CAPITAL TAXES CAPITAL GAINS TAX AND CAPITAL ACQUISITIONS TAX

Transcription

1 CAPITAL TAXES CAPITAL GAINS TAX AND CAPITAL ACQUISITIONS TAX Tax Strategy Group 16/09 19 July

2 Introduction 1. This paper deals with Capital Gains Tax (CGT) and Capital Acquisitions Tax (CAT). Capital Gains Tax (CGT) Structure 2. CGT is charged on the gain in value of an asset. The charge is triggered on disposal of the asset. This means that, in effect, it is charged on the difference in value of the asset from the time of its acquisition by the taxpayer to the time of its disposal (minus costs for upkeep, improvement etc. and potentially some indexation relief). CGT is calculated with reference to the market value of the asset and can apply to gifts as well as sales of assets. The current CGT rate is 33%. 3. Individuals, trusts, and unincorporated bodies are chargeable to CGT. Capital gains of companies are chargeable to corporation tax. The first 1,270 of chargeable gains made by an individual each year are exempt. When a taxpayer makes a loss on the disposal of an asset this can be set against gains made for the calculation of the tax in the same year or can be carried forward for offset against future chargeable gains. 4. The following are the other main reliefs and exemptions relating to CGT. 5. Disposals to spouses, separated and divorcing spouses, registered civil partners and to former co-habitants under a court order: Such disposals are treated as being at no gain/no loss and the recipient is treated as having acquired the asset at the same date and for the same value at which it was acquired by the donor of the asset. The treatment afforded to married persons was extended to civil partners and former cohabitants under Finance (No. 3) Act 2011, which transposed the provisions of the Civil Partnership Act into tax law. 6. Principal Private Residence Relief: An individual s principal private residence is exempt from CGT on disposal. Where the individual resides in the property for a part rather than the whole of the duration of ownership, the relief is apportioned accordingly. In such cases, the final year of ownership is counted as a year of occupation. 7. Retirement Relief: Business or farming assets are relieved from CGT where the person disposing of the assets is aged 55 or over and had owned and used the asset for the ten years prior to disposal. The operation of the relief differs as between persons aged 55 to 65 and persons aged 66 and over. 8. For individuals aged 55-65, the relief applies to assets valued up to 750,000 on disposal where the assets are transferred outside the family. Where the disposal is made to a child of the transferor, there is no monetary limit to the relief. For individuals aged 66 years and over disposing of business or farm assets outside the 2

3 family, the consideration limit is 500,000. For individuals aged 66 years and over disposing of business or farm assets to a child, or to a nephew/niece who has worked full time in the business/on the farm for the previous five years, the relief can be claimed up to a consideration or value limit of 3 million. The changes for individuals aged 66 years and over came into effect from 1 January 2014, having been announced in Budget 2012 in order to encourage transfers by individuals, particularly in farming, who were already aged 66 years or who would reach that age before 1 January CGT Entrepreneur Relief: Budget 2016 introduced a revised CGT entrepreneur relief. It provides that disposals of qualifying business assets (in most productive businesses but excluding those involving dealing in land or holding investments) by qualifying individuals are charged at 20% up to a lifetime limit of 1 million in chargeable gains. To qualify, among other conditions, an individual must own at least 5% of the business and have spent a certain proportion of their time working in the business as a director or employee for three out of the previous five years, prior to disposal. History 10. CGT was introduced in 1975, following the publication in 1974 of the White Paper on Capital Taxation. Prior to this the only tax on capital in Ireland was estate tax. 11. Prior to 2002 there was an indexation relief which sought to limit CGT to real gains in asset values by excluding the impact of inflation as measured by the Consumer Price Index (CPI). The relief was abolished in 2002 as part of a process which, in conjunction with introducing lower overall tax rates, sought to protect and expand the tax base by limiting tax exemptions. Indexation relief still applies to gains accrued on assets up to Roll-over relief (under which the CGT payable on the proceeds of a gain was deferred if the proceeds were reinvested, with the result that the tax liability is not realised until the assets are eventually sold) was abolished in 2003 for all disposals, including disposals as a result of a compulsory purchase order. This was part of the same base-broadening process under which indexation relief was abolished. One issue with roll-over relief was that often an individual would, having rolled over a CGT charge, not dispose of the new asset in their lifetime, so that no CGT was ever paid. Purpose of tax and considerations 13. CGT is charged on the gain in value of an asset when disposed of by a taxpayer. As the assets held by a person grow in value that person s wealth grows, just as when they receive income. 14. If there were no CGT (or if the difference in the tax burden on income and capital was significant) individuals could arrange, in various ways, for their income to be converted from a form which is liable to income tax to one based on capital gains or capital appreciation. This practice was one of the reasons that CGT was initially introduced. 3

