noted that “gains from this relief are increasingly concentrated on a small number of wealthier claimants. In 2016-17 there were 5,000 individuals making gains of greater than £1 million, and, in aggregate, they made up three quarters of the total gains for which Entrepreneurs’ Relief was claimed.”16

5 see, Institute for Fiscal Studies, 2012 Green Budget, February 2012 pp 180-196 6 see, Income tax: the additional 50p rate, Commons Briefing paper CBP249, 26 September 2018. 7 HC Deb 16 March 2016 c965. See also, Budget 2016, HC901, March 2016 para 1.171 8 Budget 2016, HC901, March 2016 p85 (Table 2.1 – item 28) 9 HMRC, CGT Statistics, October 2017 edition, table 14.1 (this is reproduced in an annex to this paper.) 10 IFS, Green Budget 2015, February 2015 – see, “Chapter 10: Options for increasing tax” p241 11 In 2017/18 total receipts from individuals were £8.2bn, of which £5.1bn came from this group of

taxpayers (see, HMRC, CGT Statistics, August 2019 table 2). 12 For example, “Is entrepreneurs’ relief for the chopping block?”, Tax Journal, 7 September 2018 13 National Audit Office, The Effective Management of Tax Reliefs, HC 785, November 2014 (para 2.11-6). 14 HMRC, Bulletin: estimated cost of tax reliefs, October 2019 p11 15 OBR, Fiscal Risks Report, CP 131, July 2019 para 4.98 16 op.cit. para 4.96. For a breakdown of taxpayers claiming this relief by constituency see: PQ26898, 12

March 2020.

5 Capital gains tax : recent developments

Initially it was anticipated that the 2019 Budget would be on 6 November, but the Budget was postponed due to the timing of the General Election.17 Following the Conservative Party’s election victory, the Government announced the Budget would be on 11 March 2020.18 In its Election Manifesto the Party had stated that it would “review and reform entrepreneur’s relief”,19 and in his 2020 Budget speech the Chancellor Rishi Sunak announced that while the relief would be retained, the lifetime limit would be cut from £10m to £1m.20 The reduction in the lifetime limit applies from Budget day, with special provision for disposals entered into before 11 March 2020 that have not been completed.21 It is estimated that this measure will raise £6.3 billion in total by 2024/25.22

This note looks at the recent debate about CGT, the Coalition Government’s reforms in the 2010 Budget, and the current Government approach to the tax. The historical background to these developments is examined in two other Commons briefing papers.23

17 HM Treasury, Chancellor Letter to the Treasury Select Committee on the Budget, 25 October 2019 18 HMT press notice, Chancellor launches Budget process to usher in ‘decade of renewal’, 7 January 2020 19 Conservative Party, General Election 2019 Manifesto, December 2019 p34 20 HC Deb 11 March 2020 cc285-6 21 HMRC, Capital Gains Tax Entrepreneurs’ Relief - reduction in the lifetime limit, 11 March 2020 22 Budget 2020, HC 121, March 2020 p67 (Table 2.1 : item 46). Estimated receipts are: £5m (2019/20),

£215m (2020/21); £1,120m (2021/22); £1,470m (2022/23); £1,670m (2023/24); £1,820 (2024/25). 23 Capital gains tax : background history, CBP860, 2 June 2010; Capital gains tax : the 2008 reforms, CBP4652,

3 June 2010

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1. The origins of the current tax structure

Prior to April 2008, capital gains were treated as the top slice of income, and the tax was charged at the same rates of tax as savings income (10%, 20% and 40%). In addition, the gain chargeable to tax was ‘tapered’, according to the length of time an asset had been held. Taper relief was first introduced in 1998: for assets held for 3 years or more, the taper shaved away 5% of the chargeable gain for each additional year the asset had been held, up to a maximum 40% relief for assets held for at least 10 years.

The taper was more generous for assets which entrepreneurs and investors held in new start-ups and their own small businesses; for these business assets, the taper applied from the first complete year this type of asset had been held, and reduced the chargeable gain by 75% for assets held for 10 years or more. Over the period 2000 to 2004, the Labour Government increased the value of taper relief substantially for business assets, and widened the definition of what constituted a business asset. As a consequence, the full value of the relief applied for business assets held for just 2 years: for higher rate taxpayers, the relief reduced the effective tax rate on these gains from 40% to 10%.24

Since its introduction the cost of taper relief rose strongly, from £550m in 2001/02 to an estimated £7.8 billion in 2007/08.25 One factor in this was the ability of partners in private equity firms to claim business asset taper relief on ‘carried interest’: monies they had invested in their own companies. At the height of the City boom, the sheer size of the rewards these individuals made caused widespread public concern, a concern which was swiftly replaced by a sense of outrage when commentators compared CGT being paid at 10% with the fact that taxpayers on the lowest incomes were to be paying income tax at 20% - with the abolition of the 10% starting rate from April 2008.

In October 2007 the Labour Government announced that to tackle this problem from the 2008/09 tax year taper relief would be scrapped, and a new single rate of CGT would be introduced set at 18%.26 The reaction of the business community was such that in the ensuing weeks, the debate about CGT reform focused almost exclusively on the impact that abolishing taper relief on business assets would have on small businesses. In January 2008 the then Chancellor, Alistair Darling, made a statement to the House confirming that alongside these changes, a new relief would be introduced, to compensate business owners and investors:

Following discussion, I am today announcing the introduction of a new capital gains tax entrepreneurs’ relief. This will complement the new regime, which I set out in the pre-Budget report last year.

24 For historical rates of CGT see, HMRC, Rates of CGT: Table A1, August 2019. 25 HC Deb 24 July 2007 cc999-1000W; Budget 2008, HC 388 March 2008 p136 26 The then Chancellor Alistair Darling made this announcement as part of his Pre-

Budget statement to the House on 9 October (HC Deb cc170-1).

7 Capital gains tax : recent developments

The reformed regime and the new entrepreneurs’ relief will come into effect in April.

The relief will provide a special 10 per cent. tax rate for the first £1 million of qualifying gains. Gains made on different occasions will qualify for the 10 per cent. rate up to a cumulative lifetime total of £1 million. However, gains in excess of that will be taxed at 18 per cent. The special 10 per cent. rate will be available on the disposal of all or part of a trading business carried on by an individual either alone or in partnership. It will also be available to individuals disposing of shares in a trading company, provided that the individual is an officer or employee of the company and takes a minimum 5 per cent. stake in the business.

The measure will benefit the owners of small businesses when they choose to sell their business, as well as business angels and other business investors who take a 5 per cent. or greater stake in the company concerned.

As a result of the reforms that I have announced, entrepreneurs and material business investors will keep 90 per cent. of the first £1 million of gains that they make. And they, and everyone else, remain entitled to make gains of up to £9,200 a year without paying any capital gains tax. That annual exemption will rise again in April. We estimate that, next year, around 80,000 business owners and investors will make disposals eligible for the entrepreneurs’ relief.

In approximately 90 per cent. of those cases, we expect the individual’s entire gain to be taxed at the special 10 per cent. rate. In the other cases, people will pay 10 per cent. on the first £1 million of gains and the standard 18 per cent. rate on the excess. The proposal remains in line with the Government’s objective of keeping the tax system as simple as possible. It is very much in accordance with representations from small business.27

Following the introduction of the single rate of CGT, Mr Darling introduced one further important change in the tax in the Labour Government’s last Budget in March 2010, prior to the 2010 General Election: a doubling of the threshold for entrepreneurs’ relief to £2m.28 Details were given in a Budget note at the time:

The amount of an individual’s gains that can qualify for entrepreneurs’ relief is subject to a lifetime limit of £1 million. For trustees, the £1 million limit is that of the beneficiary of the settlement who meets the conditions for the trustees to claim the relief. Finance Bill 2010 will include provision to increase that limit to £2 million from 6 April 2010.

Where individuals or trustees make qualifying gains above the previous £1 million limit before 6 April 2010, no additional relief will be allowed for the excess above the old limit. But if they make further qualifying gains after 5 April 2010, they will be able to claim relief on up to a further £1 million of those additional gains, giving relief on accumulated qualifying gains up to the new limit of £2 million. The other rules for entrepreneurs’ relief are unchanged. Gains qualifying for the relief will continue to be reduced by the fraction 4/9, leaving the effective rate of capital gains tax on these gains at 10 per cent.29

27 HC Deb 24 January 2008 cc1627-8 28 HC Deb 24 March 2010 c260 29 HMRC Budget 2010 Notice BN27, 24 March 2010

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Provision to this effect was made the abbreviated Finance Act which was approved with cross party support, prior to the Dissolution, and the General Election.30

As the financial crisis took hold in late 2007 CGT receipts fell sharply, from £7.85 billion in 2007/08 to £2.46 billion in 2009/10. In its last Budget before the 2010 General Election, the Labour Government commented on this trend:

CGT is particularly sensitive to changes in equity prices, reflecting the fact that it is taxed on the gain rather than the whole disposal price and that financial assets account for around two-thirds of chargeable gains. Equity prices fell by over 25 per cent in 2008-09 compared with the previous year.

The year-on-year drop in CGT receipts also reflects particularly strong receipts in 2008-09, as investors rearranged their affairs ahead of the abolition of taper relief when the CGT regime was reformed in the 2007 Pre-Budget Report.31

30 The Finance Bill was debated and agreed in the Commons on 7 April 2010 (HC Deb

cc1058-1106). 31 Budget 2010, HC 451, March 2010 p196 para C.49

9 Capital gains tax : recent developments

2. CGT and the new 50p rate of income tax

In his Budget speech on 22 April 2009, the then Chancellor, Alistair Darling, announced a number of changes to income tax from April 2010, including a new 50p rate on incomes above £150,000. The new 50p rate dominated initial reactions to the Budget, as many commentators saw it as a significant change in the Government’s approach to taxing the wealthy.

There was speculation as to whether the change would raise as much as the Government anticipated: as the Financial Times reported, “the widening gulf between top income tax rates and capital gains tax rates will sharpen the incentive to structure investments to realise capital gains rather than income, as well as creating pressure to exploit the few remaining opportunities on employment income.”32 Paul Farrelly MP put down an EDM supporting further reform of CGT partly on the grounds that, “wealthy people will still pay lower rates on unearned income than office cleaners on hard-earned low wages [and] … that the continuing discrepancy in rates constitutes a major incentive for tax avoidance.”33 Notably the Finance Act 2009 included anti-avoidance legislation to prevent two methods of converting income into capital.34

At the time of the 2009 Pre-Budget Report, the Financial Times reported that the Government were actively considering CGT reform “in an attempt to close the yawning gap between the 18% CGT rate and the new 50p top rate of income tax.”35 In an editorial the paper noted that an increase in the CGT rate would not raise relatively much money, in the context of the worsening state of the public finances, but that it “is not without merit, provided it forms part of an effort to flatten income taxes and keep rates low”:

Capital gains are taxed at 18 per cent while, from April, income tax will be levied at up to 50 per cent. It makes little sense to have capital gains taxed at such a different rate to salaries. The main result of these differing tariffs is to create incentives for rich individuals to declare their income as capital gains. Rates on the two should be equalised - as, indeed, they once were. This should not be a big bang process: there is no need to double rates overnight, but narrowing the gap would be a start.

A rise in the CGT rate would be a far better way to raise cash from rich taxpayers than raising the top rate of income tax. It also demonstrates the approach that should be taken when raising taxes: abolish special rates or reliefs rather than raising headline tax rates.36

In their 2010 Green Budget, the Institute for Fiscal Studies looked at a wide range of possible tax increases and benefit cuts to reduce the size

32 “Focus on capital gains set to sharpen”, Financial Times, 24 April 2009 33 EDM 1388 of 2008-09, 29 April 2009. 26 Members signed the EDM. 34 As noted in answer to a PQ (HC Deb 8 February 2010 c761W); for details see, HM

Revenue & Customs 2009 Budget Notes BN36 &37, 22 April 2009. 35 “Darling eyes capital gains tax increase”, 5/6 December 2009 36 “Editorial: A taxing problem”, 5/6 December 2009

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of the public deficit. While changes to the main rates of income tax, NICs or VAT could raise very large amounts of money, the authors described a number of changes that could raise significant sums while removing undesirable distortions in the tax system – including two changes to CGT:

A desirable feature of a tax system is that it should not discriminate between different forms of economic activity. However, by taxing capital gains more lightly than dividends (for higher-rate taxpayers) or employment income, the current system in the UK does favour certain types of activity over others. A particular controversy was caused over the treatment of ‘carried interest’ received by private equity fund managers, but the same principle applies to owners of small businesses, who are able to forgo some or all of their salary to increase the value of their business and then sell it on. They are then liable to pay CGT rather than income tax, which, as mentioned above, has a much lower flat rate. This also creates a distortion whereby individuals have an incentive to move into occupations in which remuneration can be taken in the form of capital gains.

Therefore, there is a strong case that aligning income tax and CGT rates would be less distortionary than the current system and would raise revenue at the same time.37 …

There is no obvious rationale for a separate tax allowance for capital gains that cannot be offset against income: it provides an incentive for individuals to arrange their affairs in such a way that they have some income and realise some capital gains each year, rather than exclusively having one or the other. Reducing the exempt amount to a much lower level (it would be desirable to have some threshold to ensure that those realising trivial capital gains avoided the compliance cost of paying CGT) and aligning income and CGT rates (meaning that it would be possible to use the income tax personal allowance for capital gains if one did not have sufficient income to use it fully) would seem a sensible reform.38

The authors noted that the Liberal Democrats had suggested both of these changes, in a policy document published in December 2009, and claimed that aligning rates, and cutting the exempt amount to £2,000 would raise around £4.1bn in total, although as the party had not set out its costing methodology “we are unable to say whether we agree with them.”39

The Liberal Democrats included this reform in their manifesto for the 2010 General Election, as one of a series of tax changes to raise £17 billion, so the personal income tax allowance could be set at £10,000. The manifesto proposed, “taxing capital gains at the same rates as income, so that all the money you make is taxed in the same way”, which it estimated would raise £1.92 billion.40

During the campaign, the Institute for Fiscal Studies published a series of briefings, and in an analysis of the party’s tax and benefit plans,

37 Note that this would not completely resolve the situation, however, as income tax is

not the only tax on earnings – NICs need to be taken into account also. 38 The IFS Green Budget, February 2010 pp159-160 39 op.cit. pp 162-3 40 Liberal Democrats, Liberal Democrat Manifesto 2010, April 2010 p14, p100

11 Capital gains tax : recent developments

welcomed the principle of aligning rates as an “excellent idea … capital gains are essentially just another form of income: there is no strong reason for taxing them less heavily, and doing so provides a big incentive to convert income into capital gains (especially for the richest, now that a 50% rate of income tax has been introduced).” However, the authors went on to raise some concerns, and in particular, were critical of the party’s expressed wish to maintain entrepreneurs’ relief:

Keeping entrepreneur’s relief forgoes a large part of the benefit of alignment. Entrepreneur’s relief applies a reduced tax rate of 10 per cent (strictly, 10/18 of the standard rate) to the first £2 million of lifetime gains on businesses (or substantial shareholdings in businesses) for which the seller worked.

This reduced rate creates the biggest differential between tax rates on capital gains and ordinary income, and those benefiting from entrepreneur’s relief – owner-managers of businesses – are more able than almost any other group to take advantage of differential tax rates, simply by retaining profits in the business rather than taking more in salary or dividends.

It is not clear whether the Liberal Democrats would keep entrepreneur’s relief as a flat 10 per cent rate or as 10/18 of the rate people would otherwise face. 10/18 would be less bad: keeping a flat 10 per cent rate would mean an even wider differential than exists now, since entrepreneur’s relief would now be operating in conjunction with an indexation allowance. But even charging 10/18 of people’s marginal rate would mean a big differential between tax rates on qualifying gains and on ordinary income.

Furthermore, keeping entrepreneur’s relief for some gains while the tax rate on other gains increased to marginal income tax rates would also put immense pressure on the distinction between business assets (on which gains would be taxed at the reduced rate) and non-business assets (on which gains would, like ordinary income, be taxed at rates of up to 50%).41

41 Institute for Fiscal Studies,Taxes and benefits: the parties’ plans: Briefing Note BN100,

27 April 2010 pp41-2

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3. Debate on CGT reform after the 2010 Election

Following the General Election, the Conservative-Liberal Coalition Government published an outline agreement, which noted that the parties would, “seek a detailed agreement on taxing non-business capital gains at rates similar or close to those applied to income, with generous exemptions for entrepreneurial business activities.”42 A few days later the Prime Minister, David Cameron, was interviewed on the BBC by Andrew Marr, and was asked about the Government’s plans to reform CGT; Mr Marr made the point that the Conservative Party manifesto had not made any proposals to align the rates of CGT with income tax:

ANDREW MARR:

One thing that has caused extreme unease is the idea among many of your own supporters, is the idea of raising capital gains tax to 40% or 50%. Hardworking Conservative inclined families who voted for you, who have put their money into, I don't know, shares or whatever it might be and are now looking at a really socking tax increase on that and thinking this is not what we voted for.

