Article

The history of Capital Gains Tax: how has government policy affected investors?

We look at the history of capital gains tax and what it might mean for investors going forward.

| 9 min read

As we await the result of the UK General Election there’s speculation on what personal taxation changes might take place. With the Labour party well ahead in the polls, and likely to form the next government, their policies are the most relevant to monitor.

While some changes have already been ruled in (VAT on private school fees) and some out (raising income tax, national insurance, and VAT rates), others have not. This is to be expected as an inaugural fiscal event informed by a considered and up-to-date look of the state of the nation’s finances should form the basis of fiscal policies. Yet an absence of information is grist for the press rumour mill, so it’s no surprise to see speculation on taxation matters surface.

One focus has been capital gains tax (CGT), the tax on investment profits, where it has been suggested tax rates might rise or that certain exemptions might no longer apply. Labour leader Sir Keir Starmer was recently quick to quash the suggestion that his party might start applying CGT to principal residences, one of the more speculative rumours doing the rounds. However, apart from that nothing is ruled in or out as things stand, so let’s look at UK capital gains tax history to help gauge whether change is likely.

What is Capital Gains Tax?

UK Capital Gains Tax history

1965 - 1979

  • The first comprehensive CGT was introduced by Labour Chancellor James Callaghan in 1965 following a large increase in property and other asset values from the end of World War II. High top rates of income tax at the time incentivised people to convert income into capital gains wherever they could to avoid tax, so the measure sought to bring the treatment of profit on capital closer to that of income.
  • Broadly, individuals were given an ‘allowance’ of £1,000 a year with any gains above that subject to the tax, which started at 15%. However, with starting values based on 1965 prices it was a few years before it started to take effect, which was during the high inflation era of the 1970s.

1980 - 1997

  • Later, in 1980, the rate became a universal 30% under Conservative Chancellor Sir Geoffrey Howe. But in 1982 an ‘indexation allowance’ was introduced, which represented the difference between the cost of the holding and the increase in the Retail Prices Index measure of inflation – the idea being that people were only taxed on gains above the rate of inflation.
  • Then, in 1988, Howe’s successor Nigel Lawson ‘rebased’ the cost of all assets held on 31st March 1982 to their market value at that date so that gains accruing before that date weren’t taxed. This was a rough quid pro quo for an uplift in the CGT rates at the time to align them with the top slice of an individual’s income. At this point the highest CGT rate became 40%.

1998 -2007

  • In 1998, Labour Chancellor Gordon Brown replaced indexation with taper relief, which reduced the tax payable on assets owned for longer periods but removed the link with inflation. His reforms also aimed to promote the creation of new enterprises and reward the risks of entrepreneurship with business assets attracting lower rates than non-business assets.

2008 -2019

  • Taper relief was abolished in 2008 by Labour’s Alistair Darling, and with it the concept of older vintages of investment facing a lower rate of tax. The rules were simpler, though, with a new, lower flat rate of 18% to make up for the absence of the taper.
  • This was, however, short lived and Conservative George Osborne reintroduced a tiered system in 2010 with a higher rate of 28%. In 2016 Osborne unveiled lower rates of 10% and 20% for basic rate taxpayers and higher rate taxpayers respectively, though higher rates continued to apply for second residential properties.
  • Alistair Darling’s 2008 shake up also introduced Entrepreneurs’ Relief, which applied a lower 10% rate to some gains made by business owners, directors, and large employee shareholders on disposals of business assets and company shares. There was a lifetime limit on the relief set at £1m and this amount was steadily increased to £10m by 2011.

2020 - present

  • In 2020, the recently appointed Chancellor Rishi Sunak dropped the limit back down to £1m and renamed it Business Asset Disposal Relief.
  • Throughout the various evolutions of CGT, the allowance – the CGT-free portion – of gains gradually increased to £12,300 in tax year 2020/21, before being cut in 2023/24 to 6,000 and again to £3,000 in the current 2023/24 tax year. Interestingly, today’s tax-free allowance, referred to by HMRC as the ‘annual exempt amount’ (AEA), is the same level as it was in 1981, although the tax rate applied back then was a flat 30% above the allowance.

Read more: UK tax brackets: how much will you pay?

Capital Gains tax today

This brings us to where we are today, save for a small reduction to the higher rate on property announced in Jeremy Hunt’s Spring Budget earlier this year. He reduced the higher rate on properties from 28% to 24%, effective from the current 2024/25 tax year.

Today’s system is at least relatively straightforward compared with the fiendish indexation calculations of days gone by. For tradable investments such as shares, same day purchases are considered as disposed of first, followed by any holdings subsequently repurchased in the 30 days following the disposal (the ‘30 Day Rule’), and then all other holdings with entry prices averaged. HMRC has guidance on these rules here.

For individuals it’s also relevant that the ISA allowance, and in their previous form PEPs or Personal Equity Plans, have offered a way to shelter investments from both income and capital gains tax. PEPs began in 1987, replaced by ISAs in 1999, and their popularity and gradual use through the years has meant fewer ordinary investors paying CGT.

Read more: Capital Gains Tax: how much do you pay on investment profits?

What does CGT history tell us about the future?

This trip down CGT memory lane is a reminder that the tax system evolves, often by incremental, small measures but occasionally through major reform.

There are number of levers governments can pull around profits on investments, and historically the decisions around upping headline CGT rates have often coincided with reliefs being added such as higher allowances, reducing gains by inflation or other means, or carving out special treatment for entrepreneurs to encourage investment.

What we are left with today is a fairly low average CGT rate by historical standards but also a very small tax-free allowance, as well as a system that takes no account of the time over which a gain was generated, or the rate of inflation during that period. It remains possible for an ordinary and unwitting private investor to fall into a trap of paying a significant sum of CGT on assets that have been held for decades but have generated a below-inflation return, at least in capital terms.

What we haven’t seen over the history of the tax is the coincidence of high rates with both a low allowance and a lack of relief for longer term holding or ‘inflationary’ gains. Any government leading taxpayers down that path could take the overall CGT burden to its highest level historically, albeit arguably greater investor wealth has accumulated within ISA allowances over time, sheltered from tax. Nonetheless any moves by a future government to align CGT rates closer to those of income tax could catch out some investors, especially without an increase in the annual allowance. Entrepreneurs and business owners looking to dispose of stakes or assets should also be aware of changing rules.

In any discussion of CGT we always return to the ISAs remaining a vital refuge for private investors. The annual ISA allowance has remained static at £20,000 for seven years and counting, but using each year’s allowance as far as possible provides a shield from both CGT and tax on investment income, as well as the duties associated with declaring and paying it.

Using all available PEP and ISA allowances since 1987, which would amount to just over £400,000, would have produced a pot worth just over a £1m today assuming a modest 5% growth each year, not to mention removing a great headache from following the ever-changing rules.

Read more: How does a Stocks & Shares ISA work?

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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Charles Stanley is not a tax adviser. Information contained within this page is based on our understanding of current HMRC legislation. Tax reliefs and allowances are those currently applying and the levels and bases of taxation can change. Tax treatment depends on the individual circumstances of each person or entity and may be subject to change in the future. If you are in any doubt, you should seek professional tax advice.