Should Capital Gains Tax be aligned with Income Tax rates, as recommended in a report by academics at CenTax?
No.
Here are five reasons why.
1. The tax system should encourage individuals to take risks and invest, leading to long-term wealth creation. We already have a tax incentive that rewards individuals for investing in risky startups (Enterprise Investment Scheme). Starting a business is hugely difficult with around 60% start ups failing. The UK would massively disincentivise individuals from starting businesses if they knew that they would be taxed at income tax rates (40%/45%) on an eventual exit, instead of 10%/20% currently.
2. Unlike some jurisdictions (France, Germany, Australia etc) the UK has no ‘exit’ tax on capital gains. This means that taxpayers are free (arguably incentivised) to leave the UK and sell their UK assets, such as a UK company, when non-resident and pay no tax in the UK on the disposal. Raising Capital Gains Tax rates to Income Tax rates would mean that more entrepreneurs are incentivised to leave the UK before selling assets. 40% or 45% of zero is zero.
3. Capital Gains Tax effectively taxes inflation. This means people who sell assets at a ‘gain’ pay tax not only on the ‘real’ appreciation, but also the inflationary increase. Paying tax at 40% or 45% on inflationary increases in an asset value is unfair.
4. If CGT were raised to match Income Tax rates, UK would have one of the highest rates in the world, with only Denmark and Australia similar (although the Australian rate is in practice half the headline rate). This is not an entrepreneur friendly environment and is not growth friendly.
5. SMEs are the lifeblood of the UK economy, employing 61% of employees. Many founders are serial entrepreneurs, using cash from the exit of one SME to start the next. If 40%/45% of the exit proceeds were taken away in tax they would have less capital and incentive to start the next.
Tag Archives: personal-finance
Inheritance Tax and frozen thresholds – Part 2
In a previous post I discussed, amongst other things, the effect of several allowances for inheritance tax (IHT) being the same today as they were in 1984.
Let’s concentrate on the IHT Marriage Allowance. This is from a real client case that I’ve come across, obviously with details and names changed.
David and Charlotte are getting married and Charlotte’s mum, Elizabeth, decides to pay the cost of the wedding. Elizabeth has used up her Annual Exemptions and Nil Rate Band.
The wedding cost Elizabeth £30,000. For IHT purposes, the first £5,000 of this is not a Potentially Exempt Transfer, per the IHT Marriage Allowance (in my previous post I show that if this had kept up with inflation it would now be £15,480). The remaining £25,000 is a Potentially Exempt Transfer.
Unfortunately, Charlotte’s mum passes away within three years of the wedding. This leaves the happily married couple in a very sticky situation. The £25,000 becomes chargeable to IHT. However, the IHT due on this sum is not, as you might expect, paid from the estate of Charlotte’s mum. It is payable by David and Charlotte themselves. This means the couple are not only mourning the death of Elizabeth, but they are also presented with an entirely unexpected tax bill of 40% of £25,000, being £10,000.
They have (broadly) six months from the death of Elizabeth to raise this money and pay it to HMRC. Further, they do not have the option to pay this in instalments.
So how could this situation have been avoided?
Firstly, when Elizabeth paid for the wedding, life insurance could have been taken out which pays any IHT due should Elizabeth die within 7 years. After 7 years, the £25,000 Potentially Exempt Transfer is outside the scope of IHT. If Elizabeth is in good health, this tends to be relatively cheap, as it is ‘term insurance’, i.e the insurance only lasts 7 years and is not lifelong.
Secondly, Elizabeth could have taken advice and gifted money to Charlotte and David over a period of time instead of in one lump sum. If Elizabeth had excess income (i.e income greater than expenses), and she made regular gifts to Charlotte and David, say £10,000 for three years, instead of £30,000 in one go, the amounts would not have been Potentially Exempt Transfers. It would be a ‘Normal expenditure out of income’ and therefore entirely exempt. As such, the amounts gifted would not be chargeable on her death, saving the young couple £10,000 in IHT.
It’s always worth considering the IHT implications when money is gifted, because it could land individuals with an unexpected IHT bill should the donor pass away.
Thoughts on the conservative budget
My take on the three main points of the budget.
Reduction in NIC rates – 1% for self-employed, 2% for employees
I am a big proponent of this. NIC is effectively a tax on ‘active’ work. If you are sitting with a big rental portfolio, investment income, or living off a fat pension you don’t pay NIC. If you undertake a trade or you are an employee you do. Arguably, this is the wrong way round. I would like to see NIC merged with income tax to simplify the system, but then basic rate employees would realise they have a marginal rate of 32%/30% and not 20%, which is politically unpalatable.
As a result of these changes higher/additional rate employees will save £754 a year.
Full expensing of plant and machinery
Full expensing allows companies to deem plant and machinery an expense for tax purposes, even if it is capitalised on the balance sheet. E.g if a company bought a digger for £200,000, it can take £200,000 off its taxable profits. Make no mistake, the change announced is a tax cut for large businesses. All companies already get a £1m full expensing allowance. It is rare for SMEs to breach this, whereas multi-nationals will often breach this many times over.
R&D scheme merging
It was announced by Hunt that the two R&D schemes are now going to be merged. This is after a huge amount of messing around with the administration and rules relating R&D in the past couple of years, which included hiring inexperienced HMRC officers to challenge claims which were clearly compliant.
Two points – it comes in for accounting periods starting 1 April 2024, so doesn’t give companies much time to prepare. Secondly, R&D isn’t actually being merged into one scheme as Hunt suggested. There will still be two schemes – the merged scheme and the SME intensive scheme (see link in comments).
Let’s hope this can be the final change to what has been a tumultuous couple of years in R&D.
NIC Cut and what it means for you
When most of us get paid in 9 days time, we’ll see more go into our bank accounts than normal. If you earn £50,270 or more, you’ll see an extra £63. If you earn less than this, you can see how much extra you’ll take home using the BBC calculator (link in comments).
This is due to Jeremy Hunt’s National Insurance Contribution (“NIC”) cut from 12% to 10% for employees. Without getting political, this is a major U-turn given that Sunak increased NIC to 13.25% in April 2022, which was reversed back to 12% by Kwateng in November of that same year. It’s been a busy couple of years for payroll software providers.
I’ve said this before, but NIC is effectively a tax on ‘active’ work. If you are sitting with a big rental portfolio, investment income, or living off a fat pension you don’t pay NIC. If you undertake a trade or you are an employee you do. Arguably, it should be the other way round, with the tax system incentivising people do ‘active’ work. There is a strong argument to merge NIC and income tax.
NIC is widely seen as a gentler and fairer tax, in that you pay money in and ultimately receive benefits out. In research by King’s College London in 2023 it was found the most common misconception was that “each person’s National Insurance contributions are kept in a personal pot to be accessed when they reach state pension age”. This is not the case at all. The link between paying NIC and receiving benefits is now vanishingly weak.
Indeed, if you have a limited company and pay yourself a salary of £12,570 and take the rest in dividends you pay no NIC at all, yet are still awarded a ‘qualifying year’. The same goes for someone on Jobseeker’s Allowance. Both give an identical state pension entitlement as someone who has paid £millions in NIC over their lifetime.
An individual needs 35 qualifying years by state pension age to receive full state pension entitlement. You can check if you are on track to do this (link in the comments). If you are missing years, you can make Class 3 voluntary contributions to fill gaps in your record.
