The danger of raising capital gains tax rates

With the Spending Review now out of the way, the Chancellor and the wider Treasury team can turn their focus to the Autumn Budget and the options for potential tax rises if they are required. The hope will be that the economic picture will improve before the Autumn, but with the global picture increasingly uncertain, contingency plans need to be drawn up.

A starting point is likely to involve dusting off the list of possibilities that didn’t make the cut in last year’s Autumn Budget. One such option, which was the subject of widespread speculation, was a more substantial increase in the rate of capital gains tax (CGT).

There were various calls ahead of the budget last year for the Chancellor to increase the main rate of CGT so that it is more closely aligned to higher income tax rates. Indeed, it was reported that a CGT rate as high as 39% was being modelled by Treasury officials. It seems inevitable that if another fiscal hole needs filling, similar demands for a bigger rise in CGT rates are likely to be made by political and economic commentators, as well as some of the Chancellor’s colleagues.

In the end, the Chancellor opted for a more modest increase in CGT rates, with the main rate increased from 20% to 24%. As we highlighted last summer in commentary on Labour’s manifesto pledges, a CGT rate increase was not originally part of their published plans and one of the reasons for that is likely to be due to the uncertain outcome of doing so.

A large proportion of CGT revenues derive from a small number of taxpayers and a significant increase in the CGT rate could materially distort their behaviour. HMRC’s response to a freedom of information request submitted by RSM UK highlights just how few people have very large capital gains but account for a large proportion of the CGT paid.

In the latest statistics published by HMRC, it is estimated that around 2,000 individuals accounted for 37% of the capital gains subject to CGT, with gains of £5m or more in the year to 5 April 2023. In the data obtained by RSM UK for the same period and the subsequent year, HMRC has confirmed how many individuals had large gains from selling unlisted shares, excluding those qualifying for Business Asset Disposal Relief.

The data shows 950 individuals had gains of £5m or more on the sale of unlisted shares in the year to 5 April 2023. So, this means almost half of the larger gains declared in 2022/23 will be on unlisted shares and is likely to be even higher if gains claiming Business Asset Disposal Relief (formerly known as Entrepreneurs’ Relief) are taken into account.

Many of these gains will be made by business owners selling some or all of their companies. Given that a significant amount of annual capital gains derive from such a small tranche of the population, it is far from guaranteed that a significant increase in the rate of CGT would translate to a windfall of additional tax receipts. The Chancellor will no doubt be mindful of the potential risks presented by a further CGT rate rise and may be wary of tax policy changes that could backfire.