What's more beneficial for business owners: a 50 per cent income tax rate or Capital Gains Tax? We do the math.
The debate over the merits of the 50 per cent top rate of income tax alternately rages and rumbles on, with recent attention turning again to the difference between rates of tax on income and capital gains.
We ask: Is CGT really more beneficial for entrepreneurs than 50 per cent income tax?
In short, no. Only businesses which generate additional wealth-producing assets such as intellectual property rights, property value enhancements or goodwill truly benefit from the more benign rates of CGT, and even then, the effective rates may not be especially attractive.
One argument goes that low taxation of chargeable gains is more important to entrepreneurs than low income tax rates. The headline tax rates appear to support this contention as, compared with income tax topping out at 50 per cent, CGT is charged at a top rate of 28 per cent while the first £10m of gains qualifying for entrepreneurs relief are taxed at only 10 per cent.
However, the lower CGT rates only offer true benefits to businesses and owners of assets which accumulate capital value. No business can retain profits without them being taxed: (at up to 50 per cent on individuals and 26 per cent on companies); and CGT can only benefit those who have a financial stake in the business and are not solely reliant on income.
Only businesses which generate additional wealth-producing assets such as intellectual property rights, property value enhancements or goodwill truly benefit from the more benign rates of CGT and even then the effective rates may not be especially attractive.
If what is sold is an unincorporated business or a company then there is only CGT to pay (although the price obtainable for sale of a company may be discounted for inherent tax liabilities of the company).
But if a company sells its business or assets, the company must first pay corporation tax on that sale (top rate 26 per cent) before the resulting proceeds are distributed to its shareholders, suffering potentially a further 36.11 per cent on dividends, unless the company is to be wound up – in which case the 28 per cent main CGT rate or 10 per cent entrepreneurs’ relief rate will apply.
Therefore, whether selling a business, or winding a business up, there will be an element of double taxation.
The effective tax rate on gains qualifying for entrepreneurs’ relief is likely to be just over 33.4 per cent, while other gains will be taxed at an effective rate of up to 46.72 per cent and sale proceeds distributed as dividends may be taxed at up to 52.72 per cent.
George Bull is senior tax partner at Baker Tilly.