DAVID CAMERON:

Well there is, I think everyone recognises, there is a problem. When you have a capital gains tax rate of 18% and a top rate of income tax at 50%, you'll find people finding all sorts of ways to treat income as capital gains. Now what we've said is there is a very big difference between the capital gains that someone pays on say a second home - which is not you know necessarily a splendid investment for the whole economy - there's a difference between that and actual investment in business assets where you what … I want to light the flames of entrepreneurialism in Britain and get people investing in businesses and setting up new businesses. So we've said that we're going to look at a different rate between those two things and that helps actually again the fairness agenda. That helps us achieve the goal of lifting tax allowances, so we take more people out of tax. I think people will understand.43

More detail was provided a few days later in the Coalition’s final agreement:

We will increase the personal allowance for income tax to help lower and middle income earners. We will announce in the first Budget a substantial increase in the personal allowance from April 2011, with the benefits focused on those with lower and middle incomes. This will be funded with the money that would have been used to pay for the increase in employee National Insurance thresholds proposed by the Conservative Party, as well as revenues from increases in Capital Gains Tax rates for non-business assets as described below. The increase in employer National Insurance thresholds proposed by the Conservatives will

42 Conservative Liberal Democrat coalition negotiations: Agreements reached, 11 May

2010 p2 43 “Interview with David Cameron”, BBC news online: Andrew Marr show, 16 May 2010

13 Capital gains tax : recent developments

go ahead in order to stop the planned jobs tax … We will seek ways of taxing non-business capital gains at rates similar or close to those applied to income, with generous exemptions for entrepreneurial business activities.44

There was a considerable amount of criticism of the proposals – from Conservative MPs, business representatives and commentators – and many argued that some form of taper relief should be reintroduced.45 Writing in the Daily Mail, David Davis MP argued a five year taper from a 40-50% headline rate to zero “would prevent the problem of switching income to capital for tax avoidance purposes, would encourage long-term saving and investment, would avoid distorting investment, would avoid distorting investment decisions, would make us internationally competitive and would raise extra revenue.”46 John Redwood MP made similar proposals in a letter published in the Daily Telegraph. Mr Redwood was particularly concerned that non-business assets might be treated less-favourably: “[Reliefs for business assets] would leave long term savers, people owning buy to let properties and people with savings for retirement which are no held within a pension fund having to pay substantial tax.”47

The case against any increase in CGT rates was also made by a number of academics and lobby groups, including representatives of the Institute of Directors and the Institute of Economic Affairs, writing to the Sunday Telegraph: “we suggest that the increase is misguided for the following reasons: it discourages saving and ultimately investment; it leads to assets being sold at suboptimal times; it may cut the supply of affordable rented housing; and it penalises equity finance for companies yet further.”48 In turn there was speculation that the Government might reintroduce taper relief on both business and non-business assets, and that pensioners might be exempted from the new tax structure.49

In this context it is worth looking back at the period up to 2008 when chargeable gains were last tapered. In December 2006 HMRC published a survey of CGT payers and agents on the introduction of taper relief in 1997: the report found that “neither CGT nor tax generally was spontaneously mentioned as influencing investment decisions, with financial (such as rate of return, selling at a market peak) and personal considerations (such as wanting to work for yourself) more important … when prompted, 3 in 10 CGT payers … said that CGT affected their decisions to acquire assets, and half … said it affected their decisions to sell assets. The main influence CGT rules had on CGT payers was for them to ensure that their gains stayed within the annual exempt amount.”50

44 HM Government, The Coalition: our programme for government, 20 May 2010 p30 45 For example, “First big test for Cameron coalition”, Financial Times, 28 May 2010 46 “Raising CGT is unfair, won’t work and will punish the hard-working middle classes”,

Daily Mail, 27 May 2010 47 “Tories in revolt over capital gains tax rise”, Daily Telegraph, 27 May 2010 48 “Letter: CGT destroys growth, enterprise and jobs”, Sunday Telegraph, 30 May 2010 49 “Osborne eyes ‘major’ CGT exemptions”, Financial Times, 31 May 2010 & “Over-65s

to be exempt from rise in CGT”, Sunday Telegraph, 6 June 2010 50 HMRC, Evaluation of the changes to Capital Gains Tax since 1998 : Research report

26, December 2006 p4. The report is available on HMRC’s archive site.

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One practitioner writing on the AccountingWeb site commented on the report’s findings:

What the report appears to say is that the prospect of paying CGT has virtually no impact on people’s decisions about the acquisition of assets, but that it has some limited impact of their decisions about selling. That appears in my experience to be borne out by the gadarene rush into the purchase of buy to let property and the complicated problems later presented to this and other websites when it seems like a good idea to sell. Furthermore, the rate of tax often seems to have little effect on people ...

So what it comes down to is asking whether the changes – designed to make us a nation of serial entrepreneurs – have actually had any impact at all on taxpayer behaviour. The answer seems to be that they have not. People who have money acquire assets. People buy business assets because they want to be in business. People buy properties to let because they think the walls are papered with gold and they think that the equity in their houses is like real money. So it goes.51

The debate on the Government’s proposals was dominated by concerns about those taxpayers who would lose out, as so often is the case with tax reform. However, in a letter to the Times, Lord Millett argued that it was only fair to increase the rate of CGT, though there was an alternative to reintroducing taper relief:

Alistair Darling rightly scrapped taper relief and reduced the rate from 40 per cent to 18 per cent. This was not a tax reduction but a rough and ready compensation for the fact that the tax was now being charged on inflationary gains. The chosen compensation was foolish, since it re-opened the door to tax avoidance and rewarded the short term while penalising the long-term investor. Darling was right not to bring back any form of taper relief; but a better way of compensating for the fact that tax would in future be charged on inflationary gains would not have been to reduce the rate of tax but to bring forward the starting point again.

The proposal to increase the rate of tax to 40 per cent is right, but the increase should be accompanied by bringing forward the starting point from 1982 to, say, 1997. This would be a rough and ready solution to the problem of long-term inflationary gains, but it would at least be practical, avoid the need to value assets at a date nearly 30 years ago, and reward the long term while penalising the short-term investor.52

In their Budget submission the Institute of Chartered Accountants acknowledged that the gap between the 18% CGT rate and the 50% higher rate of income tax “does not appear to be sustainable in the long-term”:

However, if the CGT regime is to be changed again, there should be full consultation before any changes are made and a number of possible policy options should be tabled for consideration... If the CGT rate is once again to be set by reference to the rates of income tax, it will be important to ensure that the tax rate is perceived to be fair and reasonable and does not discourage long-term saving. We also agree that it is reasonable to have a more

51 “What did CGT ever do for you?”, AccountingWeb.co.uk, 19 January 2007 52 “Letters: starting point for capital gains tax”, Times, 19 May 2010

15 Capital gains tax : recent developments

favourable rate for entrepreneurs who have built businesses over a period of time – this has been a feature of CGT in some form or other since the tax was first introduced 45 years ago.53

In a briefing on the tax the TUC argued that raising the main rate to up to 50% was “an appropriate move to collect tax from those best able to make settlement of it at this time, especially as such sums will arise from unearned income and only for those in receipt of substantial income subject to tax already.”54

Writing in the Sunday Times, the then director of the IFS, Robert Chote, observed that most of the reforms made to CGT since it was introduced “have been attempts to balance two competing objectives: the desire to minimise the scope for tax avoidance created when capital gains are taxed more lightly than income, and, second, the desire to keep capital taxes as low as possible to avoid discouraging saving and investment … Lord Lawson [with the changes made to CGT in the 1980s] and the Liberal Democrats put more emphasis on the former, while the last Labour government and the current Conservative critics of the coalition put more on the latter.”

On the grounds that “the tax system should not distort people’s behaviour in a costly way without good reason”, Mr Chote went on to make four suggestions for reform:

First, the tax rate on capital gains should be aligned with the rates on earned and dividend income, ideally with a single tax-free allowance. Different tax rates encourage people to be paid in more lightly taxed forms and to move into occupations where this is easier. Using anti-avoidance rules to restrict how people are paid in particular circumstances is much less attractive.

Second, CGT should not discriminate between business and non-business assets. People should be left to decide unbribed whether to put their money into a bank account, housing, shares, or into their own businesses, based on their own judgment of the risks and returns involved. There is an argument for taxing shares more lightly, however, because company profits that give rise to capital gains have already been subject to corporation tax. We should be wary of the argument that investing in one’s own business is a virtuous act deserving of subsidy in a way that investing in somebody else’s business is not. People should decide whether and how to build an enterprise on the basis of its commercial fundamentals, not its tax treatment.

Third, we should not try to bribe people into holding assets for longer than they would otherwise wish to do — economic welfare is best served by having assets owned by the people who value them most. The previous government justified taper relief as a way to discourage short-termism, but encouraging people to hold assets for longer than they want is not the same as encouraging companies to undertake productive investments that may take a long time to pay off.

53 ICAEW, The Emergency Budget 2010: TAXREP 27/10, 2 June 2010 paras 56,58 54 TUC, TUC Tax Briefing 2 : Capital Gains Tax, 18 June 2010 p16

Number 5572, 12 June 2020 16

Fourth, we should tax real gains rather than the illusory gains from inflation, so there is a strong case for reintroducing indexation allowances.55

Stuart Adam, senior research economist at the IFS, made a point in an interview with the Financial Times, arguing that the principle behind taper relief was a “dreadful idea … persuading people to hold on to assets they would otherwise sell, to get a lower tax rate, is a misguided thing to do.” Mr Adam went on to make an important point about tax avoidance: “the Liberal Democrats and Mr Cameron have been stressing the anti-avoidance advantages of increasing CGT by making it harder to reduce tax by converting income into capital … but the people for whom it’s easiest to do this are entrepreneurs.”56

Writing in the Financial Times, John Kay suggested that looking across the world, “there are as many different regimes [for taxing capital gains] as there are national tax systems and they are often, as in Britain, in a state of endless flux.” This state of affairs could be attributed to the fact that there is no simple answer as to how capital gains be taxed, and as a consequence, “the issue is quite properly a subject to political compromise.” The first problem in taxing gains was that they could be made in a wide variety of circumstances:

Some gains are essentially indistinguishable from income - the predictable rise to maturity of a bond issued at a deep discount - but other types of gain are altogether different in character. Suppose the price of wheat rises because of a crop failure on the other side of the world. It would be unreasonable to add the increase in the value of a farmer's property to the cash he earns from selling his products. To do so would be to tax him both on the receipt and on the expectation of it. It might seem that carefully crafted legislation would distinguish one kind of gain from another. Attempts are made to do this, as in some regimes for taxing deep discount bonds. But the task is just too hard. Changes in capital values mostly result from changes in expectations, and expectations are not things that tax inspectors can measure.

There is another practical problem: it is often impossible, and inequitable, to collect tax on a capital gain if the gain has not been realised. Any attempt to legislate complex distinctions inevitably has unintended consequences ... So the usual compromise is to tax all capital gains, but to tax them more lightly than income. It is not a happy compromise, like imposing a short sentence because you cannot tell whether the defendant is guilty. The fudge works better when income tax rates are low. When rates are higher, problems multiply, especially since the distinction between income and capital gain is not fixed by nature but susceptible to manipulation by taxpayers.

Similarly the degree to which taxpayers accrued these gains by dint of their individual effort varied considerably:

Are recipients of capital gains more deserving than recipients of income? They are certainly, on average, richer: most capital gains accrue to people who already have some capital. But here too, the answer is that some beneficiaries of capital gains are deserving

55 “Solutions to the taxing issue of capital gains”, Sunday Times, 6 June 2010 56 “Tax experts deride capital gains relief”, Financial Times, 9 June 2010

17 Capital gains tax : recent developments

and others are not. Most of us wish the people who build up successful businesses well, and hope there will be more of them. But day traders and people who invest their inheritance in gold bullion also hope to be recipients of capital gains, and it seems wrong to tax them more lightly than those who work all day for the same money. People who might be liable to capital gains tax are probably more mobile than people who make their living in other ways. But we should be careful of this argument. The purchase of lavish central London properties with money stolen from impoverished Russians does Britain little credit, and the same is true of the tax concessions that attract the oligarchs. It is also shaming when hedge fund managers pay a lower rate of tax than the people who clean their offices.

Professor Kay went on to conclude that, quite apart from these methodological problems, the principal argument for taxing gains was to ensure a wider political consensus as to the fairness of the tax system:

If the cost of putting these things right is that the rest of us have to pay a little more - and I am not sure there is such a cost - then I for one am willing to contribute my share. Our society depends on the willingness of ordinary people to pay considerable amounts of tax with a fair degree of honesty and only modest levels of complaint. We jeopardise that fragile construction, rare in time and place, at our peril. The taxation of capital gains sustains the revenue, and equity, of the income tax.57

57 “The issue of capital gains need not be so taxing”, Financial Times, 2 June 2010

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4. The Coalition Government’s reforms

4.1 The June 2010 Budget The Chancellor, George Osborne, presented the new Government’s first Budget on 22 June 2010. In his speech, Mr Osborne set out a series of changes to CGT, including a new 28% rate for higher rate taxpayers, and an increase in the threshold for entrepreneurs’ relief to £5m – to take effect from midnight on Budget day itself:

One of the most chaotic areas of tax that the new Government inherited from their predecessor is the capital gains tax regime. Some of the richest people in this country have been able to pay less tax than the people who clean for them. That is not fair, and it stems from the avoidance activity that has exploited the wider gap between the rate of capital gains tax and the top rates of income tax. Those practices are costing other taxpayers more than £1 billion every year.

It is therefore right, as set out in the coalition agreement, that capital gains tax should increase in order to help create a fairer tax system. I have listened carefully to everyone's views and considered all the options. My concern has been to balance the competing demands of fairness, simplicity and competitiveness-and I believe my decision gets that balance right. Low and middle-income savers who pay income tax at the basic rate make up over half of all capital gains taxpayers. They will continue to pay tax on their capital gains at 18%. From midnight, taxpayers on higher rates will pay 28% on their capital gains. I have also decided that the annual exempt amount for capital gains tax will remain at £10,100 this year, and will continue to rise with inflation in future years.

I am acutely aware of how important it is to protect the incentives to succeed in business and to innovate, so to promote enterprise, the 10% capital gains tax rate for entrepreneurs, which currently applies to the first £2 million of qualifying gains made over a lifetime, will be extended to the first £5 million of lifetime gains. I asked the Treasury to examine what would have happened if we had increased the rate much further beyond 28%, and its dynamic analysis showed that that would have resulted in smaller total revenues. I also considered in great detail the options presented to me for introducing tapers or indexation allowances, and concluded that the complexity and administration involved would have been self-defeating.

The changes that I have made mean that the capital gains of the majority of taxpayers are protected; that we have a top rate that is in line with those of our international competitors; that we keep the system simple and easy for any taxpayer to understand; and that we reduce the incentives to convert income to capital gains. It is revealing that the great majority of the almost £1 billion of extra receipts that we expect to see as a result of this change will come from additional income tax payments. I believe that that is the right way in which to reform the taxation of capital gains.58

58 HC Deb 22 June 2010 cc178-9

19 Capital gains tax : recent developments

At the time it was estimated that taken together these changes would raise £725m in 2011/12, rising to £825m in 2012/13.59 While a significant sum, it is worth noting that two other tax measures in the Budget – the 2.5% rise in the standard rate of VAT to 20%, and the new levy on banks’ balance sheets – were forecast to raise considerably more for the Exchequer.60

Details on the way the new 28% rate would apply were given in a Budget note, from which the following is taken:

At present section 4 of the Taxation of Chargeable Gains Act 1992 (TCGA) provides that net gains chargeable to CGT (after deduction of reliefs, losses and the CGT Annual Exempt Amount (AEA) are taxed at 18 per cent. Finance Bill 2010 will include provision to change the rates of CGT for gains arising on or after 23 June 2010.

For individuals, where their total taxable income and gains after all allowable deductions (including losses, the income tax personal allowance and the CGT AEA) are less than the upper limit of the basic rate income tax band (£37,400 for 2010-11), the rate of CGT will be 18 per cent. For gains (and any parts of gains) above that limit the rate will be 28 per cent. For trustees and personal representatives of deceased persons, the rate will be 28 per cent. Where entrepreneurs’ relief applies for individuals or trustees the rate remains 10 per cent ...

Gains arising in 2010-11, but before 23 June 2010, will continue to be liable to CGT at 18 per cent and will not be taken into account in determining the rate (or rates) at which gains of individuals arising on or after 23 June 2010 should be charged.

Certain CGT reliefs allow gains on disposal of an asset to be deferred until some time after the disposal. For instance, a gain can be reinvested in shares under the Enterprise Investment Scheme (EIS) and, subject to conditions, can be deferred until the EIS shares are disposed of. The CGT rate(s) on a gain deferred in this way will be the rate(s) at the time the deferral ends and the gain becomes liable to tax. Gains on disposals before 23 June 2010 which are deferred until 23 June 2010 or later will therefore be liable to CGT at the 18 or 28 per cent rates, in the same way as gains arising on disposals on or after that date.

In working out the CGT payable, taxpayers will be able to deduct losses and the AEA in the way which minimises the tax due.

Example 1

In 2010-11 X’s taxable income, after all allowable deductions and the personal allowance, is £27,400. The upper limit of the income tax basic rate band is £37,400. X sells an asset in May 2010 and realises a chargeable gain of £17,000. In November 2010 X sells another asset, realising a chargeable gain £25,100. X has no allowable losses to set against these gains, and the AEA for 2010-11 is £10,100. Neither of the gains qualifies for entrepreneurs’ relief.

X’s taxable income is £10,000 less than the upper limit of the basic rate band (£37,400 - £27,400). X sets the AEA against the later gain (because part of that gain is liable to tax at the higher

59 Budget 2010, HC 61, June 2010 p40 (Table 2.1 : item 14) 60 These two changes were estimated to raise £12.5bn and £2.32bn respectively in

2012/13: Budget 2010, HC 61, June 2010 p40 (Table 2.1 : item s 1 & 8)

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CGT rate), leaving £15,000 taxable (£25,100 – £10,100). The first £10,000 of the £15,000 is taxed at 18 per cent and the remaining £5,000 is taxed at 28 per cent. The £17,000 chargeable gain X realised in May 2010 before the change of rates on 23 June 2010 is taxable at the old 18 per cent rate.

For trustees and personal representatives of deceased persons, the CGT rate will be 28 per cent for gains arising on or after 23 June 2010, except where entrepreneurs’ relief applies.

This also gave details of how the new £5m threshold for entrepreneurs’ relief would work:

Entrepreneurs’ relief – rate of CGT and lifetime limit on relief

Subject to satisfying certain conditions, including the lifetime limit of £2 million, gains on disposals of entrepreneurial businesses by individuals and certain trustees qualify for entrepreneurs’ relief (Chapter 3 of Part 5 of TCGA). Currently entrepreneurs’ relief reduces qualifying gains by 4/9 and the remaining 5/9 are then charged at the single 18 per cent rate. This results in qualifying gains being taxed at an effective rate of 10 per cent.

The changes to CGT rates from 23 June 2010 would mean the 4/9 reduction no longer achieved an effective rate of 10 per cent. Finance Bill 2010 will therefore include provision to charge gains on disposals that qualify for entrepreneurs’ relief on or after 23 June 2010 at a 10 per cent rate. The previous 4/9 reduction will cease to apply from that date.

The amount of an individual’s gains that can qualify for entrepreneurs’ relief is subject to a lifetime limit of £2 million (£1 million for disposals before 6 April 2010). For trustees, the £2 million limit is that of the beneficiary of the settlement who meets the conditions for the trustees to claim the relief. Finance Bill 2010 will include provision to increase that limit to £5 million from 23 June 2010.

Where individuals or trustees make qualifying gains above the previous £2 million limit before 23 June 2010 (£1 million limit before 6 April 2010), no additional relief will be allowed for the excess above the old limit. But if they make further qualifying gains on or after 23 June 2010, they will be able to claim relief on up to a further £3 million of those additional gains (or up to £4 million where the earlier £1 million limit applied), giving relief on accumulated qualifying gains up to the new limit of £5 million. In determining at what rate(s) an individual should be charged to CGT on any other gains, those gains qualifying for entrepreneurs’ relief are set against any unused basic rate band before non-qualifying gains.

