This blog gives you the latest topical news plus some informal comments on them from ShareSoc’s directors and other contributors. These are the personal comments of the authors and not necessarily the considered views of ShareSoc. The writers may hold shares in the companies mentioned. You can add your own comments on the blog posts, but note that ShareSoc reserves the right to remove or edit comments where they are inappropriate or defamatory.
CGT Review
Last week the Office of Tax Simplification (OTS) announced a review of Capital Gains Tax. They have invited evidence and there is a simple on-line survey you can complete on the subject (see link below). As someone who occasionally pays capital gains tax, I give you my views on the subject below.
It is of course a horribly complex tax with several different rates and numerous exemptions. I need to employ an accountant to work out my self-assessment tax returns when I don’t consider my affairs particularly complex – I am mainly invested in listed shares, although I do have a few EIS and VCT investments. My accountants use specialist software to do the calculations, not generally available to retail investors and even that seems to be prone to complex misunderstandings.
This also puts a great burden on HMRC in terms of administration when it brings in less than 1% of tax revenues. Plus there is an enormous amount of effort put in by investors and their advisors to avoid paying the tax (there are lots of ways to do so). Indeed one could argue that the current Capital Gains tax regime was invented by accountants as a “make work” project due to the complexity of the rules.
Scrapping CGT
Should the tax be scrapped altogether as some people have suggested? I don’t think so for the following reason: It is very easy to convert income into capital gains, or vice versa. I recall this was done many years ago by the Beatles when instead of receiving royalties they sold the revenue stream from music royalties as an asset. But even private investors can do this – for example by investing in investment trusts that roll up the income and don’t pay it out in dividends. Another example is that of Venture Capital Trusts which are often effectively converting capital gains into tax free dividends. Or of course investors can simply avoid trading in individual shares and invest in trusts or funds which are not taxed on their individual holdings and realisations thereof.
CGT Rates and Indexation
It is therefore irrational to have different rates for capital gains and income which is currently the arrangement. That’s clearly one simplification that could be made, although investors will be furious if they have to pay more tax as a result.
But one big problem is the lack of indexation of capital gains which was scrapped some years ago by Gordon Brown and replaced by allowances. This means that you pay tax not on the real change in the value of a share, but on that created simply by inflation when the shares are worth no more in reality. This may not seem a major issue in a period of low inflation, but with money being printed like it is going out of fashion by Governments, high inflation might well return. Even a low rate of inflation over many years can result in a very large tax bill, and even worse, you may not have the option to retain the holding. A takeover bid for a company can effectively force a sale. Indexation should be reinstated as it was not difficult to take it into account in your tax returns.
Tax Tail Wagging the Investment Dog
Capital Gains Tax also distorts investment decisions. For example, you might hold on to a shareholding longer than you otherwise would because you know a large tax bill will result. So your portfolio may end up containing a lot of companies with poor prospects and their market share prices might remain higher than they otherwise would be, i.e. the market in the shares is distorted.
It also causes sales of shares to take place when they might not be best timed, simply to use up capital gains tax allowances in the current tax year. Or even to anticipate changes to tax rates and allowances by decisions from new Chancellors or new Governments.
The existing arrangements encourage the use of investment trusts and funds rather than personal investors holding individual shares. This has had a negative impact on the stock market as investment decisions are now made by fund managers rather than real owners. It has also meant that much of the profits generated by public companies end up in the hands of the fund manager rather than the end investor who rake off 1%, 2% or more per annum which can often be a very high proportion of the real return generated by companies. It also has a negative influence on corporate governance as fund managers have little interest in controlling the pay of directors for example. In effect we have a lot of absentee owners.
These defects might be considered an argument for scrapping CGT altogether but that is unlikely. However, an alternative proposal would be to reform it so that a rollover of investments did not incur tax. In other words, if you reinvested the proceeds from a sale of shares or other assets into new assets within a period of time then no tax would be payable. If no net profit is actually realised, why should investors pay tax?
Interaction Between CGT and IHT
Do people even care about paying tax on their profits when they die? Capital gains tax liability currently disappears on death and that might need to be changed if rollover was permitted but there is also interaction with Inheritance Tax here which would also need to be reconsidered.
