Should Capital Gains Tax be aligned with Income Tax rates, as recommended in a report by academics at CenTax?
No.
Here are five reasons why.
1. The tax system should encourage individuals to take risks and invest, leading to long-term wealth creation. We already have a tax incentive that rewards individuals for investing in risky startups (Enterprise Investment Scheme). Starting a business is hugely difficult with around 60% start ups failing. The UK would massively disincentivise individuals from starting businesses if they knew that they would be taxed at income tax rates (40%/45%) on an eventual exit, instead of 10%/20% currently.
2. Unlike some jurisdictions (France, Germany, Australia etc) the UK has no ‘exit’ tax on capital gains. This means that taxpayers are free (arguably incentivised) to leave the UK and sell their UK assets, such as a UK company, when non-resident and pay no tax in the UK on the disposal. Raising Capital Gains Tax rates to Income Tax rates would mean that more entrepreneurs are incentivised to leave the UK before selling assets. 40% or 45% of zero is zero.
3. Capital Gains Tax effectively taxes inflation. This means people who sell assets at a ‘gain’ pay tax not only on the ‘real’ appreciation, but also the inflationary increase. Paying tax at 40% or 45% on inflationary increases in an asset value is unfair.
4. If CGT were raised to match Income Tax rates, UK would have one of the highest rates in the world, with only Denmark and Australia similar (although the Australian rate is in practice half the headline rate). This is not an entrepreneur friendly environment and is not growth friendly.
5. SMEs are the lifeblood of the UK economy, employing 61% of employees. Many founders are serial entrepreneurs, using cash from the exit of one SME to start the next. If 40%/45% of the exit proceeds were taken away in tax they would have less capital and incentive to start the next.
Tag Archives: finance
Tax Residency for different taxes
If you are non-resident for Income Tax and Capital Gains, that means you’re non-resident for the other taxes right? Of course not – that would be too simple. This is tax we’re talking about!
Our tax system has built up over time with residency definitions developing independently based on historical contexts, legal precedents, and changing economic conditions.
Due to the different definitions, an individual could (in theory) be non-UK resident for Income Tax, Capital Gains Tax, and Stamp Duty Land Tax, but UK resident for VAT, National Insurance, Withholding Tax and the Non-Resident Landlord Scheme. And they might also be domiciled in the UK for Inheritance Tax purposes.
Some of the definitions of tax residency are below:
𝗜𝗻𝗰𝗼𝗺𝗲 𝗧𝗮𝘅 𝗮𝗻𝗱 𝗖𝗮𝗽𝗶𝘁𝗮𝗹 𝗚𝗮𝗶𝗻𝘀 𝗧𝗮𝘅 – this goes by the Statutory Residency test, which has Automatic Overseas tests, Automatic UK tests, and a Sufficient Ties test. Note that the UK test can be overridden by a Double Tax Treaty, meaning you can be UK resident under domestic law but non-resident by virtue of a Treaty.
𝗡𝗮𝘁𝗶𝗼𝗻𝗮𝗹 𝗜𝗻𝘀𝘂𝗿𝗮𝗻𝗰𝗲 𝗖𝗼𝗻𝘁𝗿𝗶𝗯𝘂𝘁𝗶𝗼𝗻𝘀 – non-residency is where you are ‘ordinarily resident’ outside the UK. This is not defined in the legislation but there is case law which assists in interpreting the definition. Your residency is where you have a settled and regular mode of life, and where you live apart from temporary/occasional absences. Although the need to use this definition can be overridden by Bilateral Social Security Agreements.
𝗦𝘁𝗮𝗺𝗽 𝗗𝘂𝘁𝘆 𝗟𝗮𝗻𝗱 𝗧𝗮𝘅 – non-residency occurs when you spend fewer than 183 days in the UK in any continuous period of 365 days beginning 364 days before and ending 365 days after the transaction occurs.
𝗪𝗶𝘁𝗵𝗵𝗼𝗹𝗱𝗶𝗻𝗴 𝗧𝗮𝘅 𝗮𝗻𝗱 𝘁𝗵𝗲 𝗡𝗼𝗻-𝗥𝗲𝘀𝗶𝗱𝗲𝗻𝘁 𝗟𝗮𝗻𝗱𝗹𝗼𝗿𝗱 𝗦𝗰𝗵𝗲𝗺𝗲 – you are non-resident if your ‘usual place of abode’ is outside the UK.