Example 2

Y has previously used £1 million of their lifetime entrepreneurs’ relief limit. In 2010-11 Y’s taxable income, after all allowable deductions and the personal allowance, is £17,400. The upper limit of the income tax basic rate band is £37,400. In May 2010 Y realises a chargeable gain of £3 million on the disposal of a business. In December 2010 Y sells another business, realising further chargeable gains of £7 million. Both disposals qualify for entrepreneurs’ relief (subject to the lifetime limits). Y has no allowable losses to set against these gains, and the AEA for 2010-11 is £10,100.

21 Capital gains tax : recent developments

The £3 million gain realised in May 2010 is subject to the £2 million lifetime limit for entrepreneurs’ relief (for qualifying disposals from 6 April 2010), of which Y has previously used £1 million. The gain is reduced by 4/9 of £1 million and the remainder charged to CGT at the single rate of 18 per cent. The increase in the lifetime limit from 23 June 2010 means that £3 million of the £7 million gain from December is chargeable at the 10 per cent rate of CGT. Y’s taxable income is £20,000 below the basic rate band (£37,400 – £17,400). But the £3 million of the gain charged at 10 per cent is taken into account in priority to other gains in determining whether total income and gains exceed the basic rate band. So the remaining £4 million gains, less the AEA, are charged at the higher rate of 28 per cent.61

In his Budget speech the Chancellor referred to the Treasury’s analysis that having a higher rate above 28% would have resulted in smaller total revenues. Alongside the Budget report the Government published details of how it had arrived at producing cost/yield estimates for its Budget measures – something governments have not done in the past.62 The process involves making a ‘static costing’ – the difference between applying the pre-Budget and Budget tax or benefit regimes to the relevant post-Budget base data – before estimating the direct behavioural effects of the change. This is the way in which individuals and businesses change their actions as a result of a policy change, and may involved changes to related taxes or benefits.

In its discussion of the Budget changes to CGT, the department stated its forecast gains in 2011/12 were “£5.2 billion for gains qualifying for Entrepreneurs’ Relief and £11 billion for other taxable gains.” The static Exchequer impact of the new higher rate, and increase in entrepreneurs’ relief was £925m in 2011/12. The department foresaw two behavioural impacts: an increase in the so-called ‘lock-in’ effect (a higher rate of tax discouraging investors from realising their gains), and a change in the composition of income (a higher rate of tax reducing the incentive to shift income into gains). The department estimated that increasing the CGT rate by 10%, reduced the tax yield by around £800m in 2011/12, but boosted the yield from income tax by £600m in the same year. This resulted in the estimate that overall the changes would raise £725m in the first full year. The document’s summary of these two behavioural effects is reproduced below:

Lock-in effects : Gains accrue through changes in asset value but they are only liable to CGT when they are realised. Consequently, it is widely accepted that CGT has the effect of discouraging asset disposals or ‘locking-in’ gains. There is a substantial body of econometric evidence on the size of this effect, predominantly from the US. Based on this evidence, the costing assumes that a 1 percentage point increase in the CGT rate would reduce gains realised in the UK on average by 2.75 per cent. As a result, the 10 percentage points increase in the CGT rate for higher rate taxpayers is estimated to reduce their gains realised by 27.5 per cent. It is assumed that this reduces the pre-

61 HM Revenue & Customs Budget 2010 Notes BN20, 22 June 2010. Also see, HMRC,

CGT – Rates and Entrepreneurs’ Relief: Questions and Answers, 22 June 2010 p6. 62 HM Treasury, Budget 2010 policy costings, June 2010

Number 5572, 12 June 2020 22

behavioural yield by around £800 million in 2011-12 rising with forecast gains over the period.

The composition of income : The current difference between CGT and income tax rates gives taxpayers an incentive to prefer income in the form of capital growth (from investment returns, equity-based remuneration etc) rather than dividends, wages and salaries, rent etc. Bringing CGT more in line with income tax rates will therefore reduce the income to gains shifting built into the tax forecasts based on the historical position (and forecast to increase following the introduction of the 50 per cent higher rate of income tax in 2010-11). The costing assumes that for every 1 percentage point reduction in the gap between the CGT rate and the 40 per cent, 50 per cent and trustees’ rates of income tax, there is an increase in income tax yield in 2011-12 of about £60 million. This adds around £600 million in 2011-12 rising with income growth over the period.63

No further estimates were published after the Budget. In answer to a PQ two years later, asking if the Government would revise this methodology “in the light of subsequent receipts”, the Government stated, “the methodology set out in the policy costings document was based on research which drew on data from a number of years. The data provided information on the impact of changes to capital gains tax over a long period of time. There are no plans to revise this methodology at present.”64 As part of a second PQ on this issue, the Government said, “no further estimates of the effect of raising the CGT rate for those gains which qualify for the higher rate have been produced. It is not possible to separate with any precision the impact of the measure from other factors affecting CGT receipts in the outturn.”65

When he appeared before the Treasury Committee after the Budget, the Chancellor was asked about his decision to reform CGT the way he had, and whether it would be reviewed at all; in response Mr Osborne said the following:

I certainly regard it as permanent as any tax change a Chancellor can make. I am not planning to revisit this decision in this Parliament.

I faced a situation when I took office that the capital gains tax regime was being abused, that the 18% rate that I inherited was so much lower than income tax rates of 40% or 50% that a multitude of schemes had been created and were being created to shift income that there was a hole in the tax system that needed to be plugged. I also felt, as indeed did other members of the Government, for reasons of equity an 18% capital gains tax rate was quite difficult to justify when we were going to be asking from other parts of the population, other parts of the income distribution, for people to make a contribution to closing the deficit that it was appropriate to look to increase capital gains. I then faced a series of options which were do I completely redesign the system, do I try and introduce indexation, do I try and introduce the taper again, and I took the view … in order to give a greater sense of stability to take the existing system and make some changes to the rates.

63 HMT, Budget 2010 policy costings, June 2010 pp26-27 64 HL Deb 26 March 2013 cWA230-1 65 HL Deb 8 July 2013 cWA22

23 Capital gains tax : recent developments

The Chancellor was also asked whether he was concerned as to the impact this might have on business; in response Mr Osborne said:

The first point I make is that the entrepreneurial relief is a very considerable one, so it is only people who are going to be making more than £5 million of lifetime gains in creating a business who would face the 28% rate whereas, for example, someone selling a second home will now face the 28% rate. After all, it was 24% just a couple of years ago so I do not think there will be many people whose fundamental life planning would have been thrown entirely off course by this. I accept it is a tax increase and no one likes a tax increase.66

Further to this the department submitted a memorandum which addressed, among other questions, the decision not to reintroduce indexation or taper relief:

The introduction of an indexation allowance was considered but the complexity and administration involved would have been self-defeating:

• Introducing an indexation allowance would have made the tax system significantly more complex, imposing large administration burdens on both taxpayers and HMRC. This goes against the Government’s aim of simplifying the tax system.

• Indexation could not have been implemented before April 2011 and there was a need to act now to ensure that there was minimal forestalling and disruption to the economy.

The introduction of a tapering relief was also considered. However, this approach would not have met the policy aims:

• A tapering relief does not address the incentives to substitute income for a capital gain. The latest available survey data (2006-07) suggests that around 75% of gains are made on assets held for five years or longer.

• Taper relief can exacerbate the lock-in effect, which reduces yield. Tapering options offering a lowest CGT rate of less than 18% also have a substantial exchequer cost.67

In general there was a positive reaction to the Chancellor’s speech – in part because many investors had expected the Government to introduce higher rates of CGT.68 Although critics had raised particular concerns about property investors, who would not benefit from business asset relief, a few days after the Budget the Financial Times reported that some housing experts regarded the rate rise as a ‘non-issue’ for the housing market:

Ahead of the Budget, some property investors had feared that a 40 per cent rate would be introduced from next April - after the coalition government said it would tax non-business assets at rates "similar" to income tax - thereby triggering a sell-off of second homes and buy-to-let properties, and big price falls. "The increase in CGT to 28 per cent is actually a relief," said David

66 Treasury Committee, First report: June 2010 Budget, HC 350, 20 July 2010 Qs227-8

Ev34 67 op.cit. Ev61-2 68 For example, “CGT increase will raise £1bn a year” & “CGT rise for higher-rate

taxpayers lower than expected”, Financial Times, 23 June 2010

Number 5572, 12 June 2020 24

Adams of Chesterton Humberts, the estate agents. "At this level, it doesn't really affect decisions on whether to buy, sell or hold, although re-introducing taper relief would have benefited the buy-to-let sector."

Analysts said that with higher-rate CGT at 28 per cent, the argument for property investment still looked strong. Capital gains still compare "very favourably" with income tax at 40 or 50 per cent, said Liam Bailey of Knight Frank. The new rate returns CGT to a similar level to pre-2008, when taper relief was able to reduce the effective rate to 24 per cent on assets held for 10 years.69

Initial reactions to the Budget were dominated by the Chancellor’s decision to achieve fiscal consolidation mostly through cuts to public spending, and – with regard to tax – Mr Osborne’s decision to increase VAT. In an editorial on the Budget, the Times noted “on capital gains tax, Mr Osborne has deftly managed the expectations of those who feared that the rate would be even higher than 28 per cent. He threaded his way carefully through the hostility of his own side to reach a level lower than his Liberal Democrat partners had hoped for, but below that of France, Australia, Sweden and the US.”70

The CBI was supportive, stating that the Chancellor had “balanced the need for fairness in CGT with a recognition of the need to support entrepreneurship and keep the system simple.”71 The Chartered Institute of Taxation suggested the changes “made the best of a bad job” as the 28% rate was “a pragmatic way of avoiding the necessity of complex tapering or indexation allowances”, though “the basic rate taxpayer who makes a significant gain will find themselves paying the higher CGT rate on some of the gain as their combined total of income and gains exceeds the higher rate threshold.”72 The Low Incomes Tax Reform Group welcomed the decision to maintain the annual exemption at £10,100, and keep the basic rate of tax at 18%, as “when governments tinker with the rules for the wealthier sections of society, then those lower down can get swept up in the additional bureaucracy that follows.”73 The Institute of Chartered Accountants also raised concerns about complexity:

It came as no surprise that the rate of CGT was increased, given that the difference between the CGT rate (18%) and the top rate of income tax (50%) would be 32% this year. In the event, a new CGT rate was introduced of 28%. However, the new rate only applies where total taxable gains and income are more than the upper limit of the income tax basic rate band; gains below that limit will be taxed at the 18% rate. This will add complexity to the CGT system. Further complications to the 2010/11 tax calculations will arise because the new rate applies from part-way through the year, to disposals on or after 23 June 2010. However, there was

69 “CGT rise is ‘relief’ for housing”, Financial Times, 26/7 June 2010 70 “Leader: Austerity Rules; George Osborne's first Budget was bolder than

'unavoidable'”, Times, 23 June 2010 71 CBI press notice, Full CBI reaction to emergency Budget, 22 June 2010 72 CIOT press notice, Budget response: CGT changes pragmatic, says CIOT, 22 June 2010 73 LITRG press notice, Emergency Budget - a compassionate axe?, 22 June 2010

25 Capital gains tax : recent developments

probably a need to act quickly to shore up leakage as taxpayers sought to convert income into capital.74

By contrast the Institute of Directors argued “the rise in CGT rates is regrettable, but not as bad as an increase right up to income tax rates would have been”75 whereas the TUC suggested the increase was “full of loopholes, and won't stop tax dodging.”76 At their post-Budget briefing, the then director of the IFS, Robert Chote, was more positive, describing the changes as “a step in the right direction in narrowing the gap between CGT and income tax rates”; while the Budget represented “a missed opportunity to move to a more coherent treatment of saving in the tax system” the Chancellor deserved some praise for having “resisted the siren voices calling for the reintroduction of taper relief.”77

Similarly there was relatively little comment on these reforms in the House, as Members focused on the issues of public spending, or, in relation to tax, the new 20% standard rate of VAT. Speaking in the Budget debates the then Shadow Chancellor, Alistair Darling, stated that the Opposition were “not going to oppose the increase in capital gains tax; especially when there is a higher 50p rate of tax, sooner or later action would have to be taken to stop the real risk of leakage.”78

Provision to set the new rate of CGT was made the Finance (No 2) Act 2010 (specifically section 2 & schedule 1). This was the subject of a relatively short debate by the Committee of the Whole House on 12 July, when the House agreed on the clause & schedule without division.79 On this occasion Members raised questions on the Government’s decisions to implement the new rate immediately, and to settle on a 28% tax rate. In response Treasury Minister David Gauke suggested that the date change would minimise distortions, and argued that it would not prove too onerous for taxpayers:

For individuals, the rate remains 18% when their income and gains for the tax year do not exceed their income tax basic rate band. Above that level, the rate is increased to 28%. Therefore, someone who is already paying income tax at the 40% or 50% rates will pay 28% on all their gains. As was mentioned in an earlier debate, the 28% rate applies to trustees and personal representatives, who will pay capital gains tax at that rate on all their gains. That ensures that trusts are not used to shelter personal gains from the higher rate of capital gains tax …

The changes come into effect from 23 June 2010, which … is part way through the tax year 2010-11. Gains chargeable in the earlier part of that year are still liable to CGT at the old 18% rate. As he pointed out, we did that to avoid forestalling and transactions being brought forward before the end of the tax year in such a way as to distort activity. We saw that after the announcement in October 2007 of a reform in the way capital gains tax worked.

74 ICAEW (Tax Faculty), Budget Report, June 2010 p4. See also, “A year of two halves”,

Taxation, 8 July 2010 75 IoD press notice, IoD backs bold Budget, 22 June 2010 76 TUC press notice, TUC fears Budget will slow recovery, 22 June 2010 77 IFS, Emergency Budget 2010 presentation – opening remarks, 23 June 2010 78 HC Deb 23 June 2010 c307. At the end of the Budget debates, the House approved

the Ways & Means Resolution relating to the new rate of CGT without division (HC Deb 28 June 2010 c677).

79 HC Deb 12 July 2010 cc 752-63

Number 5572, 12 June 2020 26

The disruption within the economy and distortive effect result in the economy becoming less efficient as a consequence of the tax system …

A number of capital gains tax rules do not specify the exact time at which a gain arises, but they do not create difficulties in relation to the change of rate in June 2010. In such cases the facts will determine whether the gain arose before or after 23 June 2010. Exactly the same question could arise in determining whether a gain arises in one tax year or the next. That question normally causes no difficulty, and there is no justification for special provisions for 2010-11.80

Mr Gauke went on to address the issue of the 28% rate, and referred to Budget costings analysis mentioned above:

The answer [to why a 28% rate was chosen] is that it is close to the revenue-maximising point … At the time of the Budget, we produced policy costings, which set out in greater detail than ever before how these matters are worked out … We start with a static costing for the additional tax that would be raised as a consequence of raising the CGT rate. Two post-behavioural factors then need to be taken into account. The first is the increase in the lock-in effect … The ultimate Exchequer impact of those two changes is that £725 million will be raised in 2011/12.81

On this occasion Stephen Timms asked the Minister why the Budget report had not given an estimate for the amount to be raised in the current tax year:

Mr Gauke: We do not get the receipts for capital gains tax through self-assessment immediately; it is only in future that CGT will be paid through the self-assessment process.

Stephen Timms: The Minister has made the point, however, that most of the gain is in fact income tax, which surely would score in the coming year?

Mr Gauke: I think we will see more of that behavioural effect as time goes by, but I am not sure that that will come through immediately. In some cases, it will depend on when the additional income will be crystallised or realised. I think that is the explanation, but if I have anything to add I will write to the right hon. Gentleman.82

The Minister gave a little more detail in a letter to the Member in which he said, “the increase in income tax yield is mainly expected to arise from sources of income taxed through self-assessment, such as dividends, interest, rental incomes and a reduction in the use of capital growth schemes that reduce taxable incomes. This means that the income tax portion of receipts is not realised until 2011/12, when self-assessment returns are made for the 2010/11 financial year.”83

80 HC Deb 12 July 2010 cc760-1 81 HC Deb 12 July 2010 c761 82 HC Deb 12 July 2010 c762 83 HM Treasury, Letter dated 26/07/2010 from David Gauke MP to Stephen Timms MP

regarding Capital Gains Tax, Commons Library Deposited Paper Dep2010-1582, 26 July 2010

27 Capital gains tax : recent developments

4.2 Subsequent debate One practitioner reviewing the reforms at the end of 2010 suggested that the 28% rate might be revisited:

Alistair Darling greatly simplified CGT in 2008 and his rules effectively carry on into the future. The current tax year, 2010/11, could be seen as a blip on the radar of simplification. Until, that is, it is thought that the differential between the top rate of income tax at 50% and the top rate of capital gains tax at 28% is still too large and needs addressing. In the life of this Parliament anyone?84

In the immediate aftermath of the June 2010 Budget there was little discussion of the reforms to CGT in the House, and in answer to PQs, Ministers stated that the Government were not planning “to revisit this decision in this Parliament.”85 In the Coalition’s second Budget in March 2011, the Government announced that it would increase the lifetime limit on capital gains qualifying for entrepreneurs’ relief from £5m to £10m – at a cost of £50m in 2012/13, rising to £100m by 2015/16 – as well as increasing the annual exempt amount in line with inflation. At this time the Government also announced that in line with other changes to increasing certain benefits and tax thresholds, from 2012 the default indexation assumption for the annual exempt amount would be the Consumer Price Index (CPI) rather than the Retail Price Index (RPI).86 The increase in the lifetime limit appears to have been generally welcomed,87 though the numbers of taxpayers affected would seem to be quite small. In an impact assessment of the change HMRC stated that 25-30,000 people each year claim entrepreneurs’ relief, of which “we estimate a small number will benefit.”88

Subsequently, at the time of the Chancellor’s Autumn Statement in November 2011, the Government stated that it would freeze the annual exempt amount at £10,600 for 2012/13, rather than increasing it in line with inflation. This would fund a capital gains exemption for gains realised and invested that year in a new ‘Seed Enterprise Investment Scheme’; the scheme is to offer 50% income tax relief on investments in new start-up companies, and is to be launched from April 2012.89 The change was estimated to raise just £25m in 2013/14,90 and was not the subject of much comment, though it was raised in a PQ:

Owen Smith: To ask the Chancellor of the Exchequer what estimate he has made of the number of individuals who will incur a net loss as a result of the freezing of the Capital Gains Tax annual exempt amount announced in the Autumn Statement.

Mr Hoban: Freezing the annual exempt amount (AEA) in 2012-13 will affect all individuals with a Capital Gains Tax (CGT) liability

84 “Where are we now?”, Taxation, 4 November 2010 85 HC Deb 27 July 2010 c936W 86 HC 836 March 2011 para 1.85; Table 2.1 : item 13; para 2.55 87 Speaking for the Opposition David Hanson supported the change when debated at

the Committee stage of the Finance Bill: Public Bill Committee (Finance (No.3) Bill), 10 May 2011 cc74-82.

