CGT Reform: Investment management

17 November 2020

On Wednesday 11 November 2020, the Office of Tax Simplification (OTS), amidst much fan-fair from the press, published its first of two reports concluding on its review of the UK’s capital gains tax (CGT) regime (the Report).

The OTS will publish two reports. The first considers the policy design and principles underpinning the tax. The second will explore key technical and administrative issues (early 2021).

The OTS is (in their words) “the independent adviser to government on simplifying the UK tax system, to make it easier for taxpayers”. However, this Report is written in response to the Chancellor’s request that the OTS reviews CGT and considers “areas where the present rules can distort behaviour or do not meet their policy intent”.

The tension between this request and the OTS’s stated function is present throughout with versions of the phrase “[i]t is for government to determine the principles and role of the tax when framing policy and determining tax rates” appearing liberally throughout the 135 pages of the Report.

This note focuses on the key take-aways for investment management professionals.

Headline issues

Carried interest is notable by its absence in the paper. It is reported that carry has a different rate and regime and differences within the CGT structure are criticised as adding complexity, but that is as far as the Report goes. There is a large focus on how employee shares and incentives are taxed but this analysis does not delve into carry.

Alignment of CGT and income tax has featured heavily in the headlines, and although the idea it is certainly explored within the Report, it certainly is not clear recommendation. Instead the Report focuses more on delineating the boundaries between the two regimes more clearly.

Rates, the OTS is very clear that rate setting is a government matter and will not be drawn on the point. Further the Report extorts the government to “carefully consider the economic implications…the tax yield and the compliance costs for taxpayers and HMRC” before concluding on a rate increase. It would be difficult to justify total rate alignment off the back of this Report.

Growth shares, which are commonly used in management incentive plans set up by portfolio companies attract a lot of criticism throughout the paper, although no proposals for reform are put forward.

Information provided to investors by investment managers is criticised in its lack of consistency and clarity and standardised reporting is proposed.

Carried interest

There have been numerous articles written about how this Report signals the death knell for the “fiscal perk that has helped mint a good many private equity billionaires” (Financial Times, Sunday 15 November 2020).

These articles are based on the fact that two of the themes within the Report are bringing greater alignment of CGT with income tax and increasing the CGT rate. However, there is no damming indictment of carried interest, as one would expect given the number of articles that have been written.

The Report criticises the complexity of the CGT regime; carried interest being one of those special rates that adds complexity, concluding that if “the government wishes to make tax liabilities easier to understand and predict, it should consider reducing the number of Capital Gains Tax rates”. However, we know what the government wished to achieve from this Report and taxpayer simplicity was not top of this agenda.

Given the level of work that has gone into developing the carried interest regime under this government, it would be understandable if they were reluctant to abandon the regime.


The Report highlights that the rate disparity between CGT and income tax means that complexity is added into the tax system to police the boundary (take a moment to think about all of the anti-avoidance rules that exist to stop people turning income into capital, not many of them are characterised by their simplicity).

A key paragraph in the Report on this area is worth setting out long-form:

“More closely aligning Capital Gains Tax rates with Income Tax rates has the potential to raise a substantial amount of tax for the Exchequer. However, there would be significant behavioural effects, which would materially reduce this, including an impact on people’s willingness to dispose of assets and trigger a tax charge, increasing the extent to which Capital Gains Tax has a ‘lock in’ effect.” 

It is notable that the first sentence in the above paragraph is the one that has received the greatest press, despite the fact that the second sentence is a pretty significant caveat. This cautionary note is repeated elsewhere in the Report, with warnings of the practical issues arising out of a full alignment.


The Report goes on to consider what should happen if a disparity remains between income tax and CGT concluding that “there is both a theoretical and a practical case for greater convergence of tax rates on income and gains”. The key words here are “greater convergence”, not total alignment.

Starting from the extreme position of total alignment the Report considers a HMRC study done in 2018-19 that finds that if all gains reported in 18/19 were taxed at the marginal income tax rate of that individual the Exchequer would be £14 billion better off a year.

Standing alone and in our current economic context this is a difficult number to ignore. However, this rather optimistic HMRC study is immediately followed by a section of the Report titled “Challenges with a rate increase” the first paragraph of which is particularly helpful in explaining why total rate alignment will not give rise to a £14bn a year increase in revenue:

“It is widely established in academic research that increases in Capital Gains Tax rates can result in large behavioural changes. The main behaviour observed is in terms of reduced realised gains. Much of this research is from the United States of America, where it is estimated that a 1% increase in rates would typically result in a reduction in realised gains of between 0.3% and 1%, which would remove some of the increase in yield.”

The concept of lock in is discussed throughout the Report, as is the risk that people may move to holding assets through corporate structures and one solution proposed is to tax gains as they accrue. Doing this in relation to all assets is accepted as being rather impractical and unfair. Although the idea has stuck in relation to certain companies with accrued gains (not all companies, for example, it is recognised that it would be unreasonable in the case of listed companies).

Growth shares

The Report spends time considering the different ways that employees are incentivised; comparing share schemes, options, growth shares and cash bonuses.

Growth shares are particularly criticised because they allow an employee to be granted shares at a low initial value and yet obtain CGT treatment on the increase in value. The OTS is also concerned about the complexity around valuing growth shares. The overall conclusion is that growth shares put particular pressure on the boundary between income and capital.

There is no clear recommendation with regards to growth shares, although the Report muses that “it could be argued that growth shares are similar to share options, as they involve what is likely to be a low tax charge on award with little risk to the employee”. Rather than conclude in the Report, the OTS recommends that if this is an area that the government wants to explore, additional work should be done. The formal wording of the recommendations in this section of the Report are to:

  1. consider whether employees’ and owner-managers’ rewards from personal labour (as distinct from capital investment) are treated consistently; and
  2. in particular consider taxing more of the share-based rewards arising from employment at Income Tax rates.

Investor information

In 135 pages only 82 words are dedicated to this topic and given that it impacts administration, we may see more on the topic in Part 2 of the OTS’s review.

In summary, the Report highlights the fact that when calculating gains on listed shares taxpayers potentially need to understand and cross reference reports from lots of different investment managers. The Report suggests that greater standardisation in how such information is reported to taxpayers, or the ability for investment managers to report such information directly to HMRC would simplify the system, making tax compliance easier for individuals.

At this stage the Report refers only to investments in listed shares, so doesn’t impact the funds industry in its entirety. However, the shot has been fired and this is a point for us to watch out for; the US already requires standardised reporting through K-1s, it wouldn’t be a stretch to see this form one of the OTS’s recommendations in Part 2 of its review.

Next steps

The second response to the consultation is due to be published early next year. It is anticipated this will cover specific points of difficulties within the current legislative framework so it is likely to be more detailed and technical rather than policy. 

In terms of anticipating any change, the most accelerated timetable for any of these changes would be for a government response at the next Budget. Although a Budget is not scheduled this year, there is some speculation that the Chancellor might opt for another Spring Budget and this would create a neat opportunity to bring in immediate changes that could take effect in April 2021. Looking at past announcements on CGT it is difficult to conclude whether any changes would have immediate effect (i.e. from midnight on the day of announcement) or if several weeks’ notice might be given so that changes take effect from, say, the start of the tax year.