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The downs and ups of capital gains tax

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Recently released details about Rishi Sunak’s 2023/23 tax return have ignited a bit of a stir about capital gains tax rates. Helen Thornley takes a ride through its history.

16th Feb 2024
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At the start of February, the prime minister published a summary of his income and gains for 2022/23. Included with details of his ministerial salary were gains totalling almost £1.8m – more than 12 times his earnings as an MP – arising on his share of a US-based investment fund. 

What attracted media attention though was not the size of the gains, but the rate of tax paid on them. His investment gains were subject to capital gains tax (CGT) at 20%, a significantly more favourable rate than the 45% rate that would have applied if the receipts had been income. 

The disclosure has restarted a debate over whether CGT and income tax rates should be different or not – a debate that has been going on for almost as long as CGT has been in existence.

1960s and 1970s

It’s hard to imagine now but, within living memory, income was subject to tax but gains were not. Inevitably, there was a great incentive for people to try to “convert” income to gains. This was particularly acute in the 1950s and 1960s, when income tax and surtaxes could reach rates of 90%.  

The first steps towards the taxation of gains were taken in 1962. Aimed at what were called “speculative gains”, a short-term capital gains tax targeted profits arising on land sold within three years of acquisition and shares sold within six months of purchase.

Labour Chancellor James Callaghan expanded this in 1965 to create the first comprehensive CGT regime. Short-term gains made on assets held for less than 12 months were subject to income tax while all other taxable gains were subject to a flat 30%. (Private residences were, of course, exempt.) 

The website of the Worshipful Company of Tax Advisers has a lovely interview by John Whiting of experienced tax practitioner Nigel Eastaway who started in practice in 1960. In the interview, Eastaway recalls the great pressure to convert income to tax-free gains and how the introduction of CGT was “fairly catastrophic” for people who had been practicing tax for many years as previous planning no longer worked. 

Although advisers took the changes badly, Eastaway’s recollection was that for taxpayers themselves, the impact was gradual. Gains were calculated based on the value of the asset at April 1965 so it was a few years before the effects of CGT started to bite – and not until the 1970s that CGT started to really sting. The high inflation of those years led to people paying tax not so much on “real” gains, but purely inflationary increases, while the 30% rate was unchanged. 

1980s 

The inflationary problem was acknowledged in 1979 when the Conservatives took power, but action was slow in coming and piecemeal. A series of measures from 1982 started to bring in limited allowances for inflation in the form of indexation but it was not until 1988 that Nigel Lawson took to the despatch box to address the issue. 

In his 1988 Budget, Lawson took significant steps to simplify CGT and strip out the unpopular effects of inflation. Assets were rebased to March 1982 values, wiping out gains before that date, with indexation left in place to remove inflationary aspects from that point. Having addressed the issue of tax on purely inflationary gains, Lawson saw no reason to differentiate rates between income and gains. The package of measures was completed by aligning CGT and income tax rates, making gains subject to the individual’s highest marginal rate of income tax.

1998

Although the inflationary elements of gains had been addressed, concerns remained about whether or not it was correct to tax short- and long-term gains in the same manner. After 10 years of debate, this culminated in another major shift in policy under Gordon Brown with the intention to encourage long-term ownership. 

With inflation low, he considered indexation unnecessary and it was frozen at April 1998. This meant some indexation remained for older assets, but no indexation applied to the cost of assets acquired after that date. To replace indexation, taper relief was introduced. This reduced the amount of gain exposed to CGT based on how long the asset had been held. Business assets were treated more favourably, taking less time to reach the highest taper rates. At the same time, retirement relief – designed to benefit those selling off their business on stepping down from work – was phased out. 

2008 

Taper relief lasted a decade before concerns over the low rates of tax paid by private equity funds led Alistair Darling to scrap both taper relief and any remaining indexation relief for pre-1998 assets. Instead, he opted for a flat 18% rate of tax and a hastily cobbled together entrepreneurs’ relief to maintain the favourable 10% rate for some business owners, modelled on the old retirement relief.