88 HMRC, Overview of Tax Legislation and Rates, March 2010 pA10 89 HC Deb 29 November 2011 c808. For details of the new scheme see, HMT/HMRC,

Overview of Legislation in Draft, December 2011 ppA3-A5 90 Autumn Statement 2011, Cm 8231 November 2011 para 1.138; Table 2.1 : item 10

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in that year. The number of individuals liable to CGT in 2009-10, the latest year for which figures are available, is estimated at 148,000 and is published at:

http://www.hmrc.gov.uk/stats/capital_gains/table14-1.xls

An additional 12,000 taxpayers each year could become liable to CGT over the next five years, as a result of the freeze. However, some individuals will arrange their disposals to keep the gains below the AEA and will therefore have nothing to pay.91

By contrast, the months after the Government’s first Budget saw a huge great deal of interest in the 50p top rate of income tax and whether the Government might withdraw it.92 In his second Budget in March 2011 the Chancellor Mr Osborne made no changes to the rates of income tax for the coming year but underlined his view that the 50p rate “would do lasting damage to our economy if it were to become permanent” and said he had asked HM Revenue & Customs to review “how much revenue it actually raises.”93 In September 2011 the Financial Times published a letter signed by DeAnne Julius, Chairman of Chatham House, and nineteen other leading economists, which argued that the 50p rate was “doing lasting damage to the UK economy”; in particular if “a small portion of these highly mobile workers [who pay the 50p rate] move elsewhere because of the 50p rate then it is clearly a self-defeating way for the Treasury to try to raise money, and a reduction in tax avoidance would be more effective.”94

Many others waged into the debate, though, as the Institute for Fiscal Studies noted at the time, HMRC would only have data on the yield from the first year of the 50p rate after 31 January 2012 – the deadline for 2010/11 tax returns – and that, in itself, this would not necessarily say very much about its potential impact in the long-term. In a detailed discussion of the 50p rate in their 2012 Green Budget, the IFS discussed the techniques taxpayers could use to avoid paying it: specifically, making pension contributions, bringing payments forward before the 2010/11 tax year, and, of relevance to the question of CGT reform, exploiting the difference between the taxation of income and gains:

The difference between the top income tax rate of 50% and the top capital gains tax (CGT) rate of 28% provides a strong incentive for individuals to obtain remuneration in the form of capital gains rather than income. This option may be available to the self-employed, who can forgo some or all of their salary to increase the value of their business and then sell it on,95 and to those who use service companies, who can put a proportion of their income – perhaps from personal endorsements – into a

91 HC Deb 15 December 2011 cc850-1W 92 As noted, for more details on this issue see, Income tax: the additional 50p rate,

Commons Briefing Paper CBP249, 26 September 2018 93 HC Deb 23 March 2011 c957. See also, HC Deb 14 September 2011 c1191W 94 “Letters: Government must abolish 50p tax rate to grow UK economy”, Financial

Times, 7 September 2011 95 Indeed, in the case of owner-managed businesses, the incentive to take remuneration

in the form of capital gains is particularly strong because of the existence of entrepreneur’s relief, which allows the first £10 million of gains realised on unincorporated businesses or shares where the shareholder has been a full-time employee or director and owned at least 5% of the shares to be taxed at a lower rate of 10%.

29 Capital gains tax : recent developments

company that will pay corporation tax and allow income to be deferred. It also applies to groups such as private equity fund managers who receive much of their income as ‘carried interest’, which is treated as a capital gain rather than income.96

It is also relatively easy to convert investment income to capital gains: individuals can shift their asset portfolios towards assets that give returns in the form of capital gains rather than income. In some cases, income from employment can take the form of capital gains: UK governments have been keen to encourage company managers to align their interests with those of the company by introducing various tax-favoured forms of share-based remuneration such as Company Share Option Plans (CSOPs). Gains made when options are realised are taxed at CGT rather than income tax rates, giving substantial tax savings. In the long term, individuals may be encouraged by the 50p rate to become self-employed in order to enjoy the resulting tax advantages.97

The authors noted that “the government does have some power to prevent, or at least limit, behavioural responses of this nature”, and from this perspective, one might think there was a case for the Government to revisit the reforms to CGT made in June 2010:

The government has already taken such a measure by placing an annual limit of £50,000 on pension contributions from 2011/12.98 It has also made a series of reforms to CGT, which involve raising the headline rate to 28%. Depending on how it weighs different costs, the government could do more. For example, it could close the gap between income tax and CGT rates (as was proposed in the Liberal Democrats’ 2010 General Election Manifesto), thereby negating any advantage to taking capital gains rather than income, though this might impact on savings and investment incentives.99

As it transpired, in his 2012 Budget, the Chancellor announced that in its analysis of tax returns for 2010/11, the department had found evidence of considerable ‘forestalling’ – taxpayers shifting income into the previous tax year to avoid the 50p rate “at a cost to the taxpayer of £1 billion.” He argued that “no Chancellor can justify a tax rate that damages our economy and raises next to nothing” and so the rate would be cut to 45p from April 2013.100 HMRC’s assessment of the 50p rate was set out in a detailed report, which estimated that the cost of cutting the rate to 45p would be only £100m by 2014/15, given the

96 Carried interest is a share of the profits of a private equity partnership that is designed

to give managers an incentive to maximise returns on investment. There was a great deal of controversy in 2007 about this practice, which at the time enabled private equity managers to pay tax at a rate of 10% rather than the top income tax rate of 40% as a result of the taper relief system for CGT that was then in place. Subsequent reforms to CGT have increased the CGT rate on carried interest to 28%, but this is still substantially less than the 50% top income tax rate.

97 The IFS 2012 Green Budget, February 2012 p184 98 The government also changed the rules concerning the amount that can be

contributed to a pension in the year it is withdrawn: previously, there was no limit to the amount individuals could contribute in the year they withdrew their pension, but the £50,000 limit applies in this year also, with the only exception being if an individual has a severe illness or on death.

99 The IFS 2012 Green Budget, February 2012 p185 100 HC Deb 21 March 2012 cc805-6. In the 2013 Budget the Government confirmed that

the additional rate would be 45% for 2013/14 (Budget 2013, HC 1033, March 2013 para 1.202-3).

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anticipated response by taxpayers to this change.101 Although the report did not discuss CGT at length, it noted that the 2010 reforms would have reduced incentives to prefer income in the form of capital growth – and that this had been taken into account when trying to isolate the impact of the 50p rate.102

For the remainder of its term of office the Coalition Government did not raise the question of revisiting this reform. In answer to a PQ in February 2013 Treasury Minister David Gauke said, “the Government believes that the current capital gains tax regime represents a good balance between raising revenue, reducing the incentives to substitute income for a capital gain and retaining incentives to save and invest.”103

In their Green Budget published in February 2013, the Institute for Fiscal Studies argued that, in the absence of any other reforms to the way capital gains were taxed, the pros and cons in terms of economic efficiency of further increases in CGT rates, closer to those for income tax, were quite finely balanced: “It would discourage saving in taxed assets such as investment property and ordinary shares; on the other hand, it would reduce the bias towards taking capital gains rather than income.” That noted, the authors went on to argue that “perhaps the biggest opportunity for converting income into lightly-taxed capital gains in the current system is not the low headline rates of CGT but entrepreneurs’ relief”, and that, “on balance” this relief should probably be abolished:

Entrepreneurs’ relief applies a reduced CGT rate of 10% to capital gains (up to a lifetime limit of £10 million) on certain eligible assets:

• shares in a trading company (or holding company of a trading group) of which the shareholder has been a full-time employee or director, owned at least 5% of the shares and had at least 5% of the voting rights, all for at least a year;

• an unincorporated business (or distinct part of a business), or business assets sold after the individual stops carrying on the business.

HMRC estimates that entrepreneurs’ relief reduced total tax liabilities by £1.7 billion in 2012–13, though it argues that abolishing it would yield substantially less than this as people would change their behaviour in response. Notwithstanding this caveat, the figure is strikingly large relative to the £200 million estimated cost of entrepreneurs’ relief when it was first introduced in 2008 – partly because the lifetime limit has been gradually increased to £10 million from its initial level of £1 million.

101 HMRC, The Exchequer effect of the 50 per cent additional rate of income tax, March

2012 pp 48-53. The report estimated that the ‘static cost’ of this tax cut, with no allowance for any behavioural response, would be £3.35 billion in 2014/15. See also, Budget 2013, HC 1033, March 2013 p66 (Table 2.2 – item t)

102 HMRC, The Exchequer effect of the 50% additional rate, March 2012 p35 103 HC Deb 7 February 2013 c432W

31 Capital gains tax : recent developments

Entrepreneurs’ relief adds complexity to the tax system and creates a range of distortions.104 It is also arguably unfair.105 More generally, the justification for applying lower tax rates to people who own their own business than to the rest of the population seems far from clear.106

In isolation, abolishing entrepreneurs’ relief would weaken the incentive for people to start a business and invest in it. However, it is far from clear that entrepreneurs’ relief is the best way to pursue these goals in any case. The Mirrlees Review argues that investment can be best encouraged by providing relief for amounts invested, rather than reduced tax rates on actual investment returns: this could be achieved by the introduction of an Rate of Return Allowance107… , and is also the approach embodied in the annual investment allowance in the current tax system. In the absence of these kinds of wider reforms to the tax base, abolishing entrepreneurs’ relief would undoubtedly have downsides as well as upsides. But the complexity, inefficiency and unfairness of the current system make maintaining the status quo an unattractive option. On balance, entrepreneurs’ relief should probably be abolished.108

Nevertheless the 2013 Budget saw no changes in entrepreneurs’ relief, nor in the rates of CGT. At this time the Government simply confirmed a decision, announced in the Autumn Statement in December 2012, that for the two year period 2014-2016 the annual exempt amount would be increased by 1% only, rather than in line with inflation.109

The IFS revisited the case for reforming CGT in its 2015 Green Budget, when the authors suggested that any increase in headline rates “would probably yield little if any additional revenue”:

HMRC’s most recent estimate is that a rise in the lower rate

104 First, it encourages owner-managers of companies to retain profits in the company

rather than take them out as dividends or salary, regardless of whether (in the absence of tax considerations) they would rather spend the money or could invest it more profitably elsewhere. Second, it provides a strong incentive to set up a business in which to retain profits, putting pressure on anti-avoidance rules, which attempt to define when companies are ‘artificial’ avoidance devices. Third, it gives companies an artificial incentive to ensure that any individual employee shareholdings are above 5%, rather than below that threshold. And fourth, it gives self-employed individuals and partnerships a large incentive not to sell assets of the business until they are ready to stop doing business altogether, regardless of whether the assets could be more profitably used by others and whether the proceeds of a sale could be more profitably used in other ways

105 The distortions in the footnote above mean that entrepreneurs’ relief discriminates against owner-managers who cannot afford to retain profits in their business, against self-employed people who choose (or need) to sell business assets before giving up the business altogether and against employees who have shareholdings of less than 5% in the company for which they work.

106 For a fuller development of this argument in a related context, see S. Adam, ‘Taxing employees, the self-employed and small companies’, in New Forms of Work, Fabian Policy Report.

107 [An RRA is an amount equal to a ‘normal’ (risk-free) return on the purchase cost of the asset, which could be deducted from actual returns on the asset – either capital gains or investment income – with any remaining ‘excess’ returns then subject to taxation at full labour income tax rates. The case for this, as part of a wholesale reform of the taxation of savings, was made in the Mirrlees Review of the UK tax system, published by the IFS in 2011 – see in particular chapters 13 & 14].

108 “Chapter 9. Broad shoulders and tight belts: options for taxing the better-off”, The 2013 Green Budget, IFS February 2013 pp260-1

109 Budget 2013, HC 1033, March 2013 para 2.70. Receipts were forecast to be £10m in 2015/16, rising to £15m the following year (op.cit. Table 2.2 – item n).

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would raise nothing, while any increase in the higher rate would actually reduce revenues slightly.110

As with almost any tax, CGT is subject to a ‘Laffer curve’ effect. As the tax rate rises, people will take more steps to avoid paying it.111 This erodes the yield from additional rises until the point where a further increase in the tax rate actually reduces revenue: after all, in the extreme case, with a 100% tax rate it would not be worthwhile to undertake the taxed activity at all and revenue would be zero. The size of the behavioural responses, and thus the revenue-maximising tax rate, are very difficult to estimate, but evidently the government believes that CGT rates are around their revenue-maximising level.112

The report also discussed earlier criticisms of the scope of entrepreneurs’ relief, suggesting that “in isolation, abolishing entrepreneurs’ relief would weaken the incentive for people to start a business and invest in it. However, it is doubtful that entrepreneurs’ relief is the best way to pursue these goals in any case.”113

The rising cost of entrepreneurs’ relief was also mentioned in a report published at this time by the National Audit Office on the management of tax reliefs by Treasury and HMRC. The NAO looked at HMRC’s administration of 10 individual reliefs, and in the case of entrepreneurs’ relief concluded that, “HMRC has carried out only limited analysis to investigate why the cost … has significantly outstripped its forecast, increasing over 500% from £500 million in 2008/09, to an estimated £2.9 billion in 2013/14 and whether the cost increase might be influenced by misuse of the relief”:

HMRC has carried out limited analysis to understand why the cost of Entrepreneurs’ relief has significantly outstripped its forecast

2.11 The cost of the relief has increased 500% in 5 years. The increase is partly explained by successive increases in the lifetime limit for claiming Entrepreneurs’ relief. In the March 2010 budget the limit rose from £1 million to £2 million. It increased further in the June budget of that year to £5 million. A further increase in the lifetime limit to £10 million in 2011-12 also led to increased claims for the relief. In addition an increase in capital gains tax in June 2010 increased the relative value of the relief (providing an 18% reduction from the capital gains tax rate, instead of 8%).

2.12 The estimated cost of £2.9 billion in 2013-14 was 3 times more than the cumulative amount forecast as a result of policy changes. Figure 8 illustrates how the cost of Entrepreneurs’ relief has continually exceeded the total forecast cost of changes

110 [HMRC’s updated estimates are that raising the lower rare would have a negligible

impact, while raising the higher rate would raise £15m in 2019/20: Direct effects of illustrative tax changes, April 2018.]

111 In the case of CGT, this could include --- among other possibilities --- saving less, moving into tax-privileged asset classes, taking income out of a business rather than letting its value build up, spreading out the realisation of gains to take maximum advantage of each year’s exempt amount, transferring assets to a lower-taxed spouse, leaving (or not moving to) the UK, or delaying selling an asset in order to postpone the latent tax liability for as long as possible --- perhaps in the hope that a future government would reduce CGT rates

112 “Chapter 10: Options for increasing tax” in, Institute for Fiscal Studies, Green Budget 2015, February 2015 p241

113 op.cit. pp254-5

33 Capital gains tax : recent developments

submitted to Parliament for approval. HMRC has not maintained a continuous forecast for comparative purposes. It produced new forecasts for each policy change. We have adjusted early forecasts to take account of changes to the rate of capital gains tax from 2010 onwards. Later forecasts took account of this effect.

2.13 HMRC has not examined previous forecasts for accuracy before estimating the costs of new policy changes. The forecasts may have been prone to error because of a lack of data at the inception of the relief and time lags in collecting tax returns meant that HMRC had limited data available for making forecasts. When it forecast the cost of increasing the limit to £10 million in 2011-12 it only had 2009-10 data available, when the capital gains tax rate was 18% and a lifetime limit of £1 million applied. However, data also showed the cost of the relief was almost double the level forecast. The latest forecasts used new methods, but forecasts are rarely within £250 million of the value of claims received.

2.14 HMRC told us that increases in the asset values and disposals might also explain the increases but it is not able to attribute increases in cost to any factor until it has more evidence. It expects to wait until the policy background has reached a steady state before conducting more detailed quantitative analysis so it can make a conclusive evaluation.

Notes

1 The cumulative exchequer impact is calculated from HMRC’s published forecasts of the original cost of the relief and four subsequent extensions.

2 Note that the 2013-14 ‘actual cost’ data is a forecast and may be revised by HMRC.

3 HMRC’s forecasts for the original cost of the relief and the first extension (which increased the lifetime limit to £2 million) were published before the increase in CGT rate in June 2010 was known about. We have adjusted those forecasts to allow for the increase in the rate of CGT in June 2010.

4 When the relief was introduced in 2008-09, its cost was forecast up to 2012-13. We have carried forward 2012-13 cost (£450 million) into 2013-14. We have not used a growth factor in making this adjustment.

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5 The exchequer impact forecast took account of behavioural change with the exception of how the rate change will effect those claiming under £2million in later years.

Source: HM Revenue & Customs’ published data

2.15 In autumn 2013, HMRC carried out a preliminary assessment of Entrepreneurs’ relief. It found that the relief may have formed a genuine incentive for entrepreneurs based on finding that the average age of beneficiaries had dropped from 59 to 53. The analysis did not explain or justify the link between age and entrepreneurship. HMRC told us that the lower average age may suggest people are not just selling businesses on retirement and that other motivations, such as encouraging entrepreneurship are contributing to its use. The analysis did not consider why the cost of the relief was greater than expected.

2.16 HMRC is exploring ways to do more detailed analysis such as external research on motivations for claiming the relief. In May 2014, HMRC commissioned a qualitative study of 50 people to find out why they claimed the relief.114

In March 2015 the Public Accounts Committee published a report on this issue in light of the NAO’s work, recommending that, “HMRC should regularly monitor variances between its forecasts of what tax reliefs will cost and what they actually cost. Where costs significantly exceed forecasts, it should seek positive evidence that the relief is working as intended and not being targeted for tax avoidance.”115 Although the report did not make any specific recommendations regarding entrepreneurs’ relief, its costs and possible abuse was something that the Committee raised with HMRC:

10. HMRC told us that there were various influences on the costs of tax reliefs that meant that simply thinking that an increase in cost was either a sign of abuse or a sign of a lack of accountability was problematic. HMRC believed it should be held accountable for watching these things and providing advice but considered that tax reliefs should not be seen as the same as spending. HMRC accepted that it should make enquiries into unexpected increases in the costs of tax reliefs and noted that changes in cost had driven it to investigate whether there was abuse in Seafarers’ Earnings Deduction. HMRC considered that its risk approach worked successfully but accepted it should be more systematic in using cost data to monitor tax reliefs.

11. The National Audit Office found that there was a difference of around £2 billion between HMRC’s forecasts of the costs of Entrepreneurs’ relief after adjusting for the changes to the scope of the relief and the actual cost. HMRC told us that a significant element of the cost variation was as a result of multiple changes in the scope of the relief. HM Treasury told us that this was a highly uncertain area. There was no quantified measure of how much investment there should be or how many people should be impacted.

12. We asked HMRC whether, given the significant sums involved, Entrepreneurs’ relief was value for money. HMRC told us it had no evidence to suggest that there was systematic abuse of

114 National Audit Office, The Effective Management of Tax Reliefs, HC 785, November

2014 para 2.11-6. The research work HMRC commissioned on ER was published in 2015, and is discussed below.

