- Liberal Democrats setting their sights on over £5 billion of new revenue by reforming capital gains tax (CGT), according to their manifesto released today
- Plan to ‘fairly reform Capital Gains Tax’ and make it their second largest new revenue stream
- Proposals involve increasing the tax-free allowance from £3,000 to £5,000 and introducing a new inflation adjusted allowance
- Increasing tax rates, possibly by aligning them to income tax rates of as much as 45%, and closing tax planning ‘loopholes’, could raise significant tax revenues
Charlene Young, pensions and savings expert at AJ Bell, comments:
“With public finances currently leaving little to no headroom for spending, it’s no surprise that capital gains tax (CGT) is attracting the attention of the Lib Dems.
“The pure rate of tax on gains is lower than taxes on earned income, and it’s not payable on your main residence.
“Increasing the rate of CGT substantially would be an unwelcome change for many investors and property owners. Although the manifesto indicates that any increase in rates should be accompanied by a modest rise in the tax-free allowance to at least offset some of the impact on smaller shareholders who’ve been dragged into the CGT web in recent years.”
CGT allowance slashed 75% in two years
“The CGT allowance has been slashed by over 75% in two years from £12,300 to its current level of £3,000. This is the amount of gains you make before CGT applies and cannot be carried over from one year to the next.
“HMRC figures estimate 260,000 more individuals and trusts will be paying CGT for the first time by 2024/25 because of the cuts to the allowance.
“Cuts in the CGT allowance means higher rate taxpayers pay £1,860 more in capital gains tax and basic rate taxpayers £930 now compared to when the allowance was £12,300 (see table below). It also means smaller shareholders with modest gains have been clobbered with the same tax rise as those with much larger gains each year.”
Bringing CGT rates in line with income tax
“The manifesto doesn’t explain what the new rates will be, but to “close loopholes” between earned income tax and investing gains would involve bringing the tax rates closer together, potentially meaning a tax rate of up to 45% - equivalent to the additional rate of income tax.
“Currently, earned income (like your salary) is taxed at 20%, 40% and 45% on different earnings bands, whilst investment gains are taxed at a basic rate of 10% and a higher rate of 20%, with rates of 18% and 24% above any tax-free allowances for gains on residential property that isn’t your main residence.”
Private investors could support higher CGT rates if tax-free allowance was restored
“Whilst a proposed increase in the tax-free allowance and an inflation adjusted index would be welcome, the combined allowances would need to be closer to the previous high of £12,300 to gain support from private investors. The Lib Dem manifesto proposes increasing the allowance to just £5,000.
“A survey with AJ Bell’s investors ahead of the Budget this year showed 68% would support an increase in the CGT rate if it meant a return of the £12,300 allowance. Only 13% favoured the Chancellor’s approach of cutting the CGT allowance to £3,000 (which was implemented as planned in April this year.”
*Source: AJ Bell Survey of 1,852 customers, February 2024.
“Because they want to use CGT reform to raise over £5 billion new cash, the Lib Dems have only pledged to increase the allowance to £5,000, which would still be less than it was in the 2023-24 tax year.
“Talk of inflation indexing brings us back to the days of Nigel Lawson as Chancellor. And whilst some inflation protection is great in theory, it’s difficult for taxpayers to understand and plan for, and risks imposing further complication in a tax system full of traps already.”
How to beat a CGT rise
There are three main ways to tackle CGT:
- By making the most of tax-free wrappers
Gains on investments held in ISAs and pensions like SIPPs are sheltered from capital gains tax altogether. The ISA allowance is £20,000 per tax year (across all types of ISA) per person.
You can even use your allowance and keep the same investment(s) by doing what’s known as a ‘Bed & ISA’ transaction. This involves selling an investment and using the cash proceeds to buy it back within the ISA as quickly as possible. There might be stamp duty and dealing costs to pay but any gains going forward will be completely tax free.
Investments in a pension get the same tax-free treatment – but do keep an eye on the amount you can pay in and keep in mind that you cannot usually access your pension until you reach age 55 (age 57 from 2028).
- Transfer investments to your spouse
It’s not clear whether this is one of the ‘loopholes’ the Lib Dems would clamp down on – but transferring investments to your spouse or civil partner is currently free from CGT. This could be useful if you’re thinking of selling an investment and they’ve not used their allowance for the year yet. If they have a lower income than you, it could mean a lower tax rate under the current rules if the gain is over their allowance.
You should make sure you keep a note of the original cost of the investment (to you) as this will also transfer across.
- Use a pension contribution to reduce taxable income
Not only can you invest the cash inside a pension free of CGT, but the gross value of your pension contribution also has the effect of reducing your taxable income. Which has a handy knock-on effect of extending your basic rate band when calculating what CGT rate you’ll pay.
How much extra tax is paid on gains after successive cuts to CGT allowance