4 As such, although the CGT yield is only a small part of the overall tax yield it plays an important role in protecting the tax base. 15. Broadly speaking, capital gains tend to accrue to a larger extent to the better-off in society. 16. CGT is triggered at the time of the disposal of an asset, rather than at the time that the gain accrues. This means that it can have a distortionary effect by creating a disincentive for people to make disposals, particularly in cases where they intend to replace the asset. 17. When a person dies no disposal of assets is deemed to take place and no CGT charge arises. Whoever inherits the asset is deemed to acquire it at its market value at that time and can only be liable to CGT on gains accrued from that point on to the point of any subsequent disposal. This could create an incentive for people not to dispose of an asset but instead to keep it with the intention of bequeathing it. As well as affecting the tax base this may be economically inefficient. Inheritance tax can play a role in counteracting this effect. In recent years the headline rates of CGT and inheritance tax (Capital Acquisitions Tax) have been the same and have been changed in tandem. 18. No specific gender and equality implications are identified for CGT. Yield 19. The CGT yield to the Exchequer for each year since 2006 to 2015 is shown in Table 1 together with the projected yield (P) for 2016 (this is the forecast yield at the time of Budget 2016 in October 2015 before the outturn for 2015 became known) Table 1: CGT Yield: Selected Years Year Yield ( m) % change (Y-on-Y) % of overall tax take ,100 58% 6.80% , % ,430-54% 3.50% % 1.60% % 1.10% % 1.20% % % 1% % 1.30% % 1.50% 2016 (P)

5 20. The large drop in the CGT yield since its peak in 2007 is due to declining asset values and a reduction in the number of property and share transactions in the wake of the financial crisis. Liability to CGT is determined by the difference, at the time of disposal of an asset, between the cost of acquisition and the value at the time of disposal. Increases in 2014 and 2015 are related mainly to a rise in both equity markets and property prices. Recent Developments 21. In 1998 the rate of CGT was reduced from 40% to 20%. From 2008 to 2012, the rate was gradually increased to its current level of 33% as part of a range of tax measures introduced to restore order to the public finances over that time. 22. In recent Budgets, targeted relieving measures have been introduced in the CGT area. For example, the revised CGT entrepreneur relief is a step towards improving the tax environment for business people. 23. The document A Programme for a Partnership Government published in May 2016 contains the following: We will reduce the rate of Capital Gains Tax for new start-ups to 10% from 2017 (held for five years and subject to a 10 million cap on gains). Cross border comparison 24. In the UK, CGT is charged at different rates for basic rate and higher rate taxpayers and varies depending on the type of asset and the size of the disposal. The rates range from 10% (for a basic rate taxpayer disposing of assets other than residential property and realising a gain which, when added to his or her income does not exceed the basic rate income tax band) to 28% (for disposals of residential property by a higher or additional rate taxpayer or a basic rate taxpayer whose gains, when added to his or her income, bring him or her into the higher rate income tax band). The annual exemption in the UK is 11,100. Principal private residence relief operates similarly in the UK to Ireland. There is no UK equivalent to CGT retirement relief. Entrepreneur relief in the UK provides for a 10% rate on qualifying gains up to a lifetime limit of 10 million, and can apply to investors as well as entrepreneurs working in a company. 25. Most European countries charge capital gains tax, although some countries tax gains as income or as savings. Reliefs differ somewhat. For instance some countries allow a relief for inflation, as happened here until 2002, while other countries do not provide for indexation and in some countries gains from the sale of a principal private residence are only exempt if they are used to buy a new home. Options 26. Rate changes: Revenue calculate that, in the absence of behavioural change, every 1% increase in the CGT rate will yield 21 million in a full year, while every 1% decrease will cost 21 million. 5