115 Public Accounts Committee, The Effective Management of Tax Reliefs, HC 982, 26 March 2015 p6

35 Capital gains tax : recent developments

Entrepreneurs’ relief and no evidence to suggest that Parliament’s intentions were not being achieved. We asked whether HMRC could provide positive assurance that there was no systematic abuse. HMRC offered to seek more positive assurance.116

Although the Coalition Government did not make any major changes to the tax, it is worth noting that in its last Budget in March 2015 it introduced provisions to prevent the exploitation of entrepreneurs’ relief by individuals using ‘contrived ownership structures’.117 The change was forecast to raise £45m a year from 2016/17.118

116 op.cit. p12 117 HMRC, Capital Gains Tax: Entrepreneurs' Relief associated disposal rules: tax

information & impact note, March 2015. See also, “Narrowing the angles”, Taxation, 4 June 2015.

118 Budget 2015, HC1093, March 2015 para 2.96, Table 2.1 – item 29

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5. The Conservative Government’s reforms

5.1 The Summer 2015 Budget The Conservative Party’s manifesto for the 2015 General Election did not make any specific proposals regarding capital gains tax, and, in his first Budget after the Election the Chancellor, George Osborne, did not mention the tax, with one exception: Mr Osborne announced the Government would “make sure investment fund managers pay the full capital gains tax rate on their carried interest.”119 Further details of this measure were given in the Budget report, which estimated this would raise £265m in 2016/17, rising to £375m the following year:

2.179 Taxation of carried interest: Base cost shifting and cherry picking – The government will introduce legislation, effective from 8 July 2015, to ensure that sums which arise to investment fund managers by way of carried interest will be charged to the full rate of capital gains tax, with only limited deductions being permitted. The government will also launch a consultation to better understand the activities of collective investment schemes, to determine under what circumstances performance returns should be taxed as a capital gain. It is not anticipated this will alter the tax treatment of carried interest.120

HM Revenue & Customs impact note on this measure gave details of the current law and how this would be amended:

Current law

Carried interest arises from an individual’s participation in an investment vehicle, typically a partnership. Sums allocated to an individual in satisfaction of carried interest are treated, for tax purposes, as though the individual and not the partnership had carried out the transactions which gave rise to the sums in question. Where a chargeable asset held by a partnership is disposed of, a chargeable gain accrues to the individual and is calculated in accordance with the chargeable gains legislation. HMRC has published Statement of Practice D12 (SoPD12) which sets out an agreed interpretation of how the chargeable gains legislation operates in these circumstances. The application of SoPD12, together with tax planning techniques, can result in fund managers being charged to capital gains tax on amounts significantly lower than their actual economic returns.

Proposed revisions

Legislation in Summer Finance Bill 2015 will introduce new sections in Part III of the Taxation of Chargeable Gains Act 1992 to require the treatment set out below for sums received by managers in respect of their carried interest.

For this purpose, carried interest will be defined by reference to the disguised investment management fees legislation introduced at Chapter 5E, Income Tax Act 2007 by section 21of the Finance Act 2015. The new sections will provide that, where an individual

119 HC Deb 8 July 2015 c325 120 Summer Budget 2015, HC264, July 2015 p96, Table 2.1 – item 27. See also, HM

Treasury, Summer Budget 2015 Policy Costings, July 2015 p31

37 Capital gains tax : recent developments

performs investment management services for a collective investment scheme through an arrangement involving one or more partnerships, then any sums received in respect of carried interest under that arrangement will constitute a chargeable gain and be subject to capital gains tax. This will cover the entire sum received by an individual, regardless of the items notionally applied to satisfy the carried interest at the level of the partnership or other entity in the fund structure.

Only specified sums will be allowable as a deduction against the sum received when calculating the chargeable gain to ensure that individuals are charged to tax on their true economic profit. In particular, a deduction will only be allowed for consideration actually given by the individual (if any) in return for the carried interest rather than for the amount that would be allowed under SoPD12. Provision will be made to ensure that credit is given for employment income tax charges where relevant.

This measure will not affect the taxation of performance-linked rewards which are charged to income tax.121

The Budget report also commented that “the Government continues to support the asset management industry in the UK, and considers that carried interest should be subject to CGT, as it reflects the underlying long term performance of a fund’s investments.”122 This point was noted in the Financial Times report on this measure:

“The government said it still “considers that carried interest should be subject to CGT, as it reflects the underlying long term performance of a fund’s investments.” But it will effectively apply the full 28 per cent capital gains tax rate by removing any element of discretion over the sums eligible for carried interest taxation. It will remove the “base cost shift” relief, whereby private equity managers could previously offset costs in their partnerships against their carried interest tax liabilities. “Individuals will normally be charged capital gains tax on the full amounts they receive in respect of their carried interest,” HM Revenue & Customs said.

Managers have previously paid rates of 18 per cent or less on their carried interest, depending on the structures they used. The taking away of base cost shift effectively removes a nearly three-decades old feature of private equity taxation in the UK. “The changes to the taxation of private equity carried interest bring to an end a basis of taxation agreed with HMRC as long ago as 1987, when the industry was in its infancy,” said Alex Henderson, a tax partner at PwC. “This is one of a series of changes that have affected the way the industry has been taxed in recent Budgets and reflects the chancellor’s progressive tightening of the tax regime and withdrawal of reliefs,” he added.”123

At this time the campaign group 38 Degrees had lobbied to have ‘carried interest’ – profits paid to investment fund managers from the fund – generally classified as income, rather than capital gains. In a report the group had commissioned on the taxation of investment fund managers, they proposed legislation to “re-characterise carried interest as ordinary income in cases where it is effectively remuneration for investment managers investing other people’s money, rather than gains

121 CGT treatment of carried interest: tax information & impact note, 8 July 2015 122 Summer Budget 2015, HC264, July 2015 para 1.177 123 “Private equity ‘carried interest’ blow”, Financial Times, 8 July 2015

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from those managers’ own investments.”124 In their response to the Budget the group acknowledged the Government’s announcement, but quote the author of their report saying, “the loophole being closed is much smaller than the Mayfair loophole. Wealthy finance managers will still pay 28% rather than 48% of tax on what they get paid to manage other people’s money.”125

The issue was raised by several Members during the Second Reading of the Finance Bill on 21 July 2015;126 for example, Roger Mullin (c1407), & Catherine West (cc1422-4). In response to the debate the Exchequer Secretary, Damian Hinds, acknowledged these comments, saying:

The hon. Member for Kirkcaldy and Cowdenbeath (Roger Mullin) … and the hon. Member for Hornsey and Wood Green (Catherine West) and others mentioned the so-called Mayfair loophole and the treatment of carried interest. Carried interest is treated as a capital gain in the UK, as in most other jurisdictions, because it is not exactly the same as a salary; it reflects the return to the manager in terms of some of investment risk that they have undertaken. That is aligned to the tax treatment applied to other investors.127

Subsequently the issue was debated when the relevant provisions in the Bill were considered in Committee,128 and at the Report stage of the Bill when the Government introduced a supplementary provision.129 On the latter occasion Roger Mullin argued, “carried interest is in effect their remuneration for managing other people’s money and should therefore be taxed as income tax.” In response Treasury Minister David Gauke said, “carried interest is a reward for a manager that is linked to the long-term performance and growth of the funds they manage. They are therefore capital in nature, and should continue to be charged capital gains tax … Bringing carried interest into income tax could raise more initially, but over time the yield would disappear as the industry moved to more competitive jurisdictions.”130

In December the Government completed its consultation on the payment of carried interest131, and announced it would introduce an objective, legislative test to determine whether carried interest should be taxed as capital gains or income, to be determined by testing the average period for which the fund holds assets.132 Provision to this

124 38 Degrees, Getting serious: how the UK government helps private equity executives

to pay lower tax rates than nurses and teachers, and what could be done about it, 2014 p11.

125 38 Degrees press notice, We’re making progress on closing the Mayfair tax loophole!!, 9 July 2015

126 HC Deb 21 July 2015 1387-1458 127 op.cit. c1450. 128 Public Bill Committee (Finance Bill), Fifth sitting, 15 October 2015 cc120-126. Initially

legislation to amend the rules regarding the taxation of carried interest was set out in clauses 40 & 41 of the Finance Bill 2015.

129 On this occasion Treasury Minister David Gauke explained that the new clause “establishes a comprehensive definition when sums arise for tax purposes under these rules” (HC Deb 25 October 2015 cc53-4). The legislation now forms ss43-45 of the Finance (No.2) Act 2015.

130 HC Deb 25 October 2015 c60, cc66-7 131 Details of the consultation are collated on Gov.uk. 132 HMRC, Investment managers: performance linked rewards: tax information & impact

note, 9 December 2015

39 Capital gains tax : recent developments

effect is included in the Finance Bill 2016.133 This was forecast to raise £210m in 2017/18, falling to £115m the next year.134 Subsequently in the Autumn 2017 Budget the Government announced that the transitional commencement provisions that were part of this reform would be removed, to prevent tax avoidance.135 The Exchequer impact of this change was put at around £150m a year.136

5.2 The 2016 Budget On 16 March 2016 the Chancellor, George Osborne, presented the Conservative Government’s second Budget. Mr Osborne announced a cut in the headline rates of CGT as well as an extension in entrepreneurs’ relief:

We want to help people to invest in our businesses and help them to create jobs. The best way to encourage that is to let them keep more of the rewards when that investment is successful. Our capital gains tax is now one of the highest in the developed world, when we want our taxes to be among the lowest. The headline rate of capital gains tax currently stands at 28%.

Today I am cutting it to 20% and I am cutting the capital gains tax paid by basic rate taxpayers from 18% to just 10%. The rates will come into effect in just three weeks’ time. The old rates will be kept in place for gains on residential property and carried interest. I am also introducing a brand-new 10% rate on long-term external investment in unlisted companies, up to a separate maximum £10 million of lifetime gains.137

The Budget report gives more details of both changes:

Cutting Capital Gains Tax

1.171 The government wants to ensure that companies have the opportunity to access the capital they need to grow and create jobs, and wants the next generation to be backed by a strong investment culture. Budget 2016 announces that, from 6 April 2016, the higher rate of Capital Gains Tax (CGT) will be reduced from 28% to 20%, and the basic rate will be reduced from 18% to 10%. There will be an 8 percentage point surcharge on these new rates for carried interest and for gains on residential property. This will ensure that CGT provides an incentive to invest in companies over property. Private Residence Relief will continue to ensure that an individual’s main home is not subject to CGT.

1.172 In addition, entrepreneurs’ relief will be extended to long term investors in unlisted companies. This will provide a 10% rate of CGT for gains on newly issued shares in unlisted companies purchased on or after 17 March 2016, provided they are held for a minimum of three years from 6 April 2016, and subject to a separate lifetime limit of £10 million of gains.138

133 HM Treasury, Overview of tax legislation & rates, March 2016 para 1.26 134 Budget 2016, HC901, March 2016 para 1.225; Table 2.1 – item 49 135 Autumn Budget 2017, HC 587, November 2017 para 3.75 136 op.cit. Table 2.1 – item 45; see also, HMRC, Capital Gains Tax: carried interest, 22

November 2017. 137 HC Deb 16 March 2016 c965. See also, 138 Budget 2016, HC901, March 2016 para 1.171

Number 5572, 12 June 2020 40

It was forecast that this change would cost £630m in 2017/18, rising to £735m by 2020/21.139 The extension of entrepreneurs’ relief was estimated to cost £5m in 2017/18, rising to £60m by 2020/21.140

HM Revenue & Customs’ impact note on the change to CGT rates noted that the costing of this measure “accounts for behavioural responses, including greater realisation of gains, and increased incentive to take capital gains relative to income.” It gave details of the current law and how this would be amended:

Current law

Section 4 of the Taxation of Chargeable Gains Act 1992 (TCGA) provides that chargeable gains accruing in the following circumstances are chargeable to CGT at 18% or 28% after deduction of reliefs, losses and the annual exempt amount (where applicable):

• 18% where a person is not a higher rate taxpayer (section 4(2))

• 28% to the extent that the person is a higher rate taxpayer or the chargeable gains exceed the unused part of the individual’s basic rate band (section 4(4) & (5))

• 28% for trustees and personal representatives (section 4(3))

• 28% for ATED-related chargeable gains accruing to any person (principally companies) so chargeable (section 4(3A))

Receipts of carried interest are charged to CGT by section 103KA of TCGA.

Proposed revisions

Legislation will be introduced in Finance Bill 2016 to amend subsections 4(2), (3), (4) and (5) of TCGA to reduce the 18% and 28% rates in those provisions to 10% and 20% respectively. This will be subject to exclusions for chargeable gains on disposals of residential property that do not qualify for private residence relief and receipt of carried interest.

Provisions will make clear that a person can use any unused income tax basic rate band in the most beneficial way.

Provisions will also make clear that a residential property interest includes an interest in land that has at any time in the person’s ownership consisted of or included a dwelling and an interest in land subsisting under a contract for an off-plan purchase. Rules will set out how gains should be calculated in the case of mixed use properties. Subsection 4(3A) of TCGA, which applies a 28% rate of CGT to ATED-related chargeable gains, is unchanged by this measure.

Subsection 4(1) and section 169N(3) of TCGA provide for a 10% rate in relation to gains that qualify for entrepreneurs’ relief; and subsection 4(3B) provides for a 20% rate in relation to Non-Residents CGT gains accruing to a company. These rates are also unchanged by this measure.141

139 Budget 2016, HC901, March 2016 p85 (Table 2.1 – item 28) see also, HM Treasury,

Budget 2016 Policy Costings, March 2016 p27 140 Budget 2016, HC901, March 2016 p85 (Table 2.1 – item 29) 141 HMRC, Changes to Capital Gains Tax rates: tax information & impact note, 16

March 2016

41 Capital gains tax : recent developments

5.3 Subsequent developments In general press coverage of the Budget focused on other measures – such as the Chancellor’s announcement of an introduction of a levy on the soft drinks industry. Similarly when the Chancellor gave evidence to the Treasury Committee the week after the Budget, Members raised other issues – including the Government’s analysis demonstrating the distributional impact of the Budget,142 a change in approach from the Coalition Government, and an issue on which the Committee and the Chancellor had exchanged views the year before.143

Following the Budget the Financial Times quoted David Kilshaw, private client tax services partner at EY, saying, “the Chancellor’s cut to the headline CGT rates will be a shot in the arm for the stock market … investors in stocks and shares [are] the main winners.”144 The Times quoted Lindsey Kutten, tax director at Pricewaterhouse Coopers, as saying, “This will be welcomed by the investment community but residential property is excluded, leaving buy-to-let investors wincing, particularly given the reductions in tax relief on interest payments and changes to stamp duty.”145 The paper also noted that the cut in rates would increase incentives to cash in capital gains as a form of income: “Simon Bashorun, the financial planning team leader at Investec Wealth & Investment, says: ‘Taken together with the changes to taxation of dividends and the normal annual capital gains tax allowance, the reduction in CGT rates makes directly-held stocks and shares investments very attractive in certain situations’.”146

Writing in the Financial Times, the paper’s personal finance editor Merryn Somerset Webb suggested that the cut in rates could be seen in the context of the Government’s aim to boost economic growth by encouraging investment in small businesses:

[The cut in rates] is particularly interesting for the simple reason that the chief executives of several big firms have told me recently how much pressure investors are putting them under to keep their dividends high (with rates this low, dividends are the one place the income starved reckon they can go for a hit) ... But if your rate of capital gains tax is very much lower than that of your dividend tax (which now comes with a top rate of 38.1 per cent), perhaps you might push for growth over income? …

Down at the smaller end, getting your hands on capital for growth also just got easier too: entrepreneurs’ relief (which reduces capital gains tax to 10 per cent) is to be extended to include long-term investors in unlisted companies. All those very well-paid people who are a few weeks away from seeing their

142 HM Treasury, Impact on households: distributional analysis to accompany Budget

2016, March 2016 143 Treasury Committee, Oral evidence: Budget 2016, HC 929, 24 March 2016 (see

Qs191-8). For more background see PQ HL1384, 27 July 2015, and the exchange of letters between the Chair, Andrew Tyrie (10 August 2015), and the Chancellor (9 September 2015).

144 “Capital gains tax rate falls from 28% to 20%”, Financial Times, 16 March 2016 145 “Tax cut gives investors green light to cash in”, Times, 17 March 2016 146 “How to make the most of the capital gains tax changes”, Times, 19 March 2016

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pensions tax relief allowance cut to £10,000 a year . . . guess where their money is about to go? Quite.147

Paul Johnson, director of the Institute for Fiscal Studies, was critical of the change, arguing that the ‘up-and-down rollercoaster ride’ to the rates of tax was “not the way to make good tax policy”

Mr Osborne, who raised CGT in 2010 and cut it yesterday, is following a long tradition of confused and indecisive chancellors who can’t quite make up their minds about whether to prioritise protecting the income tax base by having a higher CGT rate or incentivising investment by having a lower rate. We need a serious plan and strategy here. This is not the way to make good tax policy.148

In his presentation on the Budget changes to personal taxes and benefits, Stuart Adam argued that the cut in the main rate to 20% was almost a “complete reversal” of the 2010 reform, “the latest episode in an inglorious history of yo-yo-ing in CGT policy.” As with Mr Johnson, Mr Adam argued that what was needed was a “strategic response” as these reversals in policy illustrated the “underlying tension between minimising disincentives to save and minimising avoidance opportunities.”149

Writing in the Financial Times at this time, Jonathan Eley, deputy editor of the paper’s Lex column, suggested that investors should expect further reform of the tax, most likely before the end of the Parliament. Mr Eley noted that the reform broke “several of the rules of sound tax policy”, in taxing different assets at different rates, and substantially widening the gap between income and capital gains tax rates. Nevertheless these concerns might be of limited significance, if the cut in rates boosted tax receipts:

Does all this matter in the real world, though? It is possible to argue that shares should be taxed at a lower rate than property, to allow for the corporation tax already levied upon companies … Some may also feel that the supernormal returns earned by many property investors in recent years “deserve” to be taxed somehow. As for switching income to capital, this is easy for business owners to do, but rather more difficult for the rest of us … A lower rate of capital gains tax might even … lead to higher tax receipts. After seven years of central bank money printing, which has in general boosted asset prices, many investors are sitting on substantial CGT liabilities. A lower tax rate might encourage them to crystallise those gains now. They may as well — in Whitehall, the countdown to the next round of tinkering with CGT has probably already begun.150

147 “Budget: Has George Osborne had Mohamed El-Erian round for tea?”, Financial

Times, 18 March 2016 148 “Paul Johnson’s opening remarks”, IFS Budget briefing 2016, 17 March 2016

p3, p11 149 “Stuart Adam: personal taxes and benefits”, IFS Budget briefing 2016, 17 March

2016 (see slides 6-8) 150 “Why should the rich pay less tax than the rest?”, Financial Times, 7 April 2016

43 Capital gains tax : recent developments

The Finance (No.2) Bill 2015/16 was published on 24 March; clause 72 provided for this change in CGT rates.151 The clause was one of those selected for debate on the floor of the House at the beginning of the Committee stage, on 28 June. On this occasion Treasury Minister David Gauke set out the case for cutting the rates of CGT as follows:

Clause 72 will provide an incentive for people to invest in companies by reducing the main rate of capital gains tax from 18% to 10% and 28% to 20% on most gains made by individuals, trustees and personal representatives. The Government want to ensure that companies can access the capital they need to grow and create jobs, and want the next generation to be backed by a strong investment culture. We believe the best way to encourage this is to let investors keep more of the rewards when their investment is successful. At 28%, our higher rate of capital gains tax is among the highest in the developed world. We do not want high tax rates to deter investment.