Where are we now? 

Over the past 16 years, governments have mainly been making tweaks to the Darling model. The number of CGT rates has increased slightly, and the link to income levels has been restored but rates are still effectively flat for higher-rate taxpayers. A distinction has been introduced between residential property and other assets while entrepreneurs’ relief has waxed, waned and been renamed. 

In 2020/21, the Office of Tax Simplification (OTS) looked in detail at CGT and made a number of recommendations over two reports. Of these, the main changes taken up by the government were reductions in the annual exemption from April 2023 (taken in isolation from other simplifying suggestions) and more welcome improvements for divorcing couples. 

One potentially unintended consequence of the OTS’s efforts was the record year for CGT disposals in 2021/22. The accompanying analysis suggests that the suggestion by the OTS of more closely aligning CGT rates with income tax might have led to individuals bringing forward sales. 

What next? 

CGT is a tax only paid by a minority of taxpayers – less than 1% of the number who pay income tax. The latest figures for the 2021/22 tax year show that 394,000 taxpayers paid a total amount of £16.7bn in CGT. Even among those who do pay CGT, 45% of the liabilities collected come from a very small group of taxpayers – less than 4,000 individuals – who made gains of £5m or more.

However, despite the small number of people affected, CGT remains of interest to politicians. Once again, commentators are calling for some form of indexation to focus the tax on “real” gains, following our recent period of higher inflation. As someone who just remembers indexation, I’m inclined to agree. Looking back at the key years in CGT history, maybe we will get indexation back in 2028!

Replies (11)

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By FactChecker
16th Feb 2024 19:28

Aside of the interesting history lesson, or 'an amble down memory lane' as some of us regard it, the thing that jumps out at me is what *isn't* stated.

".. for the 2021/22 tax year: 394,000 taxpayers paid a total amount of £16.7bn in CGT ... (and) 45% of the liabilities collected (from CGT) come from less than 4,000 taxpayers (who made gains of £5m or more)."

So ... with tongue firmly planted in cheek ... if those 4,000 people were 'persuaded' to pay twice as much then almost no-one else would need to pay *any* CGT?
And ... how many of the remaining 390,000 people who paid CGT do so with any regularity or are they (unlike "the 4,000") predominantly 'once in a lifetime' gains?
Indeed what is the average amount of CGT paid by a UK taxpayer over their lifetime (and what is the %age of taxpayers in each 'band' of those values)?

Hopefully someone out there knows the answers to such questions ... which might shed more light on the various pros and cons for the future (as opposed to pure point scoring by politicians).

Thanks (4)
Ivor Windybottom
By Ivor Windybottom
19th Feb 2024 08:54

An important reason CGT is needed is to protect Income Tax yields by discouraging the conversion of income into gains.

Thanks (3)
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By whitevanman
19th Feb 2024 10:12

I received a 4% pay rise last year, somewhat less than inflation. Why should I pay tax on it? I also received 1% interest on my meagre investment income which is again a compensation for inflation. Why do I pay tax on that? What makes CG so different? Possibly the wealth of the few who actually pay it (or avoid paying it)? Just a thought.

Thanks (3)
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By Homeworker
19th Feb 2024 10:52

I started my careeer in tax in 1973, so remember most of these changes!
It's hard to believe that such a small percentage of the population pay CGT, given how many property (and to a lesser degree, share) disposals my small practice has dealt with over the years. When the UK property reporting "service" was first introduced I remember asking why we couldn't go back to a fixed rate of tax, making it much simpler to calculate the tax due. I have already had three clients overpay using the service as predicting income early in the year can be difficult, especially when clients are self-employed. Going back to a single rate of tax would certainly simplify matters.
Incidentally, can anyone tell me how we go about getting a refund when the overpaid CGT can't be offset, other than writing to HMRC? I have scoured the internet but can only find the temporary guidance issued for 2020/2021 and a letter is likely to take months to be dealt with.