6 27. While CGT yield in 2014 and 2015 was improved compared to the previous five years, it seems unlikely, whatever policies are adopted, that it will approach pre-crisis levels in the near future. Many of the circumstances and factors that gave rise to the high levels of pre-crash yields from CGT are different or not so prevalent at this time and seem unlikely to be repeated to the same degree in the foreseeable future. These circumstances and factors include, for example, the broad-based scale of asset price rises, the scale and frequency of transactions in asset disposals, the level of chargeable gains and the uncertainty now about the current level of capital losses being carried forward in the system and available for offset against chargeable gains. 28. The point is often made that when the CGT rate was reduced from 40% to 20% in 1998, yield increased. In fact, the yield from CGT had been increasing significantly in relative terms for some years prior to the 1998 rate change although from a low base. Several other points should be noted in this regard. The significant rate reduction happened at a time when asset values had been rising over a period and large gains were available to be realised. The rate drop may have been anticipated by owners of assets such that they held off on disposal until it came into effect. More generally, while a drop in CGT rates may stimulate activity in the short term, much of the effect will come from bringing forward disposals that would have occurred anyway but at a later date. To this extent, tax yield and economic activity are not increased overall but simply moved in time. 29. Annual exemption: The annual exemption of 1,270 has not changed since An increase in the exemption could reduce the compliance burden for taxpayers and the administrative burden for Revenue. A change to an annual exemption of 1,500 is estimated to cost about 4 million while an increase to 1,750 could cost in the region of 8 million. 30. More than one rate: The current single CGT rate has the advantage of being simple and the fact that it is matched to the CAT rate has merit (see considerations above). Charging different rates depending on the size of the gain or on the liability of the taxpayer to standard or higher rate income tax could increase the progressivity of the tax. As the majority of CGT is likely to be paid by higher rate taxpayers, reducing the rate for standard rate taxpayers could constitute a targeted reduction without significantly eroding the tax base. Any changes in this direction would, however, increase the administrative complexity of the tax for an arguably marginal benefit. 31. Supporting businesses: The document A Programme for a Partnership Government published in May 2016 contains the following: We will reduce the rate of Capital Gains Tax for new start-ups to 10% from 2017 (held for five years and subject to a 10million cap on gains). 32. This proposed measure would be similar in structure to the recently introduced entrepreneur relief but considerably more favourable and with the main difference being that it will be available only to those who commence a business from the date the new relief is introduced and not to those entrepreneurs who will have founded their business before that date. 6

7 33. The existing entrepreneur relief could be modified in line with this commitment in the Programme, depending on the competing choices to be made for available resources. Revenue have costed the introduction of a 10% rate for business disposals up to a limit of 10 million (as per the Programme for a Partnership Government) at 65 million in a full year, beyond the cost of the existing entrepreneur relief. 34. It has also been suggested that including a CGT relief or exemption for investors as part of the Employment and Investment Incentive scheme could increase the effectiveness of that scheme. This targeted relief is unlikely to be very costly and could be considered. 35. However, while supporting entrepreneurship is valuable there is no clear evidence on the marginal impact of tax reliefs on entrepreneurial activity. 36. Other Reliefs and exemptions: The scope of existing reliefs and exemptions are examined as part of the annual Budgetary and Finance Bill process and may also be reviewed as and when issues relating to their operation arise. The scope for introducing or extending reliefs or exemptions is constrained by competing choices for available resources. Any new or significantly revised reliefs would have to be considered having regard to the guidelines on tax expenditure evaluation published by the Department of Finance in