The lower capital gains tax rates introduced by this clause will make it more attractive for people to invest in companies, helping those companies to access the capital to expand and create jobs. Gains made on residential properties that do not qualify for private residence relief, and those from carried interest, will remain subject to the 18% and 28% rates. Retaining these rates will create an incentive for individuals to invest in companies rather than in property.152

Mr Gauke went on to set out the Government’s reasons for opposing a new clause tabled by the Opposition, for a formal review of entrepreneurs’ relief:

Opposition Members will be aware that the Government keep all tax policy under review. This includes entrepreneurs relief, as demonstrated by recent action taken to ensure that the relief is effective, well targeted and not open to abuse, and we will continue to act where appropriate. I can inform the Committee that officials have for some time been developing a detailed research programme designed to identify taxpayers’ motivations for using entrepreneurs relief, and I expect the results to be published at some point in 2017. I do not believe it is necessary to legislate for a review, so I hope that the Opposition will not press the new clause.153

Speaking for the Opposition Rebecca Long Bailey opposed the cut in CGR rates on the grounds that, “it constitutes a major tax giveaway to the tune of £2.7 billion over the next five years for the wealthiest in our society, at a time when the poorest communities are crying out for help and investment”:

Opposition Members want capital investment in our economy. Indeed, we champion it and we have been saying so for more than nine months. However, we question whether cutting the headline rate of capital gains tax will indeed trigger large-scale

151 “Clause 72 and Schedules 11 & 12 : Reduction in rates of CGT”, Finance (No.2) Bill

2015-16: Explanatory Notes (Bill 155 EN), 24 March 2016. This now forms s82 of Finance Act 2016.

152 HC Deb 28 June 2016 cc234-5 153 op.cit. cc235-6

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investment. We believe that it could simply line the pockets of some of the wealthiest.154

On Entrepreneurs’ Relief, Ms Long Bailey welcomed the Minister’s announcement of HMRC’s research programme, but questioned whether the relief represented value for money:

The relief was estimated to cost £2 billion in 2012-13, rising to £3 billion in 2015-16. That represents a vast amount of Government revenue that is being forgone, and there appears to be no assessment of the relief’s efficacy in encouraging entrepreneurialism. We understand the rationale behind it, but as with all tax reliefs, the Government must ask themselves whether it provides value for money and whether it works in practice.

Tax Research UK’s analysis of the relief suggests that in the 2013/14 financial year, 3,000 people received tax relief to the tune of £600,000 each, at a total cost to the Treasury of £1.8 billion.155 Will the Minister confirm whether that is the case and tell us whether the Treasury has the relevant figures for 2014-15? That analysis also highlighted a couple of issues with the logic behind the relief itself, arguing that it is given at a time when people cease to be entrepreneurs by selling their businesses, and that it therefore does not encourage entrepreneurialism. It also argues that the relief has unfortunate behavioural consequences because by increasing the reward from sale it encourages sale far too early.

The Opposition therefore feel that an assessment of the relief is in order given the vast amount of forgone Government revenue, which appears to be concentrated in the hands of a small number of individuals. I noted the Minister’s earlier comments and look forward to the results of the Government’s research, due to be published in 2017.156

In response the Minister said the following:

On the criticism that entrepreneurs’ relief is badly targeted, I argue that, of course, as with all tax reliefs, it is entirely appropriate that the Government keep it under review to ensure that it is well targeted and not open to abuse, but we believe that it is right to incentivise individuals to set up and expand their businesses. Entrepreneurs relief plays an important part in our pro-growth agenda. It is a highly popular and widely used relief, which supports about 40,000 entrepreneurs a year, according to our latest data. We do not believe that this support should be withdrawn.

The latest published cost of entrepreneurs’ relief is £3 billion, but that is a static figure; the true cost will be different, due to potential changes in the disposals and behavioural change. That behavioural change is very important. On when the data for 2014-15 will be released, these statistics are published annually, and the new release is due in October 2016.157

The House divided, and the clause was agreed by 308 votes to 264.

154 op.cit. cc239-40 155 [for details see, Tax Research UK, In 2013-14 just 3,000 people got tax relief of at

least £600,000 each at a total cost of at least £1.8 billion, 30 October 2015.] 156 op.cit. c241 157 op.cit. c245. Subsequently HMRC has published updated statistics that show the

numbers of claimants at 45,000 in 2014/15, and 43,000 in 2017/18 (Capital Gains Tax statistical tables: Table 4 – Entrepreneurs’ Relief, August 2019).

45 Capital gains tax : recent developments

HMRC completed its research programme into entrepreneurs’ relief in December 2017, although this followed an earlier report – in July 2015. In the latter case, researchers had conducted a number of interviews with taxpayers who had claimed either this, or business assets rollover relief (which allows CGT to be deferred if a gain is used to buy new assets to be used in the taxpayer’s business). Apparently there were relatively few cases where either relief appeared to have a major influence on the business behaviour and tax planning of claimants.158 HMRC’s 2017 report was based on a larger survey of taxpayers who had claimed entrepreneurs’ relief at some point in the past five years, or had paid CGT but not claimed the relief, or, based on HMRC’s information, were likely to be eligible to claim the relief in the future.159

The research found that in most cases the existence of the relief was not the primary factor in the decision to invest or sell up – but it did have a role for investors considering investment in new ventures; as noted in answer to a PQ earlier this year, “the findings showed relatively low levels of awareness of the relief at the point of investment, but that of those who were aware around half were influenced by it in their decision to invest.”160 An extract from the report is reproduced below:

IFF Research conducted 1,700 telephone interviews across three distinct groups of customers. These were drawn randomly from those who had completed a Self-Assessment tax return for the tax years ending in 2011 to 2015:

• 625 interviews with individuals that had claimed ER (within the past five years). Throughout this report, findings from these individuals have been referenced as Group 1

• 603 interviews with individuals that had paid CGT at the full rate (within the past five years) because they had not claimed ER. Throughout this report, findings from these individuals have been referenced as Group 2; and

• 472 interviews with individuals that had neither paid CGT nor claimed ER, but held assets that mean they are likely to be eligible to claim ER in the future. Throughout this report, findings from these individuals have been referenced as Group 3.

In the majority of cases, ER was not the primary motivating factor when customers were making decisions about investing in assets, or disposing of them. Most often customers were looking to release funds for personal use (39%), retire (33%) or to reinvest (29%).

However, statistical analysis of the data has shown that those most likely to be influenced by ER at the point of initial investment were those who, at the time of the interview, no longer had involvement in the company, but were intending to set up a new company and had been receiving professional advice. This may suggest that ER is influencing some people to invest who later look to re-invest in new entrepreneurial activities

158 HMRC, Capital Gains Tax – Entrepreneurs’ Relief and Business Asset Rollover Relief

research – Research Report 237, July 2015 159 Capital Gains Tax Entrepreneurs’ Relief - Research Report 456, December 2017 160 PQ134071, 27 March 2018

Number 5572, 12 June 2020 46

A fifth (22%) of all customers that had claimed ER (Group 1) reported that ER influenced their decision at some point, either at the point of investment only (5%), at the point of disposal only (13%), or at both points (3%).161 The main reason given for the influence of ER at both stages was tax efficiency. Overall, 3% of all Group 1 customers were influenced by ER due to tax efficiency at the point of investment and 6% of all Group 1 customers were influenced due to tax efficiency at point of disposal. When focusing on those that mentioned tax efficiency as the only reason, this was given by 2% of Group 1 customers at the point of investment and 4% of Group 1 customers at the point of disposal.

There were some differences in customers’ motivations for disposing of assets (including the influence of ER) by the type and value of business asset disposed of. Disposing of different types of assets was associated with different reasons for disposal, for example, those disposing of property were more likely to be planning to retire and those disposing of shares were more likely to be looking to release funds for personal use. Group 1 customers who stated that assets included in their ER claim were worth over £1 million162 were more likely to be influenced by ER at both investment and disposal.

Among customers who had not paid CGT or claimed ER in the last 5 years but had assets that could be eligible (Group 3), 16% said ER would influence their business decisions (whether to close/sell the business or invest in new ones) in the future. This was in line with the proportion of customers who claimed ER and said ER had influenced their decision at the point of disposal.

Three quarters (75%) of customers that claimed ER did not experience any barriers to claiming ER. Uncertainty around eligibility was the most common barrier mentioned by those who had claimed ER.163

Over this period the Treasury’s Patient Capital Review considered the current state of long-term finance for growing firms, and consulted on options to increase the supply of capital – asking for views on the range of tax reliefs available to investors.164 At the time of the Autumn 2017 Budget the Government published the outcome of this review; on tax reliefs most responses focused on the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS), but those who commented specifically on Entrepreneurs’ Relief “regarded it as a successful relief”:

Some expressed concern that it did not provide sufficient incentives for entrepreneurs to become serial entrepreneurs. One respondent noted: “in some circumstances, [Entrepreneurs’ Relief] can also be a perverse incentive for early sub-optimal exit to the detriment of the company”. Reflecting a few other suggestions to extend the minimum holding period, another respondent commented: ”there is a question around how far [Entrepreneurs’ Relief] balances encouraging long-term growth and the benefits to the business owner upon disposal of the assets… an extended

161 These figures do not sum to 22% due to rounding. 162 Note that this is the value customers gave during the survey. 163 HMRC Research Report 456, November 2017 pp5-6 164 See, “Chapter 6: Current interventions”, in HMT, Financing growth in innovative

firms: consultation, August 2017

47 Capital gains tax : recent developments

five year holding period for Entrepreneurs’ Relief would encourage long-term capital investment”.

Several industry groups also proposed anti-dilution measures to be introduced for founders that have their ownership stakes diluted to less than 5% by multiple investment rounds.165

In the light of these comments, the Government announced “the rules will therefore be changed to ensure that entrepreneurs are not discouraged from seeking external investment through the dilution of their shareholding. This will take the form of allowing individuals to elect to be treated as disposing of and reacquiring their shares at the then market-value.”166 Following a technical consultation in spring 2018, the Government confirmed its plans in July 2018 when it published draft provisions for the Finance Bill.167 Minor amendments were made to the legislation as originally drafted.168 The cost of this measure was estimated to be around £10m a year.169

5.4 Budget 2018 In the weeks before the 2018 Budget, there was considerable speculation that the Government might restrict or abolish Entrepreneurs’ Relief.170 In August the Resolution Foundation published a report, arguing that the relief “has a good claim to being the worst of Britain’s main tax reliefs”, and as it was expensive, regressive and ineffective, it should be abolished.171 An extract from the report is reproduced below:

Proving the economic impact of policies is always going to be ferociously difficult. But defenders of ER (if any) should try to show at least some evidence of impact or potential mechanisms for impact, in order to justify the very significant cost and complexity it adds.

Even with the goal of generally boosting ‘entrepreneurship’, concentrating the spending among a small group of 6,000 people a year may not be the best approach. For comparison, almost 5 million people are self-employed. And, looking to an even wider distribution, back in May the Intergenerational Commission proposed a use-limited £10,000 universal inheritance for everyone when they turn 25, in part to help young people start their own businesses.172 Whatever you think of that policy, it’s striking that a £4,000 per person universal inheritance would be no more costly

165 HM Treasury, Finance growth in innovative firms: consultation – response, November

2017 para 3.8 166 op.cit. para 3.23 167 HMRC, Entrepreneurs’ Relief where shareholding ‘diluted’ below the 5% threshold,

6 July 2018. This note was updated in Budget 2018 (see, Overview of Tax Legislation & Rates, October 2018 pp200-2).

168 HMT, Overview of Tax Legislation & Rates, October 2018 para 1.26. 169 HMT, Autumn 2017 Budget Policy Costings, November 2017 p17 170 For example, “Is entrepreneurs’ relief for the chopping block?”, Tax Journal, 7

September 2018 171 Resolution Foundation press notice, Scrapping Entrepreneurs’ Relief – the UK’s worst

tax break – would give government a £2.7bn head start in funding its NHS pledge, August 2018

172 Intergenerational Commission, The new wealth of our nation: the case for a citizen’s inheritance, 8 May 2018

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than ER. It’s certainly arguable that ER comes at the wrong stage in a business’s life and that supporting large numbers of young people when they’re starting up a business might do more for entrepreneurship than giving very large sums to a small number of retiring people.

Finally, even if ER were considered worthwhile overall, it might be that a £10 million limit is not worthwhile compared to a lower limit. Even the scant research done on some of those who’ve actually claimed ER found that if anything the limit was considered generous: “Most claimants felt that anyone who reached this limit did not need the 10% relief rate, and felt that the lifetime limit would not drive business behaviour.”173 Returning to the original limit of £1 million, for example, could substantially reduce the cost to the Exchequer.

In looking for tax revenues to provide promised extra cash for the NHS – where the question is likely to be “what is the least bad tax rise” – the Chancellor needs to take a long, hard look at ER: quite likely the worst tax relief in the UK.174

However, in his Budget speech the then Chancellor Philip Hammond announced that “encouraging entrepreneurs must be at the heart of any strategy for a dynamic economy, so I will retain Entrepreneur’s Relief, but to ensure it is going to genuine entrepreneurs, I will extend the minimum qualifying period from 12 months to two years.”175

To give some context, to claim Entrepreneurs’ Relief on the sale of part or all of one’s business, the claimant had to have owned the business for at least one year before the date they sold it. A longer explanation of the qualifying period was given in HMRC’s Helpsheet on the relief – an extract is given below:

To claim Entrepreneurs’ Relief you have to meet the relevant qualifying conditions throughout a period of 1 year. This period is referred to in this helpsheet as the ‘qualifying period’. It ends with the date when you disposed of the asset, or an interest in the asset for which you want relief, or the date when the business ceased, if that was earlier.

You can claim relief, subject to the conditions set out below, on a disposal of assets (including disposals of interests in these assets) which fall into the following categories:

• assets (with the exception, in some circumstances, of goodwill) used in the business comprised in a disposal of the whole or part of your business (see ‘Qualifying conditions’ below), whether you carried on the business on your own or in partnership … – qualifying business assets include business premises – not included within this category are shares and securities (see the third bullet of this list) and any other assets held as investments …

• assets that were in use for your business, or a partnership of which you were a member, and were disposed of within the period of 3 years after the time the business ceased – again, this category excludes shares and securities (but see

173 HMRC, Capital Gains Tax – Entrepreneurs’ Relief and Business Asset Rollover Relief

research – Research Report 237, July 2015 174 Adam Corlett, Entrepreneurs’ Relief has cost £22 billion over the past 10 years. Was

it worth it?, Resolution Foundation August 2018 175 HC Deb 29 October 2018 c661

49 Capital gains tax : recent developments

the next bullet) and any other assets of the business held as investments

• one or more assets consisting of shares in, or securities of, your ‘personal company’ … – the shares must be disposed of either (i) while the company is a trading company or, where you hold shares in a holding company of a group, the group of companies is a trading group or, (ii) within 3 years from the date it ceased to be either a trading company or a member of a trading group …

• assets owned by you personally but used in a business carried on by either (i) a partnership of which you are a member, or (ii) by your personal trading company (or by a company in a trading group, the holding company of which is your ‘personal company’ … – the disposal will only qualify as long as it is associated with a disposal of either your interest in the partnership or of shares/securities in the company (qualifying disposals which fall into this category are referred to as ‘associated disposals’).176

The Budget report noted this and a second measure to provide the misuse of the relief:

3.25 Entrepreneurs’ Relief: minimum qualifying period – To support longer-term business investments, from 6 April 2019 the minimum period throughout which the qualifying conditions for relief must be met will be extended from 12 months to 24 months…

3.77 Capital gains tax: tackling misuse of Entrepreneurs’ Relief – In addition to the current requirements on share capital and voting rights, from 29 October 2018 shareholders must also be entitled to at least 5% of the distributable profits and net assets of a company to claim the relief. This is to address an identified abuse of the current rules.177

Together these reforms were estimated to raise £85m in 2020/21, rising to £105m by 2023/24.178

Further details of the extension of the minimum qualifying period, and its anticipated impact, were given in HMRC’s impact note:

Detailed proposal : The measure will have effect for disposals on or after 6 April 2019, except where a business ceased before 29 October 2018.

Where the claimant’s business ceased, or their personal company ceased to be a trading company (or the holding company of a trading group), before 29 October 2018, the existing one year qualifying period will continue to apply.

Operative date : The measure will have effect for disposals on or after 6 April 2019, except where a business ceased before 29 October 2018. Where the claimant’s business ceased, or their personal company ceased to be a trading company (or the holding company of a trading group), before 29 October 2018, the existing one year qualifying period will continue to apply. …

176 HMRC, Entrepreneurs' Relief (Help sheet 275), 6 April 2018 177 Budget 2018, HC 1629, October 2018 p44, p51; see also, HMT, Overview of Tax

Legislation and Rates, October 2018 para 1.24-6. 178 op.cit. Table 2.1 – items 56, 73

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Summary of impacts

…

Economic impact This measure is not expected to have any significant macroeconomic impacts. A behavioural adjustment is made for taxpayers holding onto their assets for longer in order to meet the new criteria.

Impact on individuals, households and families This measure will impact on an estimated 3,000 individuals who sell either all or part of their business, or shares in a company in which they hold an office or employment.

These individuals will lose their entitlement to relief and will have to pay more Capital Gains Tax on their gain if they have not carried on the business or held the necessary interests in their company for 2 years. One off costs include familiarisation with these new rules. It is not expected that there will be any on-going costs.179

Similarly, further details of the change to the personal company test were in HMRC’s impact note:

Policy objective

This measure ensures that the claimant has a true material stake in business in order to claim Entrepreneurs’ Relief. Having such an interest is characteristic of true entrepreneurial activity (as distinct from simple investment or employment), so the measure ensures that allowable claims are limited to those which are within the spirit of the relief. This is part of the government’s policy of supporting enterprise.

