Massive UK tax grab would be biggest of its kind in Europe

Rachel Reeves has given her strongest indication yet that capital gains tax (CGT) hikes might on the cards.

In an interview early this week with Bloomberg TV, the new chancellor said she needs to strike the “right balance” when asked whether Labour will reform CGT at the autumn Budget.

Reeves’ guarded stance is the latest development to add fuel to a fire that was lit after Labour omitted a pledge not to raise headline CGT rates in its election manifesto. Last week, the chancellor warned tax rises are needed to plug a £22 billion fiscal “black hole”.

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Rumours are gathering pace that CGT rates could be equalised with income tax, a move that would propel the UK’s top rate on share gains to the highest in Europe. An article by TheGuardian in early June reported that Labour members were urging Reeves to hike CGT to fund public services.

While this could rake in billions for the Treasury, investors with holdings outside tax wrappers and landlords would be hit hard.

So, if this does come to pass, how would it reshape the CGT landscape? And what can you do to mitigate or avoid the tax?

First, let’s look at the current rates of income tax and CGT in England, Wales and Northern Ireland (the income tax system in Scotland differs), shown in the table below. 

You might pay CGT when you sell, transfer or gift an asset that has increased in value. Everyone can realise £3,000 worth of gains every year tax free.

How UK CGT on shares compares with our neighbours

So, how does our CGT system for investors stack up against others? The table below shows the top marginal rates across 35 European countries in descending order.

Source: Tax Foundation.

As you can see, the rates applied here are hugely disparate. The UK system currently nestles somewhere in the middle.

However, equalising rates with income tax would mean the UK has the highest top rate of CGT in Europe, knocking Denmark off the top spot. The Danes also tax gains in the same way as personal income but have a top rate of 42%, compared to the UK’s 45% additional rate of income tax. We should also note that the top rate of income tax in Scotland is even higher at 48%.

Nine countries including Belgium, Switzerland and Turkey, don’t normally tax gains, but in some cases certain conditions must be satisfied.

As no two nations’ tax systems are the same, it’s difficult to compare on an absolute like-for-like basis. One thing that does jump out though is that many countries do tax gains and income in the same way.

How much could this raise for the Treasury?

In short, the increase in yearly tax receipts would be considerable.

No matter whether Reeves jacks up headline CGT rates, annual receipts are already on a sharp upwards trajectory. Analysis conducted by interactive investor in October argued that CGT poses the greatest threat to investors’ wealth, with the Treasury’s annual take set to triple in the 10 years to 2026-27.

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There are various studies which estimate how much equalising CGT with income tax will beef up the Treasury’s coffers.

Both the Green Party and Arun Advani, a tax expert at the University of Warwick, reckon it could raise around £16 billion annually. Others put the figure in the region of £12 billion. Given the so-called black hole, it’s easy to see why the government may view CGT as an easy and lucrative target.

What’s the potential impact on investors?

Again, this could be sizeable.

Let’s say someone with annual income of £45,000 realises a £20,000 taxable gain – or £17,000 after using their £3,000 annual exemption.

Under the current system they would pay 10% on £5,270, (£527), plus 20% on £11,730 (£2,346), bringing the total tax to £2,873.

But if CGT rates were brought in line with income tax, they would pay 20% on £5,270 (£1,054), plus 40% on £11,730 (£4,692) – a total tax bill of £5,746.

In summary, their CGT bill would double.

We’ve been there before, but not recently…

Equalising taxes on income and gains would not represent new ground for the UK.

In fact, when the tax was first introduced in 1965 by then-Chancellor James Callaghan, rates were broadly in line with income tax.

Between 1980 and 2008 the CGT landscape underwent significant reform. A flat rate of 30% was put in place; there was an “indexation allowance” where investors would only be taxed on gains that outstripped inflation; followed by a “taper relief” regime which reduced CGT on assets held for long periods.

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While some of these measures helped investors, they were rather complex in parts. In 2008, CGT was simplified and a new flat rate of 18% was brought in. The rates investors pay on shares today were introduced in 2016.

What this tells us is that if CGT and income tax rates are brought in line, it would create the strictest tax system on investor gains for almost half a century.

Steps to keep HMRC at arm’s length

The impact of CGT on investment returns can be punishing. No one wants to see up to 20% wiped off their hard-earned profits and handed to HMRC.

However, by understanding your exemptions and learning some savvy tax-planning tactics, you can reduce or even avoid CGT. Here are five handy tips.

• Fill up your tax wrappers

Making the most of your tax wrappers, such as individual savings accounts (ISA) and self-invested personal pensions (SIPP), is more important than ever. Both ISAs and SIPPs protect any gains from HMRC and shelter dividends from tax, too.

Your annual ISA allowance is £20,000, while most people can pay the lower of £60,000 or 100% of earnings, into pensions every year and get income tax relief at their marginal rate – in other words, the top rate of tax you pay, which could be up to 45%. Note, your annual allowance might be as low as £10,000 if you earn more than £260,000 a year or have made a flexible and taxable withdrawal from your pension.

• Use your tax-free exemption

The CGT annual exemption, the profit you can realise every year tax free, has thinned dramatically in the past few years. It was slashed from £12,300 to £6,000 in April 2023 and halved again to £3,000 earlier this year. This means you have less scope to sell shares outside of tax wrappers and shield the money you make from tax.

However, £3,000 a year is better than nothing, so it’s important to use this allowance where you can. Using something like Bed and ISA, where you sell a profit up to £3,000 in tax-paying investments and shift them to a tax wrapper, can be a prudent strategy to protect future gains.

• Team up with a spouse

One loophole is that any transfers to a spouse or civil partner are tax free, which can mitigate or even swerve CGT if the rate of tax they pay is lower or they don’t pay tax. Just don’t forget to use your £3,000 tax-free annual exemption before switching assets.

• Consider this pension trick

If a gain trips you into a higher tax bracket, paying into a pension can help to reduce the amount of CGT payable. So, let’s imagine you earn £45,000 this year and realise a gain – after your £3,000 tax-free exemption – of £10,000.

As the higher-rate tax bracket kicks in at £50,271, £4,730 of the profit will be taxed at 20%. But if you made a pension contribution equal to this amount (which could only cost you £3,784 net due to 20% upfront tax relief) it would adjust your income back below the higher-rate threshold, meaning you only pay 10% tax on the gain.

This trick will become even more powerful if CGT rates are increased, especially as tax thresholds are set to remain frozen until 2028.

• When losses can come in handy

It’s useful to know that current or previous losses can be offset against gains made in the current tax year.

And interestingly, if your total taxable gain is above your £3,000 allowance after current year losses have been deducted, you can carry forward unused losses from previous tax years. If these reduce your gain to the tax-free exemption, you can hold back any remaining losses to a future tax year.