Thanks (0)
Replying to Homeworker:
Helen Thornley Profile picture
By Helen Thornley
19th Feb 2024 11:10

Hi - thanks for your comments. In respect of the last point, I' m afraid it's a case of ringing (I know, not fun) or writing as repayments won't be issued automatically. There's some detail in our ATT guide - https://www.att.org.uk/cgt-uk-property-reporting-service-users-guide#Sel... and a bit more in HMRC's manuals - https://www.gov.uk/hmrc-internal-manuals/capital-gains-manual/cg-app18-180

A member rang last week to chase a refund of overpaid CGT and was told it would be a 17 week wait.

Thanks (2)
Replying to Helen Thornley:
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By Homeworker
19th Feb 2024 12:16

Thanks Helen.

Thanks (0)
Replying to Homeworker:
Ray McCann
By Ray McCann
19th Feb 2024 11:35

So few people pay CGT because so few people have enough income to invest in the assets most likely to give rise to a charge. It has always been like that, the level of non-compliance is high and factoring in the way CGT works it’s amazing that so much is paid.

Thanks (3)
paddle steamer
By DJKL
19th Feb 2024 14:03

Of course, as a Modest Proposal, we could introduce CGT on sales of one's PPR with a rollover relief if funds used for a replacement new family home within say 3 years (The Swedish approach)

Given how the tax load would be spread we could also scrap IHT and introduce CGT on death/second death. (Also the Swedish Approach- no wealth tax no IHT)

It is a nonsense that other assets suffer CGT but the big one, for most people, totally escapes.

I have nearly half our assets in our family house, we have owned it for 26 years, it is currently worth just under five times what we paid for it in 1997, that increase will only get taxed if we were to lease it out (only in part) or if we get caught by IHT when the second of us pops.

We are all living longer, health and care costs rising, receiving state pensions longer, someone needs to pay for all this and it is frankly unfair to stick it on those working, repaying student loans and trying to buy a cupboard called a family home.

Thanks (4)
Replying to DJKL:
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By NotAnAccountant2
21st Feb 2024 13:30

DJKL wrote:

Of course, as a Modest Proposal, we could introduce CGT on sales of one's PPR with a rollover relief if funds used for a replacement new family home within say 3 years (The Swedish approach)

Given how the tax load would be spread we could also scrap IHT and introduce CGT on death/second death. (Also the Swedish Approach- no wealth tax no IHT)

It is a nonsense that other assets suffer CGT but the big one, for most people, totally escapes.

I have nearly half our assets in our family house, we have owned it for 26 years, it is currently worth just under five times what we paid for it in 1997, that increase will only get taxed if we were to lease it out (only in part) or if we get caught by IHT when the second of us pops.

We are all living longer, health and care costs rising, receiving state pensions longer, someone needs to pay for all this and it is frankly unfair to stick it on those working, repaying student loans and trying to buy a cupboard called a family home.

And introduce a gift tax - recipient of gifts treat it as income and (perhaps) no CGT on gains that are going to be taxable on someone else - i.e. gifts of assets are not subject to CGT but instead IT on the recipient. Maybe even have a lifetime allowance of 300K for the recipient of gifts, or maybe instead a 6K/year.

Thanks (0)
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By Simon_GNR
29th Feb 2024 14:41

When I first learned about CGT in 1987/88, for assets held a long time you had to have three columns to calculate the possible chargeable gains:
1. Using historical cost for time-apportionment of gains on pre-budget day 1965 assets;
2. Using the Budget Day 1965 value and
3. Using the 31 March 1982 value.
I think you took the lower of the gains from 1 and 2 and then compared that to the gain from 3. The lower gain from the second comparison was the one that was chargeable.
I can't remember how CGT worked for married couples. Presumably a married man had to record his wife's capital gains on his tax return as he did with her income.

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