Detailed proposal

Operative date

The measure will have effect for disposals on or after 29 October 2018.

Current law

Current law for Entrepreneurs’ Relief is included in Chapter 3 of Part 5 Taxation of Chargeable Gains Act 1992, in particular at section 169S.

Proposed revisions

Legislation will be introduced in Finance Bill 2018-19 to add 2 new conditions to the definition of an individual’s personal company in section 169S(3). Both conditions, as well as the existing ‘share capital’ and ‘voting rights’ conditions must be met. The new conditions require the individual to be beneficially entitled to at least:

• 5% of the company’s distributable profits

179 Capital Gains Tax: Entrepreneurs’ Relief: minimum qualifying period extension, 30

October 2018

51 Capital gains tax : recent developments

• 5% of its assets available for distribution to equity holders in a winding up

References to the company include any other company which is a member of the same group.

The same 2 new conditions are added to:

• the conditions for relief on associated disposals in section 169K(1B), so that they must both be met in relation to a material disposal consisting of shares before an associated disposal of an asset can qualify for relief

• the conditions for the withholding of relief on goodwill at section 169LA(1), so in addition to the existing 2 conditions, if either of the new conditions is met following a disposal of goodwill to a close company, then relief will not be due

Summary of impacts

Exchequer impact (£m)

…

Impact on individuals, households and families

This measure will impact fewer than 1,000 individuals who sell shares in a company in which they hold an office or employment. Where individuals do not hold the necessary 5% economic interests in their company for the specified time, they will lose their entitlement to relief and will have to pay more Capital Gains Tax on their gain.

The measure is expected to have a negligible indirect negative impact on family formation, stability and breakdown as a result of a higher rate of tax being payable in some circumstances.180

In its assessment of the costing of the Budget’s tax measures, the OBR highlighted that the amounts to be raised from both of these measures was highly uncertain:

• ‘Capital gains tax: tackling misuse in Entrepreneurs' Relief’: this measure adds two new tests designed to limit the eligibility for entrepreneur’s relief and prevent misuse. The key uncertainty in this costing relates to the low quality of relevant data, and we assign this costing a ‘high’ uncertainty rating overall.

• ‘Capital gains tax: extend Entrepreneurs' Relief minimum qualifying period’: this measure increases the minimum qualifying period for eligibility for Entrepreneurs’ Relief to two years. The data and modelling underpinning this costing are highly uncertain. Overall, we assign this costing a ‘high’ uncertainty rating.181

At the time the impact of these changes does not appear to have been raised at any length in the House, nor did it feature much in press coverage of the Budget.

180 Changes to personal company tests for Entrepreneurs’ Relief, 29 October 2018 181 Economic and Fiscal Outlook, Cm 9173, October 2018 p240

Number 5572, 12 June 2020 52

The Financial Times quoted Jonathan Drysch (Killik & Co) as saying, “the truth is that [the change to] Entrepreneurs’ Relief is unlikely to affect many businesses dissolving with a profit and/or gain, due to the fact that most have probably been trading for over 24 months to get to that position.”182

Writing in Taxation, editor Andrew Hubbard suggested the extension of the qualifying period was unlikely to be controversial: “[the Budget press release] suggests that 95% of disposals already meet the two-year qualifying period and … two years is still generous, particularly when we reflect on retirement relief. There, a business had to be owned for ten years to qualify for full relief.” On the change to the shareholding test, Mr Hubbard noted, “this is targeted at arrangements involving ‘funny shares’ when attempts have been made to access the Entrepreneurs’ Relief conditions without having a real economic interest. As ever, we will have so see whether there is any collateral damage: given the history of Entrepreneurs’ Relief changes this would not be a big surprise.”183

Similarly the issue did not feature very much in the Treasury Committee’s inquiry into the Budget with one exception. In their written evidence on the tax measures in the Budget, the Chartered Institute of Taxation gave their view of these changes, as follows:

Entrepreneurs’ Relief (minimum qualifying period / tackling misuse)

Budget 2018 announced that, with immediate effect, in addition to the current requirements on share capital and voting rights, shareholders must also be entitled to at least 5% of the distributable profits and assets available for distribution on winding up to claim the relief. Further, from 6 April 2019, the minimum period throughout which the qualifying conditions for relief must be met will be extended from 12 months to 24 months.

We have no particular concerns with the principle behind either of these measures, as they are intended to avoid manipulation of the existing rules, and to focus the relief on longer term entrepreneurialism. In relation to the latter measure, the transition from 12 to 24 months will need careful consideration, and it is unfortunate that there will be little time for consultation.

Without adequate consultation there is potential for unintended consequences. For example, the availability of Entrepreneurs’ Relief was substantively restricted in 2015 to counter avoidance but without any prior consultation. The unintended consequences of these measures were subsequently remedied in FA 2016 by retrospective amendments following extensive consultation with the professional bodies.

Furthermore, although the Chancellor expressed the Government’s support for the principle of this relief, as with PRR (above), it could be that these changes betoken a more sceptical look at some of its results, and if so it would be preferable if there

182 “Entrepreneurs’ tax relief rules tightened”, Financial Times, 30 October 2018 183 “Autumn Budget”, Taxation, 1 November 2018. See also, “Budget comment: the

effect on SMEs”, Tax Journal, 2 November 2018

53 Capital gains tax : recent developments

could be a broad consultation about this rather than the possibility of further piecemeal restrictions.184

Provision for both these changes, and the pre-announced change regarding the dilution of shareholdings, was included in the Finance (No.3) Bill 2018-19, specifically clause 38 and Schedule 15.185 They were considered along with a number of other clauses in the Bill at the start of its Committee stage on 19 November. On this occasion speaking for the SNP Kirsty Blackman raised concerns over the extension of the minimum qualifying period, and argued that the Government should conduct a formal review of the relief:

Our new clause 7 would require a review of the impact on investment of changes to entrepreneurs’ relief, which extend the minimum qualifying period from 12 months to two years. Given that we have Brexit hanging over us and the massive uncertainty that that brings, putting another hurdle in the way of businesses is probably not the right course of action. Both the Chartered Institute of Taxation and the Association of Taxation Technicians have raised concerns about the unintended consequences of the change.

I believe that a review is the only sensible option going forward. The Treasury regularly makes tax changes, but it does not regularly review their effectiveness, even after they have been in place for a number of years, and when it does it rarely makes those reviews public. It is all well and good to think that something may have a certain effect, but it is necessary to check whether the intended effect has come about.186

Similarly, speaking for the Opposition Peter Dowd made the case for a review of the relief on the grounds that it was poorly targeted:

Entrepreneurs’ relief costs £2.7 billion a year alone, and benefits only 52,000 people. This bloated relief—and it is bloated—is overwhelmingly spent on a small number of wealthy individuals, with 6,000 claimants receiving relief on gains of over £1 million. I will repeat that: 6,000 claimants receive relief on gains of £1 million. It is no wonder then that the IFS and the Resolution Foundation have called for it to be scrapped.

Clause 38 and schedule 15 represent yet another Conservative half-measure … On one hand the Government are lengthening the qualifying time for investors from one year to two, but on the other hand they are ensuring that shareholders will be protected from falling below the 5% threshold needed to claim the relief when a company is sold. It is hard to see how this confused measure will tackle the growing cost of the relief … we have tabled new clause 3, which would require the Government to undertake a full review of entrepreneurs’ relief. The review would consider the overall number of entrepreneurs in the United Kingdom, the annual cost of the relief, the cost per claim and the impact of the relief on productivity in the UK.187

In response to these points Treasury Minister Mel Stride said that the Government regarded the shift to a two-year qualifying condition as “as

184 Treasury Committee, 2018 Budget Written Evidence: CIOT , 5 November 2018 para

8.1-4 185 These provisions now form s39 & Schedule 16 of the Finance Act 2019. 186 HC Deb 18 November 2018 c598 187 op.cit. cc608-9

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important that we at least have entrepreneurs who are not in and out within a period of 12 months, but who are actually there for the longer term.” He did not discuss the case for a formal review of the relief, although he noted, “that of those who benefit from the Entrepreneurs’ Relief, around a third go on to reinvest in further businesses, so those tax savings are being reinvested in further economic activity.”188

5.5 Budget 2020 In July 2019 the Office for Budget Responsibility published its detailed assessment of the various risks to the public finances over the medium term, and, as part of its analysis of the risks for Government tax revenues, looked at tax expenditures and tax reliefs. The OBR argued that Entrepreneurs’ Relief met “many characteristics of a relief that poses a fiscal risk” as it had “increased significantly in cost, and the reasons for the rise (and recent fall) are largely unknown, raising the possibility that the assumptions underpinning our forecast fail to factor in something that has affected its cost in the past.”189 A longer extract from the report is reproduced below:

Entrepreneurs’ relief

4.93 Entrepreneurs’ relief allows directors of companies with significant stakes in them (as well as certain other taxpayers) to pay a lower tax rate of 10 per cent on disposals of shares below a certain threshold, rather than the much higher headline capital gains tax (CGT) rate. It was introduced by the Labour Government in 2008, at the same time as an 18 per cent flat rate of CGT. Initially the annual cost was expected to rise to £0.9 billion by 2013-14.190 In fact, it turned out to be three times that and continued rising to £4.2 billion (0.2 per cent of GDP) in 2015-16. This figure halved to £2.1 billion the following year, the most recent outturn. We forecast it to rise steadily from that level to reach £3.0 billion in 2023-24.

4.94 The sharp initial rise is most likely due to an increase in generosity. At the June 2010 Budget the Coalition Government increased the CGT rate for higher rate income tax payers to 28 per cent, significantly widening the differential to the unchanged 10 per cent entrepreneurs’ relief rate. Between the March 2010 Budget and Budget 2011, its generosity increased further as the lifetime limit on gains that can benefit from the lower rate was progressively raised, from £1 million to £5 million (at the June 2010 Budget) and then to £10 million.

4.95 The reason for the cost of entrepreneurs’ relief falling so suddenly in 2016-17 is not known. It might be related to a new 20 per cent CGT rate that applies to gains not from property or carried interest. The number of claimants dropped by around 20 per cent that year, and the gross gains on which entrepreneurs’ relief was claimed fell by 12 per cent. But it is not clear why these led to a 50 per cent drop in the overall cost of the relief. While

188 op.cit. cc636-7 189 OBR, Fiscal Risks Report, CP 131, July 2019 para 4.98 190 NAO, Effective management of tax reliefs, 2014.

55 Capital gains tax : recent developments

CGT receipts can be volatile, HMRC offered little commentary on the drop when it released the latest estimate.191

4.96 HMRC’s statistics show that the gains from this relief are increasingly concentrated on a small number of wealthier claimants. In 2016-17 there were 5,000 individuals making gains of greater than £1 million, and, in aggregate, they made up three quarters of the total gains for which entrepreneurs’ relief was claimed. The comparative figure in 2010-11 was around a half. These 5,000 claimants benefited by an average of £325,000 each.192

4.97 Evidence also suggests that entrepreneurs’ relief plays very little role in entrepreneurial decision-making. A survey of those that benefited from it showed that, at the point of investment, only 8 per cent were influenced by it and 84 per cent were not even aware it existed. Even at the point of disposal, only 16 per cent said they had been influenced by the relief, with 27 per cent still blissfully unaware but no doubt pleased to receive the windfall.193

4.98 Entrepreneurs’ relief meets many characteristics of a relief that poses a fiscal risk. It has increased significantly in cost, and the reasons for the rise (and recent fall) are largely unknown, raising the possibility that the assumptions underpinning our forecast fail to factor in something that has affected its cost in the past. At Budget 2018 the Government brought in two new measures to tighten the rules around eligibility, and to address “identified abuse”, suggesting this has also been a factor. It does not have a well-specified policy objective, other than making the UK “a more attractive location for entrepreneurs”.194

Initially it was anticipated that the 2019 Budget would be on 6 November, but the Budget was postponed due to the timing of the General Election.195 Following the Conservative Party’s election victory, the Government announced the Budget would be on 11 March 2020.196 In its Election Manifesto the Party had stated that it would “review and reform entrepreneur’s relief”,197 and in the weeks before the Budget there was a lot of speculation as to the Government scrapping it.198 Writing in the Times, the paper’s economics editor, Philip Aldrick, argued, “backing investment in entrepreneurs is vital but there is less need to provide a big, poorly targeted tax break today than ever”:

191 [In its latest edition of Estimated Cost of Tax Reliefs published in October 2019,

HMRC note the fall in the estimated cost of ER in 2016/17 “reflects falls in CGT rates for disposals not qualifying for Entrepreneurs’ Relief, applying to disposals other than on residential property” (p11).

192 This calculation is based on assuming the taxpayer pays the 10 per cent entrepreneurs’ relief rate instead of the 20 per cent rate that applies to gains on everything other than property and carried interest.

193 IFF Research, Capital gains tax entrepreneurs’ relief: behaviours and motivations, 2017, as reported in Resolution Foundation, Entrepreneurs’ relief has cost £22 billion over the past 10 years. Was it worth it?, 2018.

194 OBR, Fiscal Risks Report, CP 131, July 2019 pp106-7. For a breakdown of taxpayers claiming this relief by constituency see: PQ26898, 12 March 2020.

195 HM Treasury, Chancellor Letter to the Treasury Select Committee on the Budget, 25 October 2019

196 HMT press notice, Chancellor launches Budget process to usher in ‘decade of renewal’, 7 January 2020

197 Conservative Party, General Election 2019 Manifesto, December 2019 p34 198 “Don’t scrap entrepreneurs’ tax relief, chancellor told”, Times, 2 March 2020

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Private money has been pouring into the venture capital and scale-up space as asset managers allocate more funds to high-risk, high-return prospects, giving angel investors new exit points. Besides, existing enterprise investment scheme and venture capital trust structures provide £950 million of tax relief a year anyway, and have a “positive impact on behaviour”, the NAO says. For all the bleating of a few small business owners, scrapping entrepreneurs’ relief does not make the government anti-enterprise.199

By contrast Chris Sanger, EY’s Head of Tax Policy, wrote a piece on the CIOT’s blog to argue that the relief could be reformed to encourage serial entrepreneurship:

It’s important to remember the origins of Entrepreneur’s Relief and indeed its predecessor, Business Assets Taper, that was introduced in 1998 … Back in 1998, entrepreneurs considering selling their businesses, and without access to retirement relief, faced the stark choice of paying CGT at the marginal income tax rate of 40 per cent, or leaving the UK before selling up and paying minimal, if any, tax given the UK’s tax treaties. Unsurprisingly, many chose the latter. Faced with the loss of lots of “rainmakers”, the Government introduced the Business Assets Taper to help retain those individuals, with a view to fostering the “Dragons Den” culture.

This intention can be recognised in the announcement in January 2008 that the abolition of Taper Relief would include the introduction of Entrepreneur’s Relief. Although the original design proposed to the Government recommended that Entrepreneur’s Relief be a limit per investment, thereby encouraging serial entrepreneurship, the final relief put forward by the Treasury involved a lifetime limit, counterintuitively removing the incentive for those who were the most successful in their first investment.

So, in evaluating the relief, the question should not be whether Entrepreneur’s Relief has a theoretical cost when compared to taxing at the full rate, nor whether it encourages people to start businesses. Indeed, the fact that the relief is only claimed by those who are successful is a sign of success of the relief (targeted on the rainmakers) rather than a sign of weakness.

So, while the criticisms may be justified, that is not a reason to remove the relief. Instead, policy makers should consider whether, without the relief, we would see entrepreneurs choose to leave the UK rather than stay and pay the tax.

The reduction in the default rate of CGT and the requirement to stay non-resident for longer will have reduced that incentive to leave, but it still remains. Rather than abolition, reforms could instead be focused on encouraging serial entrepreneurship and enhancing that focus.200

In his 2020 Budget speech the Chancellor Rishi Sunak announced that while entrepreneur’s the relief would be retained, the lifetime limit would be cut from £10m to £1m:

We were elected on a manifesto that promised to review and reform entrepreneurs’ relief. I have now completed that review,

199 “Good intentions do not make ‘Britain’s worst tax break’ worthwhile”, Times, 3

March 2020. 200 “A role for Entrepreneur’s Relief?”, CIOT blog, 9 March 2020

57 Capital gains tax : recent developments

and here is what we are going to do. Entrepreneurs’ relief is: expensive, at a cost of over £2 billion a year; ineffective, with fewer than one in 10 claimants saying that the relief was an incentive to set up a business; and unfair, with nearly three quarters of the cost going to just 5,000 individuals. Just because it is called Entrepreneurs’ Relief does not mean that it is entrepreneurs who mainly benefit. For all these reasons, I have heard representations that I should completely abolish it. The Institute for Fiscal Studies has criticised it. The Resolution Foundation called it “the UK’s worst tax break”.

I am sympathetic to that argument, but, at the same time, we should not discourage those genuine entrepreneurs who do rely on the relief. We need more risk-taking and creativity in this country, not less. So I have decided not to fully abolish Entrepreneurs’ Relief today. Instead, I will do what the Federation of Small Businesses called “a sensible reform” and reduce the lifetime limit from £10 million to £1 million. A total of 80% of small business owners are unaffected by today’s changes.201

The reduction in the lifetime limit applies from Budget day, with special provision for disposals entered into before 11 March 2020 that have not been completed. Details were set out in a tax information note published alongside the Budget report:

Current law

Current law is at sections 169H to 169V of, and Schedules 5B and 7ZA to, the Taxation of Chargeable Gains Act 1992. Section 169N provides that Entrepreneurs’ Relief is available subject to a maximum lifetime limit of £10 million per individual.

Proposed revisions

Legislation will be introduced in Finance Bill 2020 reducing the Entrepreneurs’ Relief lifetime limit to a maximum of £1 million. The rules will also provide that the lifetime limit must take into account the value of Entrepreneurs’ Relief claimed in respect of qualifying gains in the past.

Rules will also be introduced that apply to forestalling arrangements entered into before Budget day. In such cases the disposal will be subject to the £1 million lifetime cap unless:

1. The parties to the contract demonstrate that they did not enter into the contract with a purpose of obtaining a tax advantage by reason of the timing rule in section 28 of the Taxation of Chargeable Gains Act 1992, and

2. Where the parties to the contract are connected, that the contract was entered into for wholly commercial reasons.

In addition, where shares have been exchanged for those in another company on or after 6 April 2019 but before 11 March 2020, and

• both companies are owned or controlled by substantially the same persons, or

• persons who held shares in company A hold a greater percentage of shares in company B than they did in company A and, on 11 March 2020, the personal company

201 HC Deb 11 March 2020 cc285-6

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test, the trading company and the employee/officer test are met in respect of company B,

Then if an election is made under section 169Q of the Taxation of Chargeable Gains Act 1992 on or after 11 March 2020, the share disposal is to be treated as taking place at the time of the election for Entrepreneurs’ Relief purposes, meaning that the new lifetime limit of £1 million will apply.

