Following a wide-ranging consultation, in November 2020 the Office of Tax Simplification (OTS) published its first report on simplifying Capital Gains Tax (CGT), in which it considered the policy design and principles underpinning CGT. In its second report, published on 19 May 2021, the OTS focuses on practical, technical and administrative issues.
The report makes recommendations covering the following areas:
- Awareness and administration
- Main homes
- Divorce and separation
- Business issues
- Investor issues
- Land and property issues
The government is under a statutory duty to respond to the OTS’ report and we anticipate that it will give serious consideration to the recommendations contained within it. If the implementation of any of these recommendations would be advantageous in the case of a specific transaction, then it may be worth delaying the transaction until the end of the summer in the hope of a timely response from the government – provided that doing so would not have significant adverse consequences.
People who may benefit from the implementation of the OTS’ recommendations include:
- Those looking to build a new home on their land for their own occupation.
- Divorcing couples negotiating a financial settlement which involves the transfer of assets spanning more than a year.
- Those wishing to sell a business or land where the sale proceeds may be paid over a number of years.
- Potential candidates for the Enterprise Investment Scheme who do not currently meet all the criteria for the relief.
- Those looking to make use of Rollover Relief where there has been, or there is anticipated to be, a Compulsory Purchase Order.
- Landowners who are considering entering into a land pooling arrangement.
- Leaseholders wishing to extend their lease where they also own a share in the flat management company which holds the freehold.
Awareness and administration
The OTS observes that a persistent theme from the consultation is the limited awareness or understanding of CGT, of when it may arise, or the reporting and paying obligations when it does. The OTS proposes a number of approaches to increase awareness and simplify administration, including extending return deadlines and integrating the reporting of CGT into a central hub.
Main home
Gardens and grounds
The OTS identifies an anomaly in the mechanics of the rules, which provides an incentive for homeowners to sell their gardens to a developer in preference to building another home to move into on their land. It recommends that Private Residence Relief be adjusted to cover developments in a taxpayer’s garden, which the taxpayer subsequently occupies, to make these more tax neutral.
Nominations
The OTS sees no realistic alternative to the nomination system, whereby a taxpayer who has more than one eligible home can choose which home they wish to benefit from Private Residence Relief. However, it makes a few suggestions to improve the practical operation of how nominations are made.
Divorce and separation
Currently, divorcing or separating couples can only transfer assets between each other without triggering an immediate CGT charge in the tax year of their separation. The OTS notes that this length of time is inadequate and recommends that the 'no gain no loss' window on separation should be extended to the later of:
- the end of the tax year at least two years after the separation event;
- any reasonable time set for the transfer of assets in accordance with a financial agreement approved by a court, or equivalent process in Scotland.
Business issues
Deferred proceeds
The OTS notes that the proceeds from the sale of a business or land can be received in several different ways. Proceeds can take the form of cash or other assets, they may be paid over a number of years, or a business can be sold for a price that is dependent on future events. The OTS identifies several different practical issues which arise out of these complex transactions.
The OTS suggests that CGT should be charged on a 'receipts' basis, with tax paid when proceeds of sale are actually received, while preserving eligibility to existing reliefs. However, the Exchequer implications of this need to be considered as there would be a delay in the payment of CGT and a reduction in tax revenue due to the spreading of the gain across multiple tax years where more than one Annual Exempt Amount will be available.
Debts
The OTS identifies a range of challenges in the way debts are treated:
- It is not always obvious whether a debt is a 'simple debt' (outside of the scope of CGT), or a 'debt on a security' (within scope). There is also lack of certainty around whether relief can be claimed on an irrecoverable debt, as this depends on HMRC’s subjective assessment of the commercial position at the time the loan was made. The OTS recommends that HMRC improve their guidance on both of these issues.
- The OTS also considers corporate bonds: debts or securities issued by a company to raise finance. The treatment of corporate bonds is effectively a choice determined by specific terms in the loan documentation which generally have no other commercial significance. It therefore suggests an irrevocable provision in the documentation for a corporate bond to specify that it is subject to CGT, which would remove the need for confusing and complex clauses.
Business Asset Disposal Relief
Business Asset Disposal Relief provides that, where at the time a business ceases there is a disposal of one or more business assets, relief may be claimed as long as the disposal is made within the three year period beginning with the date of cessation. The OTS notes that this requirement to sell when or after the business ceases may not reflect some common retirement scenarios.
The OTS recommends that HMRC include more detailed examples in their manuals about how they might interpret the legislation in certain situations where the date of cessation is unclear, to help and reassure those looking to retire over a period of time.
