Office of Tax Simplification’s first report on capital gains tax – how does it affect share incentive arrangements?
November 27, 2020
In July this year, the Chancellor, Rishi Sunak asked the Office of Tax Simplification (OTS) to carry out a review of Capital Gains Tax (CGT) to ‘identify opportunities relating to administrative and technical issues as well as areas where the present rules can distort behaviour or do not meet their policy intent.’
Publication of first report by OTS
OTS published ‘Simplifying by Design’, the first report (Report) of its current CGT review, strangely, only two days after the closing date for submissions. A more detailed report focusing on technical and administrative issues will be published early next year.
The Report makes the following eleven recommendations:
- aligning CGT rates with income tax rates or policing boundary between CGT and income tax
- if CGT rates are more closely aligned with income tax, then
- average gains over the holding period of an asset
- some allowances will be required to take account of inflation
- use of companies to take advantage of lower corporation tax rate should be barred
- allow more flexible use of losses
- reduce the number of CGT rates and the extent to which liabilities depend on the taxpayer’s income
- rewards for personal labour of employees and owner managers should be taxed as income (for example, trading profits on winding up or sale are currently treated as capital) as distinct from capital investment; and share based rewards should be taxed as income arising from employment(see below)
- reduce the annual CGT exemption (currently £12,300) to around £2,000 – £3,000 as the purpose of having an annual exemption is to simplify administration
- if the annual exemption is not reduced then the chattel exemption should be broadened to include personal effects, linking returns to personal tax accounts and making tax compliance easier
- remove the tax-free CGT uplift on death
- in addition to removing the CGT uplift on death, the beneficiaries of an estate should receive the assets at their historic base cost and tax on a future disposal would be paid by the donee
- if the CGT uplift on death is removed, then rebasing all assets and extending gift holdover relief to a broader range of assets should be considered
- the removal of entrepreneurs’ relief/business asset disposal relief; to be replaced with some form of retirement relief
- the abolition of investors’ relief.
Impact on share incentive arrangements
The Report also looked at share schemes and share based payments. Notably, the Report discussed arrangements such as growth share plans, where shares are issued to employees when the value is low but when the shares are sold on exit at a later date, the gain on the disposal is taxed under CGT, at a much lower rate than income tax. The Report gives an example, Case study 5 which demonstrates how a taxpayer, who is awarded growth shares, is subject to CGT on disposal of the shares and pays significantly less tax than the taxpayer in Case study 6, who is subject to income tax and national insurance contributions liabilities on the exercise of an unapproved option. The Report considered that the growth share plan is conceptually similar to unapproved share options, although a huge disparity exists in the way the rewards are taxed. Their recommendation is that share based rewards from such arrangements should be treated as rewards from employment and should be taxed as income rather than gains.
Tax-advantaged share schemes such as EMI, CSOP, SAYE and SIPs were also discussed. The Report recognises that there are policy reasons for such arrangements. The Report also notes that evidence of the effectiveness of tax-advantaged share schemes in promoting economic growth is mixed. While being sceptical, it appears that the Report seems to suggest that there is some justification for having all-employee schemes, such as SAYE and SIP.
It should be noted that OTS does not formally represent Government policy. It is difficult to predict at this stage which of the recommendations will be acceptable to the Government.
Following the economic downturn because of the pandemic, the Government will probably be looking at increasing tax revenue. While on the one hand, increasing the CGT rate is likely to bring in some revenue, it could also slow down transactions, which, in turn, could hinder growth and recovery. Perhaps the Government will balance these two factors and consider a modest increase in the rates of CGT.
So far as share-based incentives are concerned, in our view, it is unlikely that there would be any changes to all-employee share plans. Whilst a rise in CGT rates may have an impact on EMI schemes, it is unlikely to affect CSOPs significantly. However, there may be a risk that growth share schemes may come under more scrutiny by HMRC.