This also addresses the anticipated impact on individuals, households and families:

This proposal is expected to impact individuals who dispose of all or part of their business individuals who dispose of share in their personal company and trustees who dispose of business assets, with gains above the new lifetime limit. This is expected to be 9,000 individuals in total. There will also be an impact on individuals disposing of Enterprise Management Incentive shares that qualified for Entrepreneurs’ Relief, with gains above the lifetime limit. This is expected to be around 120 individuals.

Reducing the lifetime limit on Entrepreneurs’ Relief-eligible gains to £1 million will significantly reduce the cost of the relief, with 17% of Entrepreneurs’ Relief taxpayers being affected by the change and 58% of gains being made ineligible for Entrepreneurs’ Relief. This reflects that the majority of the cost of Entrepreneurs’ Relief is generated by a small minority of very affluent taxpayers’ gains.

The impacts on individuals and families will vary, depending on the value of their gains, income levels and personal circumstances.

Customer experience is expected to stay broadly the same because this measure does not bring new taxpayers into the tax system and does not significantly change processes for existing taxpayers.202

It is estimated that this measure will raise £6.3 billion in total by 2024/25.203

Further details on this measure were given in a technical note published by HMRC, updated to include detail on an additional anti-forestalling rule included in the Finance Bill published on 19 March.204

Initial responses to the Budget focused on the measures the Chancellor announced in response to the Covid-19 pandemic, and this reform has attracted very little attention in subsequent weeks. Writing in Taxation Craig Simpson (Bates Weston) argued, “the change feels somewhat like a revenue-raising sticking plaster and more action is needed to reform tax reliefs to encourage people to set up their own business”:

Entrepreneurs’ relief might not have encouraged entrepreneurialism – I am not sure it was ever intended to – it was more akin to a reward for risk taking and wealth generation. The tax system can be an effective tool to drive behaviour in the right

202 HMRC, Capital Gains Tax Entrepreneurs’ Relief - reduction in the lifetime limit, 11

March 2020 203 Budget 2020, HC 121, March 2020 p67 (Table 2.1 : item 46). £5m (2019/20),

£215m (2020/21); £1,120m (2021/22); £1,470m (2022/23); £1,670m (2023/24); £1,820 (2024/25).

204 HMRC, Reduction in the lifetime limit for Entrepreneurs' Relief - technical note, 19 March 2020. For a technical discussion of these provisions see, “Entrepreneurs’ relief: the anti-forestalling rules”, Tax Journal, 1 May 2020

59 Capital gains tax : recent developments

direction and it is my opinion that reform to measures designed to encourage entrepreneurialism should be central to our thriving and fantastic owner-managed business sector.205

The Chartered Institute of Taxation has submitted representation on a number of provisions in the Finance Bill, including this one. The CIOT express disappointment that the reform was announced without any formal consultation, and raise concerns that, “the change has been made very abruptly and with some jagged edges, impacting some innocent commercial arrangements which had largely been put in place on Budget day.” An extract from this submission is reproduced below:

There are no transitional provisions. This is striking as capital gains tax changes are inevitably retroactive, affecting gains that have already accrued but not yet been realised, and investment decisions that have already been made. The draft legislation draws the line; those one side of it have the full benefit of the old £10m limit and those the other side have the new £1m limit.

The line drawn is complicated by what are described as anti-forestalling provisions. There are two sets. In reality these appear to bring under the new £1m lifetime limit some commercial transactions that would not likely have been undertaken in an attempt to forestall this change. Again, it is striking to have strong anti-forestalling measures for what is in essence a change of policy rather than anti-avoidance legislation.

The first anti-forestalling measure applies where an unconditional contract for the sale of a business was entered into before Budget day (11 March 2020) but completion takes place on or after that date. The reduced lifetime limit of £1m, rather than the pre-Budget £10m limit may apply unless conditions, which appear onerous, are met.

There are exceptions to this measure but the conditions to be met are exacting. However, it is our understanding that this provision is intended to counteract arrangements whereby a contract is put in place (maybe before a genuine buyer has been found) to lock-in the pre-Budget lifetime limit. We understand the conditions for the old, higher limit for relief for these contracts will be met if, for example, the process of entering the contract with a genuine buyer undertaken for commercial reasons was merely accelerated in order to be in place before Budget day.

The second anti-forestalling measure applies where there is an exchange of shares (or a share reorganisation) between 6 April 2019 and 10 March 2020 and a shareholder elects to crystallise the gain on their old shares and pay tax on it (with the benefit of entrepreneurs’ relief) rather than defer the gain (as more normally happens with reorganisations and share exchanges) till their new replacement shares are sold at a perhaps much later date - but when they might not be entitled to the relief. This might be because they hold less than 5% of the new shares: holding 5% is a condition of the relief. In certain circumstances, the new lifetime limit of £1m will apply to gains made as a result of such an election rather than the £10m limit in force at the time of the actual exchange or reorganisation if an election had not actually been made by Budget day.

Some taxpayers who have never known or thought about this change in law or tried to forestall it, and who completed

205 “End of an ERa – almost”, Taxation, 26 March 2020

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commercial reorganisations prior to Budget day will be caught by this change: normally these elections are only filed after the event, with the tax return. This distortion could be largely addressed by a relatively straightforward amendment to the Finance Bill incorporating a simple test of whether the seller qualified for entrepreneurs’ relief immediately post exchange. If the seller did not so qualify, the election could still be made post 11 March with the £10m lifetime limit preserved.206

Finally, the Treasury Committee held three evidence sessions after the Budget, and in one of these, Harriet Baldwin asked the witnesses of their response to this change:

Q29 Harriett Baldwin: … Does the panel welcome where things came out in terms of entrepreneurs’ relief? …

Paul Johnson [Director, Institute for Fiscal Studies]: It is clearly a move in the right direction. It was fairly remarkable that you could effectively earn—because that is really what it was—that amount of income and pay 10% tax on it at the end. As the numbers show, something like 5,000 people get an average of £350,000 worth of tax relief each under the system.

Q30 Harriett Baldwin: Do we know the gender breakdown? …

Diane Elson [Chair, Women's Budget Group]: The Government have said it is largely white male, but they have not given detailed figures for it. These pensions and tax allowances all tend to be biased towards high-income men. They are the ones who gain most from it and other people do not. This is money we are losing that could be spent where it is really vital, like in social care.

Q31 Harriett Baldwin: You welcome the changes on entrepreneurs’ relief.

Diane Elson: I welcome the changes, but I am sorry it was not abolished.

Q32 Harriett Baldwin: Does anyone else want to argue for it being abolished further?

Paul Johnson: What might it be for? It might be for increasing entrepreneurship, given the name of the relief, encouraging people to build new businesses and so on. There is absolutely no evidence that this plays any role whatsoever in that context. It is essentially a way of working as a self-employed person or what have you, keeping the money within the company and taking it free of tax, or with significantly reduced tax, at the end.

If you want to promote certain kinds of entrepreneurship, you need a much better-targeted policy up front, rather than one that, in the end, rewards those who have been very lucky or productive, or what have you, far more than those doing the same thing as an employee or in any other form. It is one of the many ways in which we differentiate how we tax income according to the legal form in which it is earned, creating obvious opportunities for using it as a tax avoidance mechanism.207

206 CIOT, Finance Bill 2020: Clause 22 and Schedule 2 - Entrepreneurs’ Relief (to be re-

named Business Asset Disposal Relief), 13 May 2020 207 Treasury Committee, Oral evidence: Spring Budget 2020, HC 214, 16 March 2020

Qs29-32

61 Capital gains tax : recent developments

Provision to make these changes to Entrepreneurs’ Relief is made by clause 22 and Schedule 2 of the Bill. This part of the Bill was debated and agreed, without a vote, in Public Bill Committee on 9 June.208 Opening the debate the Financial Secretary Jesse Norman set out the Government’s case for cutting the lifetime limit to £1m:

The clause and schedule 22 rename entrepreneurs’ relief as “business asset disposal relief” and reduce the lifetime limit for gains eligible for relief so that from 11 March 2020 the relief can be claimed on gains of up to £1 million. The purpose of renaming the relief is simply to reflect its function and purpose more accurately ...

Evidence shows that for some people—indeed, quite a few people—the relief has been a tax planning tool, helping some of the richest people in society to pay less tax rather than discharging its purpose of incentivising entrepreneurship and enterprising business activity … The reform ensures that the Government can more sustainably support small businesspeople with up to £100,000 capital gains tax relief available over their lifetime … The previous lifetime limit of £10 million was an unsustainable degree of support for those less in need of it … The new £1 million lifetime limit is far more sustainable and better targets the people who it was intended should benefit from the relief.209

The Minister went on to reject a new clause, tabled by the SNP, for a formal review of the impact of the new £1m limit:

New clause 8, proposed by the SNP, would require the Chancellor of the Exchequer to review the impact of clause 22 and schedule 2 amendments to capital gains tax legislation within six months of passing the Finance Act. Specifically, it would require the Chancellor to review the impact on business investment, employment and productivity in the constituent nations and English regions of the United Kingdom.

I want to highlight that the Government have already conducted an internal review of this relief, building on the 2017 HMRC-commissioned independent research. The review considered the distributional effects and benefits of this relief against its cost, to understand better the targeting of the relief. This reform is strongly influenced and informed by that analysis and ensures that the majority of entrepreneurs are unaffected.

Furthermore, the effects of the changes to the relief will not be visible within six months’ time. As with all tax reliefs, we will continue to review and monitor the effects of this change as standard.210

Speaking for the Opposition Bridget Phillipson said that “the action on the relief is welcome, even if we believe it is overdue and could go further.”

Any number of organisations are critical of maintaining it in any form, although the criticism is not unanimous. … The Institute for Fiscal Studies has stated that the £1 million relief in the clause is still too generous. The Association of Accounting Technicians says it is disappointing that the Government have failed to scrap it altogether, highlighting an overwhelming body of evidence from focus groups, HMRC-commissioned research, the Office of Tax

208 Public Bill Committee (Finance Bill), Third Sitting, 9 June 2020 cc66-71 209 op.cit. c66 210 op.cit. c67

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Simplification, the National Audit Office and others, “which indicates that the relief does not achieve its policy objectives, that it’s extremely expensive, poorly targeted and ultimately ineffective.” In the light of that, will the Minister set out for the Committee why the Government have not gone further in this area?211

Ms Phillipson also supported the case for a formal review saying, “there is a strong body of evidence of the entrepreneurs’ relief not working effectively. I would appreciate a better understanding of the impact the amendment seeks to achieve.” She went on to raise wider concerns as to the way tax reliefs are assessed:

There is a wider issue here … regarding the Government’s efforts to monitor the effect of tax reliefs such as entrepreneurs’ relief. The National Audit Office’s excellent recent report on tax reliefs shows that the Government are not reporting costs on over two thirds of them and that HMRC did not know whether most tax reliefs offered value for money. I believe the Public Accounts Committee will be taking evidence on this very shortly and publishing its report on the work of the National Audit Office in considering this important issue.

We on the Opposition Benches will be following that discussion carefully, because it seems incredible that the Government do not have a proper grip on that area, where there is a real problem around value for money and whether the information provided to Parliament is sufficient, so we can understand whether tax reliefs are having the outcome intended by Government and whether fairness is built into the system.212

Speaking for the SNP Stephen Flynn argued, “we need to know what the Government’s long-term direction of travel is”:

The IFS believes that entrepreneurs’ relief is poorly targeted; the FSB, on the other hand, is broadly supportive; and the Chartered Institute of Taxation believes that a public consultation on objectives and efficacy is necessary.

There is a broad range of views about this policy, so the time has come for the Government to undertake a review in the public domain so that we all understand the direction of travel and know where they seek to go.213

In response to these points the Minister argued that the Government “have tried to strike a balance by trying to keep the vast majority of entrepreneurial activity that is protected in place while cutting back on aspects that are ineffective or regressive”, but acknowledged that “there is always scope for further reform at future fiscal events”:

The question is … raised whether we should have acted more decisively. I have highlighted that that would have had the effect of penalising many entrepreneurs who entered into these arrangements in good faith and would have had all their gains cancelled out. At the same time, it was necessary to put in anti-forestalling measures, because as soon as the fact of a change becomes clear, there is enormous potential scope for abuse and avoidance …

211 op.cit. cc67-9 212 op.cit. cc69. Further to the Member’s comments see, NAO, The management of tax

expenditures, February 2020. Details of the Committee’s inquiry is on its site. 213 Public Bill Committee (Finance Bill), Third Sitting, 9 June 2020 c70

63 Capital gains tax : recent developments

I am sympathetic to the point that the hon. Member for Houghton and Sunderland South (Ms Phillipson) makes about a more structured approach to the analysis of tax reliefs. That point is well made. My answer to her comments about the IFS’s concerns about the residual relief is that there is always scope for further reform at future fiscal events.214

214 op.cit. cc70-1

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6. Annex: CGT statistics The following pages reproduce one section of HMRC’s Capital Gains Tax Statistics, presenting historical data on estimated taxpayer numbers, gains, and tax accruals (updated August 2019).

Table 1 and Figure 1 show the long term trend in key statistics for CGT.

In 2017/18, the number of taxpayers, amount of gain and amount of tax were the highest in the history of the tax and continues the long term increasing trend. The total amount of chargeable gains was £57.9 billion; an increase of 13% from the previous year. This growth has been driven by the performance of equities and property markets, resulting in both the number of taxpayers and the gains per taxpayer increasing. The number of taxpayers increased by 3% when compared with the previous year to 281,000.

This was driven by the increase in the number of individuals which, for the first time, surpassed the number of individuals in 2007-08. The total amount of tax liability was £8.8 billion in 2017/18 and this was an increase of 14% from 2016/17. This puts liabilities at above the 2015/16 level, the previous record high for CGT liability.

There is however a different story for trusts when compared to individuals. For trusts, the totals for the number of taxpayers, amount of gain and amount of tax all decreased. Despite this, the mean value for the amount of gain and tax for trusts has increased from 2016-17 to 2017-18. Historically the number of CGT liable trusts and their chargeable gains and tax paid have been volatile.

Definition of gains over time

In Table 1 users should be aware that the definition of gains is not comparable over the long time series provided. Comparisons only in gains from 2008-09 are all on a consistent basis.

• For years to 1997-98, “Gains” are the sum of chargeable gains from all disposals made by a taxpayer; i.e., having deducted indexation allowance and other reliefs, but before deducting the Annual Exempt Amount, past capital losses, or trading losses.

• For years from 1998-99, “Gains” refers to total taxable gains net of reliefs available at disposal, and after deduction of trading losses, past capital losses and taper relief, but before deducting the Annual Exempt Amount.

• Gains between 1998-99 and 2007-08 are not comparable to subsequent years. This is because taper relief was abolished in 2008-09. Taper relief reduced the gains which were taxable by a percentage which was determined by how long the asset had been held.

65 Capital gains tax : recent developments

Table 1: Estimated taxpayer numbers, gains and tax accruals by year of disposal1987-88 to 2017-18

Numbers: thousands; Amounts: £ millions

Individuals Trusts 1 All taxpayers

Number 2Amounts of Amounts Number Amounts of Amounts Number Amounts of Amounts

Year of disposal gains 3of tax gains 3

of tax gains 3of tax

1987-88 135 7,994 1,993 17 718 182 152 8,712 2,175

1988-89 135 5,366 1,637 16 626 155 151 5,992 1,792

1989-90 127 4,832 1,495 17 654 163 144 5,486 1,658

1990-91 96 2,912 869 12 419 107 108 3,332 976

1991-92 75 2,634 804 10 365 90 85 2,999 894

1992-93 60 1,885 539 9 275 67 70 2,160 606

1993-94 77 2,740 809 12 445 110 90 3,185 919

1994-95 64 2,212 651 10 367 93 73 2,579 745

1995-96 86 3,131 890 13 809 220 98 3,940 1,110

1996-97 97 3,918 1,203 20 1,053 255 117 4,971 1,458

1997-98 142 5,444 1,657 28 1,575 369 170 7,019 2,026

1998-99 135 5,958 1,936 25 998 313 160 6,956 2,249

1999-00 185 8,761 2,821 27 1,493 475 212 10,254 3,296

2000-01 178 7,732 2,425 25 1,256 394 203 8,987 2,819

2001-02 122 4,556 1,324 16 816 257 139 5,372 1,581

2002-03 133 6,588 2,052 12 774 249 144 7,362 2,301

2003-04 153 6,869 2,037 13 986 319 166 7,855 2,356

2004-05 181 58% 42% 9,170 2,792 15 1,076 409 196 10,247 3,201

2005-06 204 58% 42% 11,562 3,599 21 1,215 452 225 12,777 4,052

2006-07 242 58% 42% 15,404 4,893 23 1,460 550 264 16,864 5,444

2007-08 250 59% 41% 20,874 6,961 21 1,910 733 272 22,784 7,694

Amounts of gains and tax from 2008-09 onwards when taper relief abolished are not directly comparable with amounts in earlier years.

2008-09 133 60% 40% 14,015 2,266 13 1,614 282 146 15,629 2,548

2009-10 152 60% 40% 18,423 3,012 16 2,243 390 168 20,666 3,402

2010-11 171 59% 41% 23,295 3,837 18 2,331 476 188 25,625 4,313

2011-12 148 59% 41% 21,718 3,436 14 1,599 413 163 23,317 3,849

2012-13 p 156 58% 42% 22,104 3,494 16 1,372 341 171 23,477 3,835

2013-14 p 195 57% 43% 30,484 5,052 20 2,137 537 215 32,622 5,589

2014-15 p226 57% 43% 38,058 6,201 20 3,133 803 246 41,191 7,005

2015-16 p243 57% 43% 47,147 7,850 19 2,520 628 262 49,667 8,479

2016-17 p 249 56% 44% 47,982 7,111 24 3,301 633 273 51,283 7,744

2017-18 p 260 56% 44% 54,671 8,218 21 3,267 596 281 57,938 8,814

1 Includes personal representatives of the deceased.

2 Before the introduction of Independent Taxation in 1990-91 each taxpaying married couple counted as one "individual". From 1990-91 each person in a marriage

or civil partnership who has a Capital Gains Tax liability is counted separately.

3 Gains are after the deduction of taper relief and losses plus attributed gains but before deduction of the Annual Exempt Amount. Different taper rates

applied during the period from 1998-99 to 2007-08 when taper relief applied.

p Provisional. Changes to figures in the earlier years are likely to be very small. Changes in more recent years may be slightly greater due to late filling. For 2017-18

the cut of data was taken earlier in the year than previous publications, which may mean numbers published are subject to larger revisions due to late filling and

amendments, particularly trusts.

Males as % of total

individuals

Females as % of total individuals

Number 5572, 12 June 2020 66

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