Capital gains tax
A capital gain is the profit made when selling an asset that has increased in value since it
was purchased [link 80]. In the UK, capital gains made on qualifying assets (including shares not
in an ISA or PEP, property other than your main residence, and personal possessions
worth more than £6,000, such as jewellery, artwork and antiques [link 81] are subject to Capital
Gains Tax (CGT).
Capital Gains Tax rates and allowances.
CGT is only charged on gains in excess of an annual tax-free allowance called the Annual
Exempt Amount, which is currently set at £12,300 [link 82]. This is only slightly less than the
standard Personal Allowance, which exempts people from paying Income Tax on the first
£12,570 they earn [link 83].
CGT is charged only when a capital gain is realised or the asset is “disposed of”, meaning it is
sold, gifted (to someone other than your spouse, civil partner, or a charity), swapped for a
different asset, or compensated for - e.g. if you receive an insurance payout for it being lost
or destroyed - [link 84]. Therefore, an individual must realise profits of at least £12,300 in a
financial year to be charged any CGT whatsoever. CGT is, in this sense, a highly
progressive tax as only a small group of taxpayers realising substantial gains pay anything
at all [link 85]. Furthermore, within this group most of the CGT liability falls on an even smaller
section of people who make very large gains. In 2018-19 the aggregate CGT liability of all taxpayers was £9.5
billion from 276,000 people, with 40% of that liability generated by the less than 1% of
CGT taxpayers who realised gains of £5 million or more [link 86].
Just considering the tax-free allowance by itself understates quite how generous it is. The
vast majority of wealth in the UK is tied up in property and private pensions [link 87]. Both of these
sources of wealth are largely exempt from CGT. CGT does not apply to any profit made on
your primary residence, nor is it applied to investment growth of assets held within
registered pension schemes [link 88]. CGT is also not applied to any capital gains made on
assets held within an ISA; individuals can currently save up to £20,000 per year in ISAs
before they even start eating into their CGT allowance, let alone generating an actual tax
liability [link 89]. Any prudent investor can make tens of thousands of pounds in profit each year
before they start worrying about having to pay CGT, as long as they make full use of all the
available exemptions. Even if the Annual Exempt Amount were abolished it would still be that only the minority of investors who have maxed out on their ISAs and pension plans would be subject to paying CGT.
CGT rates depend upon whether or not the taxpayer pays the higher rate of Income Tax
(i.e., if they have an income of more than £50,270). If they do, they are charged at a rate of
28% on gains from residential property and 20% on gains from all other chargeable
assets. If they are only a basic rate taxpayer they pay reduced rates of 18% and 10%
respectively [link 90]. Considering that the basic rate of Income Tax is 20%, the higher rate is
40%, and incomes over £150,000 pay the 45% additional rate [link 91] , however much tax
someone pays their capital gains will always be taxed at a lower rate than their income
(without even considering National Insurance, which is effectively an additional tax on
employment).
Bed and breakfasting.
The tax-free Annual Exempt Amount, combined with the fact that CGT is only charged
when assets are disposed of, has allowed for exploitation of the rules to avoid CGT. “Bed
and breakfasting” is a trick whereby an owner artificially disposes of their asset for tax
purposes whilst effectively maintaining control of the asset and regaining ownership at a
later date [link 92].
The logic behind this is fairly straightforward. The tax-free allowance cannot be carried
forward, it only applies to gains realised that year. Therefore, disposing of an asset every
year and then re-buying it means an individual can make full use of their tax-free allowance
every year, whereas waiting to realise a gain might mean only being able to utilise a single
year’s allowance.
For example, imagine you own some shares which have increased in value by £10,000
every year for ten years, resulting in a total capital gain of £100,000. If you had just bought
them, waited ten years, then sold them you would realise the profit all at once and been
liable to pay CGT on the whole gain. At the current rate and allowance this would mean a
higher rate taxpayer pays 20% of (£100,000 minus £12,300), resulting in a CGT bill of £17,540. On
the other hand, if you had sold the shares at the end of each year and then repurchased
them you would have realised a £10,000 gain each year; as this is less than the annual
tax-free allowance, you would never have had to pay any CGT, despite making the
same profit over the whole ten year period.