𝗜𝗻𝗵𝗲𝗿𝗶𝘁𝗮𝗻𝗰𝗲 𝗧𝗮𝘅 – this is not actually based on residency (currently) but on a closely linked concept called ‘domicile’. Massively simplifying, you can be non-UK domicile and therefore not subject to Inheritance Tax where you have a ‘voluntary residence as an inhabitant’ overseas and a ‘settled intention to permanently reside’ there.
𝗩𝗔𝗧 – you are non-resident if your ‘usual place of residence’ is overseas. Again, this is not defined in legislation but there is a raft of case law to assist.
Do we really need all these separate definitions? This could have been something for the Office of Tax Simplification to look at, if it hadn’t been abolished back in 2022.
R&D Tax Credit Changes
I was interviewed regarding R&D tax credits for this month’s North West Business Insider (link below).
HMRC are cracking down on R&D tax claimants. As with many government policies, it has gone from one extreme to another – an effective ‘anything goes’ with a number of cowboy ‘specialist claim firms’ to HMRC routinely challenging (and denying) entirely legitimate claims. In other words, taking a sledgehammer to crack a nut.
The rules have been tinkered with endlessly since 2021. So far we have had:
-A new tax credit cap – with exceptions
-A new part of the tax return to be completed by claimants (CT600L)
-Denial of relief for overseas contractors in 2023 (which was pushed back to 2024) – with exceptions
-Changes to the rates in 2023
-Changes to qualifying costs to include data hosting/cloud computing
-Changes to qualifying activities to include pure mathematics
-A requirement for an Additional Information Form;
-A new ‘R&D intensive rate’, for which the percentage to qualify changed from 2023 to 2024;
-Advanced notification; and
-Arguably most importantly, a change to HMRC’s underlying policy on R&D, which was never legislated.
We finally have an end in sight with the ‘merged scheme’, which is – according to Jeremy Hunt – a “new simplified R&D tax relief, combining the existing R&D Expenditure Credit and SME schemes”. Except it’s not. There’s going to be two separate schemes running, which includes a second scheme for loss making SMEs. The less generous ‘merged scheme’ came into force yesterday. HMRC updated their guidance on this on Wednesday last week, five days before it came into force (link in comments). Plenty of time to plan then…
Businesses, on the whole, hate tax uncertainty. The R&D tax field since 2021 has been a prime example of an unstable tax environment. Businesses and R&D tax advisors are hoping for a long period of stability after these tumultuous years.
And on the bright side there is still a lot of benefit to completing an R&D tax credit claim where eligible.
Thoughts on the conservative budget
My take on the three main points of the budget.
Reduction in NIC rates – 1% for self-employed, 2% for employees
I am a big proponent of this. NIC is effectively a tax on ‘active’ work. If you are sitting with a big rental portfolio, investment income, or living off a fat pension you don’t pay NIC. If you undertake a trade or you are an employee you do. Arguably, this is the wrong way round. I would like to see NIC merged with income tax to simplify the system, but then basic rate employees would realise they have a marginal rate of 32%/30% and not 20%, which is politically unpalatable.
As a result of these changes higher/additional rate employees will save £754 a year.
Full expensing of plant and machinery
Full expensing allows companies to deem plant and machinery an expense for tax purposes, even if it is capitalised on the balance sheet. E.g if a company bought a digger for £200,000, it can take £200,000 off its taxable profits. Make no mistake, the change announced is a tax cut for large businesses. All companies already get a £1m full expensing allowance. It is rare for SMEs to breach this, whereas multi-nationals will often breach this many times over.
R&D scheme merging
It was announced by Hunt that the two R&D schemes are now going to be merged. This is after a huge amount of messing around with the administration and rules relating R&D in the past couple of years, which included hiring inexperienced HMRC officers to challenge claims which were clearly compliant.
Two points – it comes in for accounting periods starting 1 April 2024, so doesn’t give companies much time to prepare. Secondly, R&D isn’t actually being merged into one scheme as Hunt suggested. There will still be two schemes – the merged scheme and the SME intensive scheme (see link in comments).
