Understanding Labour Capital Gains Tax Reforms: A Comprehensive Guide

The changes made in the UK Labour Capital Gains Tax (CGT) for 2024 are undoubtedly a landmark in the UK taxation system by the Labour Party. These reforms aimed at solving the problem of unequal wealth distribution and boosting tax revenue impacting investors, business owners, and affluent individuals. This article analyses the rationale behind such changes along with the anticipated outcomes.

What is Capital Gains Tax?

The Capital Gains tax is the government tax paid when individuals sell specific assets for a profit. This profit can come from the selling of real estate (except for the primary house), shares, bonds, and other forms of investments. When an individual disposes of an asset for a value greater than that of its purchase price, then the profit made, termed ‘capital gain’, is taxed. The amount of CGT owed is determined by a number of factors, including the seller’s income level and the appreciation period of the asset.

Previously, Capital Gains Tax (CGT) rates were much lower than income tax rates, providing an avenue for taxpayers to minimise their taxes by reclassifying income as capital gains. Historically, the government has used favourable tax treatment of investment income to stimulate economically productive activity. With Labour motivating reforms, though, CGT has now been reformed to respond to the widening gap between wealth generation and wage growth to ensure high earners contribute appropriately.

Key Labour Capital Gains Tax Reforms in 2024

The reforms related to CGT taxation released by the Labour Party in 2024 have brought about some of the most noteworthy changes. As with propositions set out so far, these changes will shift more of the tax burden toward high-income earners while providing some relief to the low- and middle-income groups. Here are the most important ones:

1. Increased CGT Rates

One of the most significant elements of the new 2024 CGT reform is the increase in taxation on higher earners. Previously, the CGT rates were lower than the income tax, and there was some leeway under the existing rules. For instance, the base rate of CGT was established at 10 per percent and the higher rate was established at 20 percent. The new reform by Labour increases them as follows:

• The basic rate of CGT increases from 10% to 18% for basic rate taxpayers.
• The higher rate of CGT rises from 20% to 24% for those in the higher income tax bands.

This move brings CGT rates closer to income tax rates, particularly for higher earners, with the aim of reducing tax avoidance strategies that involve converting income into capital gains.

2. Changes to Business Asset Disposal Relief (BADR)

Business Asset Disposal Relief (previously called Entrepreneurs’ Relief) is one of the most important parts of CGT for business owners, as it provides them with a lower rate of CGT upon selling a business, including shares in a business. Before, business owners had a lifetime cap of £10 million, so they would only pay 10% on the sale of their business.

Under the new rules, the lifetime limit for BADR is reduced to £1 million, and the tax rate is gradually increased:

• From 10% to 14% starting on 6 April 2025.
• The rate will increase further to 18% starting on 6 April 2026.

The phased increase in the tax rate means that entrepreneurs may have to reconsider their business exit strategies. The reduction in the lifetime limit might also make it less attractive for entrepreneurs to sell their businesses and take advantage of the tax benefits.

3. Higher Tax on Carried Interest

Investment professionals such as venture capitalists and private equity fund managers often receive perks like ‘carried interest’. This refers to a fraction of the returns or profits from an investment fund, and ordinarily, carried interest has been taxed as a capital gain instead of income. This has always resulted in a lower burden of tax for the private equity industry.

With the 2024 reforms, Labour aims to close this loophole by raising the tax rate on carried interest from 28% to 32%, effective from 6 April 2025.

4. Abolition of Non-Domicile Status

Non-domiciles (non-dom) is a tax status claimed by foreign constituents that live in the UK. They pay tax only on the income earned within the UK, and foreign gains or income are free from UK tax. This has attracted a lot of criticism owing to the fact that ultra-high-net-worth individuals stand to benefit from paying virtually no tax on their globally concealed wealth.

Under the 2024 reforms, Labour has decided to abolish the non-dom status entirely, replacing it with a residence-based tax system.

The Rationale Behind the Reforms

The Labour Government is looking to completely change the system of capital gains tax, and they are doing it with multiple goals in mind:

Reduce the Gap in Wealth Distribution

This is perhaps a very important primary reason for the modification of tax policies in the UK. A lot of people in the UK are employed and receiving wages below the median wages, but there is a selected group of people who invest and continue to get richer, either through investment or by shifting their income through capital gains, which are taxed at a much lower rate than income, hence avoiding higher brackets of taxes.

By raising CGT rates, the Labour government intends to make sure that the wealthy pay a more equitable amount in taxes, which, in turn, will be used for public services. This reform is aimed at rectifying the imbalance created in the tax system, as some people earn money through hard work and others through passive income investments.

Adding to the Funds Available for Public Services

For some time now, the government of the UK has been undergoing a difficult financial period owing to the economic effects of the COVID-19 pandemic and increased spending by the government. Labour’s CGT reforms are expected to generate sufficient revenue to finance public services like healthcare, education, and infrastructure.

Eliminating Tax Evasion Schemes

This reform also intends to address tax avoidance schemes and strategies that enable the wealthiest taxpayers to reduce their tax bills. Labour plans to restrict some of the tax avoidance strategies that exist within our capital gains system by equalising capital gains taxes with income tax rates.

Conclusion

The 2024 reforms to the capital gains tax policy introduced the most sweeping changes in the tax policy of the United Kingdom. The policy is aimed at increasing economic inequality by closing loopholes and increasing taxes on capital and primary reliefs. Though well meant in accordance with policy, the extent of their impact on investors, wealth creators, and ultra-high-net-worth individuals is still ambiguous. It is yet to be seen what these changes do to the economy in the United Kingdom.