8 Capital Acquisitions Tax (CAT) Structure 37. The capital acquisitions tax code covers gift and inheritance tax. CAT is charged on transfers of assets made by way of gift or inheritance. The person receiving the gift or inheritance is liable. CAT is charged at 33% on the market value of the asset received on the valuation date, which is the date at which the beneficiary becomes beneficially entitled to the asset. 38. Each beneficiary is entitled to receive a certain amount tax-free over his or her lifetime before transfer values come to be liable to CAT (to reduce compliance costs transfers before 1991 do not count towards this amount). The amount that can be received taxfree varies according to the source of the receipt. These amounts are called the group thresholds. They are as follows: Group A: tax free threshold, 280,000 applies where the beneficiary is a child (including adopted child, stepchild and certain foster children) or minor child of a deceased child of the disponer. Parents also fall within this threshold where they take an inheritance of an absolute interest from a child. Group B: tax free threshold, 30,150 applies where the beneficiary is a brother, sister, a nephew, a niece or lineal ancestor or lineal descendant of the disponer. Group C: tax free threshold, 15,075 applies in all other cases. 39. The following are the main reliefs and exemptions relating to CAT. 40. Small Gifts Exemption: The CAT code contains an exemption on the first 3,000 of taxable gifts (not inheritances) received in a tax year. This annual exemption is separate from and in addition to the lifetime group thresholds which relates to gifts and inheritances received from 1991 to date. 41. Spouses, Registered Civil Partners and former co-habiting spouses: Gifts and inheritances between spouses are exempt from CAT. Finance (No. 3) Act 2011 extended this treatment to registered civil partners and former co-habiting spouses who transfer property under a court order. 42. Dwelling House Exemption: Finance Act 2000 introduced an exemption from CAT for certain dwelling houses. While the focus of the predecessor to the current exemption (a capped relief introduced in Finance Act 1991) was to alleviate hardship caused by a CAT liability imposed on a relative who inherits a house in which they had been living with the disponer, Finance Act 2000 introduced an exemption under certain conditions for both gifts and inheritances of a dwelling house irrespective of the relationship between disponer and beneficiary. The main condition is that the beneficiary has to occupy the dwelling house as his or her only or main residence for three years prior to the gift/inheritance and continue to reside in it for six years after the gift/inheritance. In addition, the beneficiary must not, at the time of the gift or inheritance, have a beneficial interest in any other dwelling house. The dwelling house exemption is a full exemption without a ceiling or a requirement that the beneficiary 8

9 has to be related to the disponer. The scope of this exemption is currently under review. 43. CAT Agricultural/Business Relief: Qualifying farmers can avail of CAT agricultural relief. The relief is available in respect of gifts and inheritances of agricultural property and a deduction of 90% is provided from the market value of the property in order to arrive at its agricultural value for CAT purposes. Among the main conditions to be satisfied so as to qualify for agricultural relief, 80% of the beneficiary s assets, after having received the gift/inheritance, must consist of qualifying agricultural assets. The beneficiary must also be an active farmer or lease the agricultural property to an active farmer. 44. Relief for CAT purposes also applies to gifts and inheritances of certain business property, subject to conditions. The taxable value of such property is reduced by 90% for CAT purposes. In order to qualify for this relief, the business concerned must not consist wholly or mainly of dealing in land, shares, securities, or currencies or making or holding investments. 45. Agricultural and business reliefs from CAT are designed to facilitate the intergenerational transfer of businesses and farms as going concerns. 46. CGT/CAT same event relief If CGT and CAT is payable on the same event (for example, a gift of land by a parent to a child) any CGT paid by the parent can be used by the child as a credit against her/his CAT liability. One effect of this relief is to limit the potential for a gift having a much higher tax charge than an inheritance of the same asset (while gifting is a disposal for CGT purposes, death is not treated as a disposal event for the purposes of that tax). This same event relief does not apply in cases where no CAT would be due in any case. History 47. CAT was introduced in 1975, following the publication in in 1974 of the White Paper on Capital Taxation. Prior to this the only tax on capital in Ireland was estate tax. 48. Estate tax was a tax on the estate of a deceased person. CAT, by contrast, is a tax not on the estate but on the amount received by an individual by gift or inheritance. The difference is relevant, for instance, in cases where an estate is divided between a large number of people. Given the individual tax-free amounts to which they will all be entitled, the aggregate of the individual CAT charges is likely to be less than the estate tax charge would have been. 49. Prior to 1994 the rate of gift tax was lower at 75% of the rate of inheritance tax. This was intended to encourage transfers of assets during the lifetime of the giver or disponer. This treatment was discontinued as it was determined not to be producing a benefit which warranted the cost and, because from the point of view of the 9

