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Impact of Capital Gains Tax if Merged with Income Tax

Impact of Capital Gains Tax if Merged with Income Tax

Capital Gains Tax (CGT) in the UK currently ranges from 10% to 28%, depending on the asset type and taxpayer status. However, recent political discussions have raised the possibility of merging CGT with income tax, i.e., removing CGT as a separate tax class thereby treating it just as any other income and potentially increasing the tax rate on gains to as high as 45%, especially when it comes to sale of property. This article examines the potential consequences of such a move, which is likely to include primary residential properties that are currently exempt, thereby affecting not only property investors but anyone who owns a property.

The current CGT and income tax structures

Capital gains tax (CGT) is levied on profits made from the sale of assets. CGT is paid by individuals and trusts. Tax is only paid on gains above a threshold (the Annual Exempt Amount), which is £6,000 for individuals and £3,000 for trusts in 2023-24 and is set to fall to £3,000 and £1,500 for individuals and trusts respectively from 2024-25 onwards.

Currently, CGT and income tax are separate, each with its own tax-free allowances. For the 2023–2024 tax year, the personal allowance for income tax is £12,570, which is separate from the annual exempt allowance for CGT explained above.  Basic rate income taxpayers are typically subject to lower CGT rates: 10 per cent on gains from most assets and 18 per cent on residential property and ‘carried interest’ (performance-based rewards for investment managers). Primary residences (i.e. one’s main home) are exempt from CGT. For trusts, and for individuals whose combined income and gains are above the higher rate income tax threshold, higher rates of CGT apply (20 per cent for most assets, 24 per cent (from 6 April 2024) on residential property and 28 per cent on carried interest).

Potential Changes and Implications

 

Merging Capital Gains and Income Tax: Potential Impacts

 

Doing away with CGT or merging CGT with income tax would mean gains could be taxed at much higher income tax rates, because most assets, especially property, are in 6-figures. This significant increase in tax would drastically affect investors and property owners. Imagine you bought a property for £100,000 20 years ago, with a deposit of £20,000. You are now selling the property for £200,000, and you are left with a capital gain of £100,000. Even if you are a median earner with £30,000 annual income, this capital gain will push you to the high earner rate of 45% if CGT were done away with and merged with Income Tax.

Impact on Landlords

Landlords are already facing increased tax liabilities due to recent reductions in the CGT allowance. If CGT rates align with income tax, landlords selling properties could face tax rates as high as 45%, up from the current maximum of 28% for residential property gains. This steep increase could discourage investment in rental properties, leading to fewer available rentals and exacerbating housing shortages.

Effect on Investors

Investors in stocks, shares, and other assets would also be adversely affected. The potential increase in CGT rates from 10% to 20%-45% for Basic Rate taxpayers or 20% to 40%-45% for Higher Rate taxpayers would reduce the attractiveness of these investments, possibly leading to decreased market activity and slower economic growth.

Broader Economic Implications

The merger of CGT with income tax could significantly impact the broader economy. We expect the Treasury to raise substantial revenue from the freezing of income tax thresholds from April 2022 to April 2028, indicating a trend towards higher taxation for high-earners. If CGT rates are aligned with income tax, this could further reduce disposable income and investment, potentially slowing economic growth. Several industries such as stock markets, startup investments and property investments will come under tremendous pressure from the reduced disposable income.

Potential Political Changes

Political party positions on CGT vary, with right-wing ruling out a rate increase while left-wing indicating they either have "no plans" to increase CGT to some calling for this merger. However, economic circumstances and the need for additional funding could lead to a re-evaluation of these positions.

Conclusion

The potential doing away of CGT, i.e. merger of CGT with income tax represents a significant shift in tax policy that could increase the financial burden on investors and property owners, and disincentivise future investments. While this move aims to generate additional tax revenue, it could also lead to decreased investment activity and slow down  economic growth for decades to come. Policymakers must carefully consider these impacts to ensure a balanced approach that supports economic stability while maintaining tax fairness. The future of the UK’s investment landscape hinges on finding the right balance between revenue generation and economic vitality.

Disclaimer: The views expressed in this article are for informational purposes only and should not be considered as financial or tax advice. Readers are encouraged to consult with qualified professionals for personalised guidance regarding their specific financial circumstances and tax implications.

 

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