Classic bed and breakfasting involved selling the asset on the last day of the financial year
only to buy it back the next morning, typically arranging the whole thing in advance with a
broker [link 93]. Such blatant manipulation has not been possible since the 30-day rule was
introduced in 1998. This rule means that in order to realise a capital gain a trader cannot
repurchase the same asset without first waiting 30 days [link 94], and furthermore cannot enter
into a repurchase agreement at the time of sale [link 95], or else they will be treated for tax purposes
as if they had never disposed of the asset at all.
With these rules in place bed and breakfasting is still possible, but in a looser sense. The
requirement to wait 30 days before repurchasing an asset means that traders engaging in
this strategy are exposed to genuine shifts in the market that could cost them, which they
would not have been in any significant sense when they could engage in overnight trades. It may still
be worth doing this for an asset that appreciates at a sufficient and consistent rate, but it
is no longer quite so desirable.
Bed and breakfasting could be facilitated via some complicated derivative trading.
Contracts for Difference (CFDs), which are essentially a bet on the direction that the price
of an asset – typically shares – will move, could be used to effectively stay in the market
during the 30 day-period in which someone must wait to realise their gain for tax purposes.
If, after selling some shares, you take out a CFD contract betting that their price will increase, then
you can effectively counter-act the risk of a significant rise in the share price before your
repurchase. If the price goes up you benefit through the CFD which can cover the
increased repurchase price; if the price goes down you lose money in the CFD but you can
also repurchase the shares for less [link 96].
Other techniques resembling bed and breakfasting which can be successful include:
“Bed and spouse-ing”: one partner in a couple can sell an asset and the other buy the
same asset at the same time, then do the opposite a month later, provided that the
transactions are independent. One partner cannot sell to the other.
“Bed and ISA”: assets can be sold and then the same assets purchased through an ISA,
provided it does not take an individual over their ISA limit.
“Bed and SIPP”: assets are sold, the cash proceeds used to contribute to a Self-Invested
Personal Pension (SIPP) which then uses the cash to purchase the same asset.
“Bed and similar”: some assets may be effectively interchangeable, for example, shares in
a similar company or two different tracker funds which own the same underlying shares.
Selling one asset and then buying an almost identical asset could allow an individual to
effectively maintain the same investment without breaching bed and breakfasting rules [link 97].
Taking income as gains.
The fact that CGT is charged at significantly lower rates than Income Tax creates a strong
incentive for anyone to convert as much of their income as possible into capital
gains, which potentially undermines the greater part of the UK tax base [link 98]. Indeed, when
CGT was first introduced in 1965 it was intended to discourage precisely this activity. The
then-Chancellor, James Callaghan, argued:
“There is no doubt that the present immunity from tax of capital gains has given a
powerful incentive to the skilful manipulator of which he has taken full advantage to avoid
tax by various devices which turn what is really taxable income into tax-free capital
gains.” [link 99]
While capital gains are no longer tax-free they are still taxed less than regular income, so this issue has never
been entirely resolved. When the Coalition government took office in 2010 they introduced
the higher rates of CGT for higher rate taxpayers in order to reduce the gap between CGT
and Income Tax rates, again to disincentivise avoidance, however they still did not close
it [link 100].
The simplest way to take advantage of the difference between rates is for business
owners, partners, and employees, who have the opportunity, to sacrifice some or all of their
salary in exchange for shares in their company. If they sell those shares to provide
themselves with an income, they will be taxed at lower CGT rates rather than having to pay
Income Tax [link 101].
It is also worth noting that there are different tax rates and a separate allowance for
income from dividends. Dividends have an annual tax-free allowance currently set at
£2,000 and are taxed at rates of 7.5% for basic rate taxpayers, 32.5% for higher rate
taxpayers, and 38.1% for additional rate taxpayers [link 102]. For higher and additional ratepayers
this puts them between CGT and Income Tax. This means that shareholders would, for tax
purposes, typically prefer that the companies they own retain profits and increase the
value of their shares, creating a capital gain, rather than return profits to shareholders as
dividends.