10 beneficiary upon whom the tax is charged, gifts and inheritances are in most relevant ways equivalent. 50. Prior to 1999, CAT was charged at progressive rates according to different bands or slices relating to the overall amount received by gift or inheritance by a person beyond the relevant tax-free amounts, similar to the way the bands for standard and higher rate income tax operate. The rates and bands varied over time. This arrangement had the advantage of progressivity and of protecting yield while being less onerous on those receiving smaller overall amounts. The current single rate has the advantage of comparative simplicity. 51. When a single rate structure was introduced in 1999 it began at what had previously been the lowest CAT rate of 20%. Immediately prior to this, the top rate had been 40%, while it had previously been as high as 55%. 52. Prior to 2011 the tax-free thresholds were indexed to the Consumer Price Index. The principle behind indexation was that the thresholds should, in real terms, retain their value over time. Indexation created complications for Revenue and practitioners. The practice was discontinued in a context where the scale of changes in property values (property makes up a large part of the transferred assets liable to CAT) diverged strongly from the overall rate of inflation. Purpose of tax and considerations 53. One of the reasons presented worldwide for inheritance tax is that it acts to address, to some extent, the concentration of wealth within families and to spread some of the benefit of inter-generational wealth transfers to society, generally. 54. According to the OECD hierarchy of taxes, taxes on fixed capital are the least harmful to economic growth. CAT mostly falls under this category of tax. 55. The basic principle on which CAT operates is that when a gift or inheritance takes place the wealth of the beneficiary grows, and this growth in wealth should be liable to taxation in the same way as income or gains through employment or investment. 56. Conceivably such receipts could be taxed as income but as they tend to come in larger, irregular chunks (e.g. where an individual inherits a valuable property) this could lead to a higher rate of taxation than warranted by the overall level of benefits received over a lifetime. 57. As with income tax where a certain amount can be earned each year before a tax liability arises, so with CAT where a certain amount can be received over a lifetime tax-free. The amounts that can be received tax-free depends on the relationship between the disponer and the beneficiary and these amounts have varied since the introduction of CAT. 10