CGT on Property
Property is taxed at different rates, although the property you live in is exempt. This has of course encouraged people to invest in a home as an asset for their retirement. This has powered the house price bonanza in recent years and encouraged people to occupy bigger houses than they need. Although encouraging home ownership is meritorious, it is not clear why gains from owning a home should be tax free. Reforming this could be a political hot potato although a “roll-over” provision and other exemptions could mitigate the adverse consequences.
Entrepreneurs
Capital Gains Tax has always had a negative impact on business creators although there are allowances that reduce their liability when a business is sold. Much tax planning activity is prompted by such outcomes which typically undermines the tax take. Another related issue is that high capital gains tax rates encourage wealthy entrepreneurs to move to countries where capital gains taxes are lower or even zero. We lose their expertise and also they spend their money in other countries as a result.
Conclusions and Recommendations
In summary Capital Gains Tax is ineffective, generates relatively little in tax from very few individuals and is a disincentive to entrepreneurial activity. It can result in tax being paid on purely inflated share prices and when no actual cash is realised as the profits are soon reinvested. It does of course discourage therefore new investment and distorts the stock market.
In my opinion, capital gains tax needs a complete overhaul. If you agree, or disagree, please add some comments to this article. I’ll ponder those before making a full submission to the OTS review.
OTS Capital Gains Tax Review: https://www.gov.uk/government/consultations/ots-capital-gains-tax-review-call-for-evidence-and-survey
You might also want to participate in this Equity Development webinar on taxation and the AIM market.
Roger Lawson (Twitter: https://twitter.com/RogerWLawson )
Post Date: July 22, 2020
13 Comments
Leave a Comment Click here to cancel reply.
This site uses Akismet to reduce spam. Learn how your comment data is processed.
Other Blog Posts
- EDUCATION
- MEMBERSHIP
Copyright © 2010/2023 All rights reserved. Sharesoc ® (UK Individual Shareholders Society). Terms of use and legal information (note this site uses cookies)
Digital Marketing by Chillibyte.
Digital Marketing by Chillibyte.
Dear Roger,
Thank you; a lot to think about!
Can you show a simple tax and costs example of holding a share yourself or through an investment fund/trust for five years with an increasing dividend and then that holding being sold at twice cost please? I had not gathered that there is a tax advantage via funds/trusts. Of course they may well not sell the holding when you do?!
Yours, Mark Guthrie
The point is that funds don’t pay CGT on sales within the fund, so if you hold a fund and don’t sell there is no CGT however much it trades.
Mark: There are too many variables in such a calculation to give you a sensible answer. It depends on your personal tax position for example, how you hold the shares (tax free in ISAs or SIPPs), etc, etc. This web site gives you the basics though: https://www.gov.uk/capital-gains-tax
I don’t agree that indexation was simple, if you had bought a holding in multiple purchases at different times and prices it was extremely hard to calculate the base cost or even understand how the rules worked. Replacing indexation with tapering was a big improvement IMO – unfortunately that fell foul of headlines about people paying less tax than cleaners, which completely missed the point but created political heat. The basic problem is that gains accrued over many years or even decades are all taxed in the year of sale (or not at all if there never is a sale). My proposal, at least for shares, would probably be to tax on unrealised gains as accrued, with a substantially higher allowance so only the wealthy would need to worry about it – as things stand you can potentially have something like 1 million in each of ISAs and SIPPs so only the wealthy are likely to pay CGT anyway.
Hi Roger
I agree with your criticism of the complexity of CGT and its consequences. I have just two comments on your own ideas.
You are dead right about the removal of indexation but doing the indexation calculations was also fraught with difficulty so I suggest a simpler “rough justice” (you might modify my precise suggestions). Capital gains tax on recent purchases should be taxed as part of one’s income – they amount to short term trading, not investing. To avoid game playing, around year end, define any gains made from the current or previous tax year’s purchases as income on which one should pay one’s marginal rate of income tax. For gains made from purchases in any of the four tax years preceding those two years, charge a flat rate of, say, 20%. For purchases in the the five years prior to that, say 15%. and for earlier purchases say 10%.
