Capital Gains tax Will deferred proceeds change after the OTSs recent report

Why the OTS ran a second report

In July last year, the Chancellor asked the Office of Tax Simplification (OTS) to review capital gains tax (CGT). The aim was to “identify opportunities relating to administrative and technical issues as well as areas where the present rules can distort behaviour or do not meet their policy intent”.

Following its review, the OTS published its first report in November 2020. Named “Simplifying by design”, it considered the policy design and principles underpinning CGT. You can read our previous insight discussing this first report here.

In May this year, the OTS published its second report, “Simplifying practical, technical and administrative issues” (the Report). We’re focusing on this Report throughout this article, in particular, its section on deferred proceeds.

What are deferred proceeds when it comes to CGT?

Deferred proceeds come about when an asset is sold and the payment of a proportion of the purchase price is deferred. An example of this is where the future amount payable is dependent on upcoming events, such as the profits that the company will earn in the future.

Currently, CGT is payable on:

The value of the ascertainable deferred proceeds; and
The net present value of the unascertainable deferred proceeds.

This means that a taxpayer may be liable to pay CGT on a gain they haven’t yet received and may not receive for a number of years.

If the actual gain is greater than the estimate, CGT will also be payable on the balance. There is the option to pay the CGT due in interest-free instalments if the deferred proceeds are to be received by the taxpayer over a period of more than 18 months.

If the actual gain is less, the taxpayer may elect to carry that loss against their original gain calculated using the estimate of the earn-out’s value, or make a claim for a CGT repayment.

The Report’s observations and recommendations

The Report identifies a number of problems with the current treatment of CGT on deferred proceeds, including:

It is hard for taxpayers to understand, and involves unnecessary steps that increase costs for the taxpayer.
It can result in CGT being payable on sums that are not yet received and may never be received.
The option to pay the CGT in instalments is ineffective and, although there is no available data on uptake, the Report says that the number of applications is thought to be no more than a handful.
The valuation of unascertained proceeds takes time, money, and is unnecessarily complicated – compared to understanding the actual proceeds which may be known in the short to medium term.

Based on these findings, the Report recommends that CGT should be payable on a receipt basis when the proceeds of sale are actually received. This would remove the need for a taxpayer to make an election or a claim for overpaid CGT, and avoid the expense and time of valuing unascertainable deferred payment.

Implications of potential CGT rule changes

The recommendation in this second report that CGT should be payable on a receipt basis would lead to reduced revenue in the short term. It will also delay the payment of CGT, as the payment would not be needed until the proceeds of sale are actually received.

This appears to be at odds with the first report, which was looking at ways of increasing tax revenue (such as aligning CGT rates with income tax rates). The current CGT rules on deferred proceeds ensures that CGT is payable immediately, with an adjustment when the deferred proceeds are received.

There is no indication as to how the Government will respond to the recommendations in this second report, or even to those in the first report. However, it is quite likely that there will be some changes to the CGT system.

As we commented in our previous insight on the first OTS report, the Government has to consider whether the tax system is fair and to address the deficit arising as a result of Covid-19. A potential increase in the rates of CGT may still be a reasonable approach, given the current economic situation and the need to collect from tax revenue sooner rather than later. Increasing the rate of CGT might be a relatively straightforward way of doing so. We will keep you up to date of any developments in this area.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at July 2021. Specific advice should be sought for specific cases. For more information see our terms & conditions.