Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

Investors have been put on alert that tax on some investment gains could be about to rise.

A report last week from the Office of Tax Simplification (OTS), the government body, laid out a number of potential changes to the regime for Capital Gains Tax (CGT) which would make investment tax more punitive, and the Chancellor of the Exchequer Rishi Sunak must now decide which, if any, he wants to take forward.

The headline change proposed by the OTS is to equalise the rate of CGT with that of Income Tax, which would amount to a significant rise. At the moment, any gains on investments not held in vehicles such as an ISA or pension are liable to CGT, with each of us allowed to make £12,300 of gains each year before the tax applies.

After that amount, capital gains on assets like shares or bonds are taxed at 10% for Basic Rate taxpayers and 20% for higher or additional rate payers. The rates for second properties (those properties that are not your main residence) are higher - 18% for basic rate-payers ad 28% for higher and additional rate taxpayers.

The proposed change would bring those rates to whatever rate of Income Tax an individual pays - 20% for Basic-rate taxpayers, 40% for higher rate taxpayers and 45% for additional rate-payers.

What’s more, the OTS has also floated a reduction in the annual allowance for CGT from £12,300 to just between £2,000 and £4,000, which would bring far greater numbers into the scope of the tax, and to make the system for gains on inherited assets less generous as well.

Could these changes actually happen? The case for a rise in investment tax has been strengthened by the huge government spending forced by the Covid-19 pandemic. The Chancellor will desperately want to soften the blow to the nation’s finances and tax rises of some kind seem likely. CGT is paid, by definition, by the wealthiest and could therefore represent a soft target if a tax raise has to come.

On the other hand, this is certainly not the first time that reports like this have emerged and seldom do the most dramatic changes come to pass. Pension tax relief has been another target over the years following similar reports from the OTS, and so far successive Chancellors have resisted. Tax rises are unpopular, even among those with little chance of actually paying the tax, and there would be fierce opposition from the Conservative government’s own supporters.

The fact that a CGT hike is being discussed, however, should remind us of the importance of shielding investments from tax if we can. Money saved into an ISA can grow free from capital gains tax and no income tax applies when you withdraw money from an ISA. We are each allowed to contribute £20,000 a year into an ISA.

Money saved into a pension enjoys the same shelter from CGT while also offering the potential of tax relief on contributions. With your 2020/21 tax year pension allowance you can receive tax relief on contributions up to a maximum of £40,000, capped at the amount you earn if this is less. Those earning above £200,000 may be subjected to a lower allowance. You can normally take up to 25% tax free cash from age 55, with the rest of your withdrawals subject to income tax at your marginal rate.

The prospect of tax rises on investments shrinking means it’s more important than ever to take maximum advantage of the breaks on offer from ISAs and pensions.

More on ISAs

More on Pensions

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

Topics Covered:

Tax efficiency; ISA; SIPP

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