Will capital gains tax changes continue to drive M&A activity in 2021?

The Office of Tax Simplification (“OTS”) published its report reviewing the CGT regime, making a number of recommendations to the Government, and it is anticipated that these will form the basis of any changes.

Background

Currently CGT is charged at 10% to basic rate taxpayers, and 20% to higher/additional rate taxpayers, with a 28% rate on residential properties other than main residencies (which are currently exempt from CGT), with a number of reliefs also available, such as Entrepreneurs’ Relief. This is in contrast to the main income tax rates of 20% for basic rate taxpayers, and 40/45% for higher/additional rate taxpayers.

CGT is usually payable on the disposal of, inter alia,:

• Businesses/shareholdings;
• Real Estate; and
• Investment portfolios.

Given the disparity between CGT and income tax rates, the fact that CGT is usually only applicable to more wealthy individuals and the cost of the Covid-19 pandemic, there have already been many articles in the press discussing potential CGT rate increases. The press has also picked up on this report and there have been a number of articles about this in the media.

The report

The OTS is independent from Government and the Treasury, so this does not necessarily reflect future policy, but this report was commissioned by the Chancellor, Rishi Sunak, and is likely to be considered when plans for future Budgets are being drawn up.

The report makes different recommendations depending on whether the Government’s priority is tax simplification, rate alignment or proper delineation between what is a capital gain (e.g. a gain on risk capital) and what is merely income wrapped up as a capital gain.

In summary, the recommendations are:

Recommendation 1

If the Government considers the priority is to stop people trying to convert income into capital, it could:

• close the gap between CGT rates with Income

Tax rates; or

• address the boundary rules between CGT and Income Tax.

Recommendation 2

If the Government considers more closely aligning CGT and Income Tax rates it should also consider:

• reintroducing relief for inflationary gains (indexation allowance);
• how it interacts with corporation tax; and
• more flexible use of capital losses (such as relief against income).

Recommendation 3

If the difference between CGT and Income Tax rates is to remain, and the Government wishes to just simplify CGT, it could consider reducing the number of CGT rates and the extent to which these depend on the level of a taxpayer’s income.

Recommendation 4

If the Government considers addressing CGT and Income Tax boundary issues, it should:

• consider whether employees and owner-managers’ rewards from personal labour (as distinct from capital investment) are treated consistently and, in particular;
• consider taxing more of the share-based rewards arising from employment, and of the accumulated retained earnings in smaller companies, at Income Tax rates.

We would stress that the report is not law and is not a statement of intent from the Government – it is simply the findings of a review. However, areas that may be of concern to businesses are:

1. Future business disposals – shareholders will have only recently got comfortable with the idea that the gain will be taxed at 20% outside the first £1m. If it all becomes chargeable at higher rates this will take time to become the ‘new normal’.
2. Employee incentive shares – specifically growth/hurdle shares – these may lose some of their advantages if the proposals in the report are implemented. 
3. PE fund managers and similar; whilst the CGT rate for PE fund managers is already at the higher rate, any further increase will affect the realisation of carried interests.

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