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!
