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Convert Income to Capital
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Capital Gains Tax vs Income Tax

THE REASON why capital gains tax rates were increased in the recent Budget was to satisfy the Liberal Democrat desire to tax capital gains “at the same rates as income so that all the money you make is taxed in the same way.”

For the latest information on this subject, see our guides covering capital gains tax rates

In particular, the Government wanted to crack down on people converting heavily taxed income into leniently taxed capital gains.

Many investors and business owners will be delighted to know that the changes announced in the Budget failed miserably to achieve this result.

Capital gains, including those made over short periods of time, such as one year, are now taxed at most at 28%, compared with the top income tax and national insurance rate of 51%.

Furthermore, to the surprise of many, the annual CGT exemption, currently £20,200, was left intact and not reduced.

This means that a couple, who enjoy two CGT exemptions and manage to free up their basic-rate tax bands so that £37,400 each of capital gains are taxed at 18% will face the following effective CGT rates:

Gain                Effective Tax Rate
£20,000           0%
£50,000           11%
£100,000         15%

Clearly paying 15% tax on a capital gain of £100,000 is hardly onerous. The rate is only marginally higher than the 14% that was payable under the rules that existed immediately prior to the Budget.

Even couples who cannot free up their basic-rate tax bands will still benefit from converting income into capital gains. The following are the effective CGT rates payable by a couple who enjoy two CGT exemptions but have the remaining gain taxed at 28%:

Gain                Effective Tax Rate
£20,000           0%
£50,000           17%
£100,000         22%

Once again paying capital gains tax at 22% is a lot more appealing than paying income tax at 40% or 50%.

So converting income into capital gains remains an attractive tax planning strategy.