Understanding the OTS's capital gains tax review

For example, a flat tax rate of CGT would be simple to understand and operate – especially in comparison with the four rates that can currently apply, together with the complex interaction with the income tax basic rate band for the taxpayer.

However, whether it is fair that the wealthy pay the same rate of tax as those less well-off is, naturally, a highly charged question. 

The OTS takes the line that taxes should be neutral and minimise distortion of behaviour, therefore, it argues as previous chancellor’s Callaghan and Lawson did that income and gains should be taxed in similar ways.

It says the fact that CGT rates are lower than income tax rates distorts the behaviour of taxpayers: encourages them to seek a return that is taxable as a gain rather than income.

The report goes on to state that if the government wants to address this distortion, it should “consider more closely aligning CGT rates with Income Tax rates” – hence the dramatic headlines about tax rises. 

However, the OTS does recognise that levelling rates would carry a significant ‘lock-in’ risk with taxpayers simply not selling assets that have appreciated in value and instead holding them until they die so that they can be passed on to the next generation (sometimes tax free). This might well prove to be a more damaging distortion to the economy. 

Whether it is fair that the wealthy pay the same rate of tax as those less well-off is, naturally, a highly charged question. 

More helpfully, the OTS does say that if the government does not wish to address the distortive impact of lower rates of CGT, it could still simplify CGT by “reducing the number of CGT rates and the extent to which liabilities depend on the level of a taxpayer’s income”.  

In respect of boundaries with other taxes, the OTS have identified the use of shares and securities as a form of remuneration as an area where income tax should potentially apply. They are differentiating between investments on similar terms to external investors against an investment of ‘labour’. 

The annual exempt amount

We now have a number of small income exemptions to ensure that individuals with a small amount of savings, trading and property income (under £1,000) do not have to complete a tax return.

The CGT annual exemption originally started out with the same purpose but over the years it has been increased by various chancellors to the current level of £12,300. HMRC statistics show that many investors sell assets each year to effectively use this exemption as a tax relief.