Investor issues
Enterprise Investment Schemes
The Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS) are intended to provide support for growth investment in start-up and early-stage companies by giving tax reliefs to investors who subscribe in cash for new shares in those companies. However, these schemes have restrictive eligibility criteria and require specific clearance from HMRC. Whilst the OTS acknowledges the need for strict criteria to avoid exploitation, it notes that the rules are overly limiting and can cause practical problems for genuine applicants.
The OTS recommends a review of the rules for EIS, with a view to ensuring that procedural or administrative issues do not prevent their practical operation. The OTS suggests the following specific improvements:
- The government should provide taxpayers with a measure of flexibility in relation to non-substantive technical issues which risk invalidating claims where the substance of the transaction meets the policy objective.
- A short period of grace should be allowed between a company receiving funds and issuing shares. Currently, shares in companies that qualify for enterprise investment schemes have to be issued when, or shortly after, any funds are received, which can be commercially unreasonable.
- Consideration should be given to aligning the treatment of revived deferred gains for EIS and revived SEIS reinvestment relief gains so that Business Asset Disposal Relief can be claimed on the latter as well as the former.
- The eligibility criteria should be reviewed on an on-going basis to ensure they can reasonably be met in practice and do not unduly restrict companies’ commerciality.
- HMRC should improve the functionality of the forms and their guidance in consultation with professional bodies and adviser groups.
- The government should explore whether CGT relief should still be accessible by the investor even when Income Tax relief has not been claimed. Currently, for Enterprise Investment Scheme reliefs to be available, Income Tax relief must have been claimed and been given on all or part of the original investment. The OTS notes that it is an odd outcome for an individual to be denied CGT relief if they did not have a liability to pay Income Tax when they first made that investment.
Foreign Assets
When foreign assets are bought or sold, their costs and proceeds are converted into sterling when they are incurred or received in order to calculate the gain. This means that their absolute gains or losses in the foreign currency are ignored for CGT purposes. The OTS notes that this approach can be complicated as it requires historical exchange rate conversions of both the acquisition cost and any enhancement expenditure.
In contrast, there is a specific CGT exemption for foreign exchange gains or losses that arise from movements of money in a foreign currency bank account. The exemption was introduced to remove the complexity and number of the computations that would otherwise be required.
The OTS suggests that gains or losses on foreign assets should be calculated in the relevant foreign currency and then converted into sterling. This would be simpler for those taxpayers who operate foreign bank accounts and more intuitive for those regularly buying and selling assets in foreign currencies.
Land and property issues
Rollover Relief
In normal circumstances, Rollover Relief allows the gain arising on the sale of a qualifying business asset to be deferred where the proceeds are reinvested into another qualifying business asset in the same or an ancillary trade. For these purposes, land which farmers occupy for their own trade will qualify for relief, but land they rent out ('let' land) will not usually qualify. However, there is an exception to this rule where land is compulsorily purchased.
The OTS notes that restrictions around such claims present particular challenges for owners of farming land and recommends an expansion of the specific Rollover Relief rules which apply where land and buildings are acquired under Compulsory Purchase Orders. It identifies a number of technical issues and puts forwards proposals to address these.
Land pooling arrangements
Land pooling involves a collaboration between multiple landowners to assemble separate areas of land into a cohesive whole which is suitable for development, so that planning permission can be secured and infrastructure put in place before sale to the developer. The OTS notes that the current treatment of land pooling arrangements can give rise to a range of CGT and Stamp Duty Land Tax issues before the land is sold and the proceeds are available. To address this, landowners need to consider complex structures, which present significant taxation and commercial challenges.
The OTS recommends that the government explore ways to make land assembly more tax natural. It proposes two approaches:
- Allow equalisation payments between landowners to be tax deductible.
- Create a specific type of land pooling vehicle that would freeze the tax status of the land at the point of entry and allow land to be sold with a neutral tax outcome.
The OTS also states that there is clear potential for better and more comprehensive HMRC guidance and for a clearance procedure.
Flat Management Companies
The OTS identifies problems with the taxation of lease extensions in the case of leaseholder-owned flat management companies:
- Where a leaseholder extends the length of their lease, the flat management company which holds the freehold can be subject to Corporation Tax on the basis that it has sold the lease at a gain.
- At the same time, a leaseholder may also have a CGT liability, as they are treated as selling their old lease to the flat management company before acquiring the new extended lease.
- By granting a lease extension at less than its market value, the flat management company may be treated as having paid a 'dividend' to the leaseholder/shareholder, which will taxed as income in the hands of the leaseholder.
These implications are not appropriate where leaseholders do not pay the flat management company for the lease extension, which is common where the leaseholder and the freeholder are effectively the same person. The OTS suggests that all these issues could be addressed by treating the freeholder company as a nominee for the leaseholder.
For more information, please contact Emma Heelis-Adams or your usual Burges Salmon contact.