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HMRC internal manual

Capital Gains Manual

Reason for legislation

The introduction of a comprehensive Capital Gains Tax on all gains realised on the disposal of assets after 6 April 1965 was one of the twin reforms of the FA65, the other being the introduction of Corporation Tax. It gave official recognition to a concept of taxable capacity based not only on income but on gains from the realisation of capital assets.

The Income Tax Acts proceeded on the principle that to be chargeable as income, receipts must be derived from an identified `source’. Receipts so derived, the `fruit’ of the `tree’, were income, but the source itself was a capital asset, and a profit from the sale of the source was a capital profit. Where a person made a business of buying and selling land or securities, or other assets commonly regarded as of a capital nature, the profits from the dealings were chargeable as income; but in such cases the source was not the land or securities themselves but the trade, the land or securities being trading stock. Where, however, the capital asset was acquired as an investment the profit from its realisation was a capital profit and not taxable, even though the asset might have been acquired in the hope or expectation of a profit when it ultimately came to be resold. In order to establish Income Tax liability it was necessary to show, on the facts of the case, that the taxpayer’s activities amounted to a trade or an adventure in the nature of trade.

It was widely recognised that many transactions, although not amounting to an adventure in the nature of trade, were in fact entered into with a view to gain and produced a profit which, if not technically income, was closely analogous to income and appeared a proper subject for taxation. But gains were not taxed until 1962, when the Finance Act imposed a tax on short-term gains arising from the acquisition and disposal of assets. And even then the gains were still chargeable to Income Tax as unearned income under Case VII of Schedule D, the justification for taxing them being that short-term gains (3 years for land, 6 months for all other assets) were in the nature of income. Thus it could be argued that capital as capital was not taxed. That argument was removed by the 1965 legislation.

The question whether capital gains were a proper subject for a charge to tax had been a matter of general debate for some time, and particularly in the years immediately after the Second World War when the economy was enjoying a considerable measure of growth. The scope which this presented for the realisation of tax-free capital receipts, particularly by individuals buying and selling stocks and shares, drew attention to the disparity in the tax treatment of wages and profits on the one hand, and capital gains on the other. As a result, the adequacy of income as a measuring rod of a person’s taxable capacity was called into question. It was held by many that while income may well have been a reasonable guide to a person’s ability to pay in the 19th century, the sophisticated economics of the mid-20th century demanded a broader base for the tax system.

The opponents of the tax argued that it was undesirable to impose a tax on capital gains for two reasons. First, it would damage the economy by blunting incentives and restricting the mobility of risk capital; and, second, the administrative requirements for the enforcement and collection of the tax would be so great that the yield would be almost negligible. On the other hand, the supporters of the tax rejected the possibility of harm to the country’s economic development, citing in support of their views the American economy which had been living with a Capital Gains Tax since 1913. But for them there were other and more important reasons why capital gains should bear their fair share of taxation: capital receipts, they argued, particularly those from short-term transactions, added to a person’s spending or saving power in just the same way as did income. Consequently they ought to be taxed as such. In other words, the tax could be justified on grounds of equity alone.