The rationale for having a tax system which discriminates between different forms of
receiving income from a company is unclear, but that is exactly what the UK’s tax regime
does [link 103]. For some reason, the taxman would seemingly prefer that you make capital gains
rather than take an income from your salary or dividends. The existence of different
allowances for each source of income also bizarrely disfavours people who only have a
single source of income. As well as raising questions of equitability, this potentially creates
inefficient distortions where market behaviour is biased towards creating capital gains as
much as possible.
Aligning allowances and rates.
If the differences between CGT, Income Tax, and the tax on dividends foster avoidance,
inequality and inefficiency then why not get rid of them? In their 2019 General Election
manifestos both the Labour Party [link 104] and the Liberal Democrats [link 105] included proposals to
abolish the separate tax-free allowances for income and capital gains, instead giving
individuals a single allowance to cover all their earnings, and to align CGT rates with
Income Tax. Labour also proposed aligning taxes on dividends with Income Tax in the
same way. Labour’s costings show they believed that about £14 billion in additional
revenue could be raised from these reforms, taking into account behavioural effects
(people adjusting their affairs to minimise any increase in their tax liabilities).
​​
This would remove entirely the tax advantages enjoyed by capital gains, yet it would still be preferable to
income from employment because the latter is also subject to paying National Insurance,
for example, and would have a considerable impact on reducing the gap.
How successful the revenue-raising aspects of aligning rates would be is debatable. CGT
has been described as a “voluntary tax” because it is only paid when assets are disposed of.
If someone really does not want to pay CGT they can hold on to their asset rather than
selling it [link 106]. This could be a form of economic distortion itself as it incentivises holding on to
assets for longer. This means that the impact of raising rates and abolishing the separate
allowance could be frustrated by people delaying the disposal of their assets, or disposing
of them before the rates increase. When CGT rates were increased in 2010 it was
predicted that they would raise revenues [link 107]. Instead revenue fell over the next couple of
years, although it has risen substantially since 2013-14 [link 108]. Of course, if the key issue is
inequality and wanting to create a fairer tax system, how much revenue any reforms raise
is not necessarily the only measure of success.
​
80 https://www.investopedia.com/terms/c/capitalgain.asp
81 https://www.gov.uk/capital-gains-tax/what-you-pay-it-on
82 https://www.gov.uk/capital-gains-tax/allowance
s83 https://www.gov.uk/income-tax-rates
84 https://www.gov.uk/capital-gains-tax
85 https://www.ifs.org.uk/uploads/gb/gb2015/ch10_gb2015.pdf#page=15
88 https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm024100
89 https://www.gov.uk/individual-savings-accounts
90 https://www.gov.uk/capital-gains-tax/rates
91 https://www.gov.uk/income-tax-rates
92 https://www.gov.uk/hmrc-internal-manuals/capital-gains-manual/cg13350
93 https://www.investopedia.com/terms/b/bed-and-breakfast-deal.asp
94 https://www.gov.uk/hmrc-internal-manuals/capital-gains-manual/cg51560
95 https://www.gov.uk/hmrc-internal-manuals/capital-gains-manual/cg13370
96 https://www.contracts-for-difference.com/tax-free-trading-with-cfds.html
99 https://library.croneri.co.uk/cch_uk/btr/500-000
100 https://researchbriefings.files.parliament.uk/documents/SN05572/SN05572.pdf
102 https://www.gov.uk/tax-on-dividends
103 https://www.ifs.org.uk/budgets/gb2008/08chap10.pdf
106 https://citywire.co.uk/funds-insider/news/capital-gains-tax-what-is-it-and-do-we-really-need-it/a620760
107 https://www.telegraph.co.uk/finance/personalfinance/tax/10954502/Cut-Capital-Gains-Tax-everyone-
avoids-paying-it-anyway.html
108 https://obr.uk/forecasts-in-depth/tax-by-tax-spend-by-spend/capital-gains-tax/
​
​
​
​
​