Let’s hope this can be the final change to what has been a tumultuous couple of years in R&D.
American exceptionalism in regards to tax
A global minimum tax of 15% was introduced for large multi-national enterprises on 1st January, with almost no media fanfare. At the time of writing, around 55 countries have implemented this, including the UK and the EU bloc.
USA has not. Should we be surprised? No.
Below are some examples of the USA going against international tax norms.
1. USA taxes its citizens rather than those who are resident in the USA. This means that if you were born in the US but have lived in the UK for your entire life, USA’s Inland Revenue Service will still – potentially – want a chunk of your income. The only other country in the world to attempt to do this (badly*) is Eritrea.
2. Double Tax Treaties between countries override domestic law in (almost) every circumstance. They must have this status to allow for proper functioning of the treaty. The US, uniquely in international tax, in Internal Revenue Code §7852(d) effectively gave itself the right under their domestic law to override a treaty.
3. As far as I’m aware, all OECD countries use the OECD Model Tax Treaty as the basis for their treaties. Developing countries will generally use the UN Model Tax Treaty. About 90% of the world’s treaties are based on these two models. However, the US again decides to be different, and bases its treaties on the US Model Tax Treaty.
4. The US implemented FATCA in 2010, which essentially placed a massive compliance burden on any financial institution in the world that serves US citizens. It forces them to report detailed information on their US citizen account holders or have account holders face penal measures. Arguably, only the US with its massive economic and political strength could have implemented such a measure. In 2014 the OECD implemented the Common Reporting Standard (“CRS”), which allows for information on taxpayers to flow between signatories, with over 120 jurisdictions who have now signed. The US has never been a signatory to the CRS.
5. Double Tax Treaties often contain words or phrases which need interpreting. As an example, in the case of Macklin V HMRC (2015), the word ‘established’ in a Double Tax Treaty in regards to a pension fund needed to be clarified. Rules on treaty interpretation are found in the Vienna Convention on the Law of Treaties, coming into force in 1980. There are now 116 jurisdictions who are signatories. USA has never become a party to the convention.
6. The Multi-Lateral Instrument (“MLI”) allowed for some the recommendations of the OECD’s Base Erosion and Profit Shifting action points to be implemented into tax treaties without needing to renegotiate the entire treaty. It’s why if you search for many tax treaties you’ll find what appear to be two versions; the original treaty and the treaty containing the changes made by the MLI (e.g search UK/France double tax treaty). At the time of writing, 102 states have signed this. Guess what? The US has never signed up for the MLI.
NIC Cut and what it means for you
When most of us get paid in 9 days time, we’ll see more go into our bank accounts than normal. If you earn £50,270 or more, you’ll see an extra £63. If you earn less than this, you can see how much extra you’ll take home using the BBC calculator (link in comments).
This is due to Jeremy Hunt’s National Insurance Contribution (“NIC”) cut from 12% to 10% for employees. Without getting political, this is a major U-turn given that Sunak increased NIC to 13.25% in April 2022, which was reversed back to 12% by Kwateng in November of that same year. It’s been a busy couple of years for payroll software providers.
I’ve said this before, but NIC is effectively a tax on ‘active’ work. If you are sitting with a big rental portfolio, investment income, or living off a fat pension you don’t pay NIC. If you undertake a trade or you are an employee you do. Arguably, it should be the other way round, with the tax system incentivising people do ‘active’ work. There is a strong argument to merge NIC and income tax.
NIC is widely seen as a gentler and fairer tax, in that you pay money in and ultimately receive benefits out. In research by King’s College London in 2023 it was found the most common misconception was that “each person’s National Insurance contributions are kept in a personal pot to be accessed when they reach state pension age”. This is not the case at all. The link between paying NIC and receiving benefits is now vanishingly weak.
Indeed, if you have a limited company and pay yourself a salary of £12,570 and take the rest in dividends you pay no NIC at all, yet are still awarded a ‘qualifying year’. The same goes for someone on Jobseeker’s Allowance. Both give an identical state pension entitlement as someone who has paid £millions in NIC over their lifetime.
An individual needs 35 qualifying years by state pension age to receive full state pension entitlement. You can check if you are on track to do this (link in the comments). If you are missing years, you can make Class 3 voluntary contributions to fill gaps in your record.