Your point about reinvestment of realised proceeds from sale is also very good but the time period allowed for that reinvestment should be pretty limited to demonstrate the genuine reinvestment intention clearly. Personally I would propose 7 days but you might think 14 days would allow better for practical barriers to reinvestment. You might also allow partial immediate reinvestment with tax being imposed on any proceeds not reinvested in that period. Finally, I don’t see a reason to allow this concession for traders so it should only be used if the original purchases were made earlier than the tax year preceding the previous tax year (as above).
Roger. I think indexation, or the lack of, is a big issue. Sometimes, e.g. with property, it is not possible to sell a part of your holdings each year to use up allowances. My preference would be for indexation to be reinstated so that you are only taxed on the real gain. An alternative could be to allow carry forward of any unused allowance each year to provide more proportionate cover for the sale of a large item, where the gains have accrued over many years but where you are taxed on the full amount of gain in one year. HMRC would probably want to drop the size of the allowance if people can carry forward, but that would probably still be fairer for most people and would have the benefit of removing the need to be selling shares near the end of the tax year just to use up the annual allowance.
Roger – quite agree that this area needs a complete root to branch over review, but cannot agree with your comments on the personal residence exemption. Let’s take an example – we’re currently in the process of moving home. If the government tax the gain on our home, that would mean that moving house would generate a tax liability which, to pay off, would cause us to move to a substantially poorer home. In turn, this would probably mean that we don’t move and hence the property market would grind to a halt putting all of those nice estate agents out of a job and reducing stamp duty.
A quick additional comment on Stephen’s point. Unfortunately taxing unrealised gains would probably be a nightmare and a prices move taxed gains could turn into losses. However, the point about the wealthy using ISA’s is spot on. The way to deal with this is to reduce the annual ISA limit from a ludicrous £20K (which ordinary people can save £20K in a year?) to, say, £5K and maybe impose a lifetime limit on ISA’s.
For quoted shares I don’t think it would particularly be a nightmare, you’d just have to value your portfolio once a year which you should be doing anyway. The exact price used wouldn’t normally be an issue because it would come out in the wash, using a lower price one year would just give you a lower base for the next year. Unquoted shares and property would be harder and might have to be dealt with separately. It’s obviously likely that in some years you’d have a loss but that could just be carried forward as we already have for realised losses. I think the main issue for such a system would be potentially making a lot more people file a tax return, hence the higher allowance.
Thanks for all the comments. My responses are:
– Taxing unrealised gains would be an absolute nightmare. You might get a tax demand when there was not cash to pay it, unless you actually realised the gains – which is not always easily possible (say for unlisted or illiquid listed shares). There would also be the problem of valuing unlisted shares and other property.
– As regards having a different tax rate for different lengths of holding periods, i.e. pay less tax the longer you held the shares, I have seen this suggested before. I think it has some merits (e.g. it might discourage “speculation” rather than “investment”, but it also tends to distort investment decisions and hence the market.
– As regards the complexity of indexing gains this is not a problem at all. All investors should keep a record of when they purchased shares and indexing them is easy. A simple spreadsheet can keep track of investments and what investor does not know how to use that software? I was trading shares when indexation was allowed and it never proved difficult for me or my accountants.
CGT is definitely hugely time-wasting for investors and HMRC – a great incentive towards using ISAs/SIPPs wherever possible!
CGT calculations are fiendishly complex and often many hours of calculation results in £0 CGT payable.
A great simplification of every tax is highly desirable, though current areas of unfairness would then be replaced by others. Far too much time and effort is spent trying to apportion tax either to take according to one’s means or to give according to one’s needs, but there will always be a shortfall and unfairness, so simplicity is preferable, being a constant virtue.
i have decided not to invest through my nominee account because of this problem as at one time i tought it would be a good idea to use money in my easy access account to increase my investments.
We have now submitted our joint the UK Shareholders Association/ShareSoc response
Cliff Weight
Director
ShareSoc