11 Yield 58. When a person dies no disposal of his/her assets is deemed to take place and no capital gains tax charge arises. Whoever inherits the assets is deemed to acquire them at market value at that time and can only be liable to CGT on gains accruing from that point on to the subsequent disposal of the assets. In the absence of a gift or inheritance tax, there would be an incentive for individuals to hold on to assets or transfer them in a sub-optimal way from the point of view of the Exchequer and the economy, generally. In recent years the headline rates of CGT and CAT have been the same and have been changed in tandem. 59. No specific gender and equality implications are identified for CAT. 60. The CAT yield to the Exchequer for each year since 2006 to 2015 is shown in Table 2, together with the projected yield (P) for 2016 (this being the forecast yield figure at the time of Budget 2016 in October 2015 before the outturn for 2015 became known) Table 2: CAT Yield: Selected Years Year Yield m % change Y-on-Y % of overall tax take % 0.70% % 0.80% % 0.80% % 0.80% % 0.70% % 0.70% % 0.80% % 0.70% % 0.90% % 0.90% 2016 (P) While the yield from CAT can be volatile from year to year, it should be borne in mind that CAT yield usually represents around 1% of the overall tax yield. Recent developments 62. In 1999 CAT was set at a flat rate of 20%. From 2008 to 2012, the rate was gradually increased to its current level of 33%. This occurred as part of a range of tax measures introduced over this period to help put the public finances on a stable footing. These measures also involved reductions in the levels of the Group tax-free thresholds which in the case of the Group A threshold was reduced by 58% in the period 2008 to 2012 (the Group B and C thresholds were reduced by 42%). 11

12 63. As part of Budget 2016 the Group A tax-free threshold, applying primarily to gifts and inheritances from parents to their children, was raised from 225,000 to 280,000. Cross border comparisons 64. Inheritance tax in the UK is an estate tax, charged on the value of the estate of the deceased rather than the amount received by any individual. It is charged at 40% on the value of individual estates over 325,000 (called the Inheritance Tax Threshold). There are certain reductions and exemptions when the estate is passed in particular ways. For instance inheritance from a spouse is tax-free and the two thresholds applicable to the individual estates of spouses can then be added together on the death of the surviving spouse. Gifts are not taxed in of themselves but to prevent avoidance through the gifting of assets shortly before death, inheritance tax can be recouped on the value of gifts when the disponer dies within seven years of making the gift. 65. The 2011 Mirrlees Review in the UK recommended a move from their inheritance tax regime to something more like CAT, with progressive rates. The Review concluded that inheritance tax in the UK was unfair for failing to tax those who pass on gifts of wealth during their lifetime and [for benefiting] those who can arrange their affairs to escape taxation at death while taxing more highly those (usually of more modest means) who cannot arrange their affairs to avoid taxation. 66. Inheritance and gift tax regimes vary widely internationally. In some jurisdictions tax is charged on the estate while in others it is charged on the beneficiary. While many jurisdictions have both gift and inheritance tax, some have only inheritance tax while others have only gift tax. Where one or both taxes does not apply other taxes may apply instead, for instance capital gains may carry through inheritance for CGT purposes. Options 67. Rate changes: Revenue estimate that every 1% increase in the CAT rate will yield 11 million in a full year, while every 1% decrease will cost 11 million. 68. Changes to thresholds: Revenue estimate that every 5% increase or decrease in the three tax-free thresholds would cost/yield million. 69. The advantage of a CAT regime with higher rates and higher thresholds is that the tax primarily affects those receiving larger amounts by way of gifts or inheritance, which may be more progressive. The advantage of a regime with lower rates and lower thresholds is that it broadens the tax base, supporting stability and robustness of yield. 70. The document A Programme for a Partnership Government published in May 2016 contains the following: we will work with the Oireachtas to raise the Band A Capital 12

13 Acquisitions Tax Threshold (including all gifts and inheritances from parents to their children) to 500, If this measure entails only a change to the Group A threshold without any change to the other two thresholds, this would mean that the difference in treatment between transfers from a parent and other transfers will be considerably larger than it has been in the past. Revenue have costed this measure at 75 million. A 5% increase in the Group B and C thresholds, in addition to the larger increase in the Group A threshold, would cost an additional 5 million while a 10% increase in the B and C thresholds in this context would cost an additional 9 million. 72. Other Reliefs and exemptions: The scope of existing reliefs and exemptions are examined as part of the annual Budgetary and Finance Bill process and may also be reviewed as and when issues relating to their operation arise. The scope for introducing or extending reliefs or exemptions is constrained by competing choices for available resources. Any new or significantly revised reliefs would have to be considered having regard to the guidelines on tax expenditure evaluation published by the Department of Finance in