NEWS & VIEWS
Following the budget, and as we wait for the latest announcements on Capital Gains Tax by the Treasury on Tax Day or suggested in the Office of Tax Simplification report, we thought that it was a good time to remind ourselves of how this tax has evolved.
Capital Gains Tax (CGT) was first introduced by Labour Chancellor James Callaghan in 1965. It is believed that one of the primary drivers for its introduction was the rapid growth in property values following World War II. A capital gain was defined as the profit made when an asset is sold (purchase price less any expenses). The most common capital gains are realised from the sale of shares, bonds, precious metals and property. Therefore, the tax primarily targets business owners and investors. The tax also applies to trusts, though often different rules apply. In this examination of history, we will focus on the application of CGT to individuals’ wealth.
In the main, the tax is applied to gains made over a particular amount, called an allowance. The allowance amount has increased steadily over time, from £1,000 for individuals in 1977 through to £5,000 in 1990/91 and £7,200 in 2000/01. It is now at £12,300 in 2020/21.
The rate of tax was also changed several times by different governments. For individuals, it was originally set as three bands:
These bands remained until 1980 when Conservative Chancellor Geoffrey Howe changed it to a universal rate of 30%. In 1988, the next Conservative Chancellor Nigel Lawson aligned the rates with those of income tax, leading to the UK having one of the highest rates of CGT in the world (40% for higher ratepayers). These rates remained until 2008 when Labour Chancellor Alistair Darling introduced a flat rate of 18% for all. Though this was short-lived, as the new Conservative Chancellor George Osborne brought in a rate of 28% for higher rate payers in 2010. The last change to be made to rates was in 2016 was also by George Osborne. New lower rates of 10% (for basic ratepayers) and 20% (for higher ratepayers) were introduced but did not apply to transactions involving residential property or carried interest.
The method of calculating the capital gain has also seen many changes. This calculation addresses how to determine the price of shares when the holdings may have been bought in several tranches and at different prices – so which shares are being sold during disposal?
From 1965 to 1982 the calculation was split into two parts. Any short-term holdings, held for less than a year, were disposed first and based on a ‘Last In First Out’ (LIFO) calculation. Then shares held for over a year were pooled and an average price calculated. In 1982 the rules were changed, same day purchases were disposed of first, followed by any holdings purchases in the 10 days prior to the disposal. The remaining calculation was based on the holdings split into three groups. First an average price for shares acquired on or after 6th April 1982, then an average price for shares acquired between 6th April 1965 and 5th April 1982, and finally an average price for any shares acquired before 5th April 1965. These three groups were commonly known as the 98 pool, 82 pool and 65 pool respectively.
However, in 1998 the regulations changed again and introduced the ’30 Day Rule’ to counter the practice of ‘Bed and Breakfasting’. This process is the sale and subsequent repurchase of shares around the end of the financial year in order to take advantage of any unused allowance and minimise the amount of CGT to be paid. The new calculation became same day purchases were disposed of first, followed by any holdings purchased in the 30 days following the disposal (the 30 Day Rule). Then it was LIFO for shares acquired after 5th April 1998 and then the remaining calculation was based on the holdings split into three groups. First an average price for shares acquired between 6th April 1982 and 5th April 1998, then an average price for shares acquired between 6th April 1965 and 5th April 1982, finally an average price for shares any acquired before 5th April 1965. The first of these groups was renamed as the Section 104 pool. These rules were considered very complicated and in 2008 steps were taken to simplify the calculation.
From 2008 the method of calculating the capital gain became same day purchases were disposed of first, followed by the 30 Day Rule. Then the remaining shares were all combined into one ‘Section 104 pool’ and an average price calculated.
Over the years there have also been a number of exemptions and reliefs applied to the calculation. The main exemptions are for a principal private residence, personal possessions valued at less than £6,000 and holdings in ISAs or gilts. In 1982 an indexation allowance was introduced by Chancellor Geoffrey Howe. This allowance is the difference between the cost incurred and the same costs indexed by the Retail Prices Index. Then in 1988, Chancellor Nigel Lawson ‘rebased’ the cost of all assets held at 31st March 1982 to their market value at that date to ensure that gains accruing before then were not charged to tax. However, in 1998 Labour Chancellor Gordon Brown replaced indexation with taper relief as a way of rewarding risk taking and promoting enterprise. Though this added a whole layer of additional complication to the calculation of CGT.
The new taper relief meant that chargeable gains were now tapered according to the length of time that the asset had been held after 5th April 1998. Business assets were treated differently to non-business assets. Assets acquired before 17th March 1998 qualified for an additional bonus year to the period for which they are treated as held after 5th April 1998. The taper was applied to net gains that were chargeable after the deduction of any allowable losses. Losses are set against gains in the order that produces the lowest tax charge. Taper relief was abolished in 2008.
Entrepreneurs’ tax relief was introduced by Chancellor Alistair Darling in 2008. It was primarily an incentive for people to establish businesses in the UK by reducing the rate of CGT when the business was sold. Initially, the entrepreneurs’ relief was limited to £1m. This figure steadily rose to £10m by 2011. However, in 2020 new Conservative Chancellor Rishi Sunak dropped the limit back down to £1m and renamed it Business Asset Disposal Relief.
And this brings us to today – as we anticipate the next changes that may impact the calculation of CGT.
Capital gains tax: background history, House of Commons Library, June 2010. Capital gains tax: the 2008 reforms, House of Commons Library, June 2010. Capital gains tax: recent developments, House of Commons Library, September 2020. Capital Gains Tax review – first report: Simplifying by design, Office of Tax Simplification, November 2020.