The Chancellor has asked the Office for Tax Simplification to carry out a wide-ranging view of capital gains tax (CGT). Corporation tax paid by companies on their capital gains is not in the scope of the review. Over the last few years significant changes have already been made to how the real estate sector is taxed – there have been multiple SDLT increases, the annual tax on enveloped dwellings has been introduced and so have new rules on taxing offshore developers of UK land. Most recently, corporation tax has been expanded to cover capital gains made by non-resident landlords when they sell UK property, and the reduction in value of entrepreneurs' relief will have affected some individuals hoping to sell property development companies in the short/medium term. As a result, there may be concern that even if real estate is not the immediate target of the review, any CGT changes recommended could increase further the tax burden on the sector.

Given the wide remit of the review, it is difficult to predict exactly what it will end up recommending.

Removing the CGT exemption on sale of a main residence (the "principal private residence" relief, or PPR) would be a significant revenue-raiser for the Chancellor, at least over the long term. In their May 2019 estimate of the "cost" of the main tax reliefs HMRC thought that this exemption reduced CGT collections by about £27 billion per year (before taking into account the ways behaviours would change if the exemption were removed). For comparison, the cost of entrepreneurs' relief (about £2 billion per year) was a lot lower, but that did not save ER from being significantly cut back in the last Budget. Of course, ER was a considerably easier target politically than people's homes. Moreover, even if PPR were abolished immediately it would be some time before that led to a material increase in tax revenue if (as seems likely in light of how corporation tax was extended to non-resident landlords) taxpayers were allowed to rebase their homes to the current market value when calculating the capital gain on an eventual sale. Although there may be economists who would back this sort of change, it seems politically unlikely under the current government – then again, the government has already contemplated "six impossible things before breakfast" in the course of its response to Covid-19.

Alignment of the CGT rates with income tax rates is a more plausible potential change that the OTS could recommend – or at least a material increase in some or all of the current CGT rates. As things stand, CGT rates are considerably lower than income tax rates – which gives taxpayers a real incentive to try to realise value in the form of capital not income (see, for example, the periodic discussions about how private equity carried interest is taxed at CGT rates and not income tax rates). Arguably that is anomalous, and there have been periods in the UK when the income tax and CGT rates were aligned. Alignment of rates would be a significant change, and would probably be more politically feasible than removal of the PPR – but as CGT collections are only about £9 billion per year there is a limit to how much revenue can be raised with rate increases alone.  

Coupling rate increases with removal or reduction of the current "annual exempt amount" (essentially, the amount of capital gain you can realise each tax year without paying CGT) could go further. If alignment with income tax is the direction of travel then there would be some logic in having a single annual tax-free allowance covering both CGT and income tax rather than a separate one for each tax. This sort of change would affect in particular owners of second homes and buy-to-let landlords (who already pay CGT at a higher rate (28%) than most taxpayers (20%)), and it is possible that this sort of change could be targeted at real estate gains in particular rather capital gains generally (though targeting the change in that way would obviously reduce any revenue increase the Chancellor would see from this measure).

More technical changes that could be recommended by the OTS include the recommendations it has already made separately on how inheritance tax (IHT) and CGT interact. As things stand CGT is not charged on death and inheritors acquire the deceased's assets at market value for CGT purposes – and so could sell shortly after inheriting without realising a capital gain (and so without a CGT cost). At the same time, some assets benefit from exemption from IHT – in particular certain agricultural land. The OTS suggested in its IHT report removing the market value uplift for inherited assets that were exempted from IHT, in order to remove the current disincentive to sell/pass on farms and other property during one's lifetime, and that recommendation seems likely to be repeated in this review.

A more fundamental issue, not in the scope of this review, is that CGT is clearly only charged when there is a gain (albeit given the removal of indexation allowance that gain can be rather notional). Absent a disposal (actual or deemed) at a gain (also actual or deemed), there is nothing to tax and no CGT for HMRC to collect. If the real objective of the government is to raise material amounts from the UK's fixed capital, introducing a wealth tax of some description on the ownership of assets might be needed. Real estate assets are immovable and high value, and their ownership is already formally registered – all of which potentially make them particularly vulnerable to a new wealth tax.

Key Contacts

Paul Concannon

Paul Concannon

Partner, Tax & Structuring
United Kingdom

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Peter Sayer

Peter Sayer

Partner, Tax & Structuring
London

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Charlotte Fallon

Charlotte Fallon

Legal Director, Tax & Structuring
London

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