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The absurdity of confusing Capital Gains Tax (CGT) with Income Tax

8 comments

“Taxing capital gains at the same rates as income, so that all the money you make is taxed in the same way.” Liberal Democrat Manifesto.

Fair?

When you ‘earn’ money on the Lottery, you don’t pay any tax.

Here is a rough working for a company that has been built from scratch by an entrepreneur over 15 years. These numbers are simple and based on some basic (and unrealistic) assumptions for the sake of simplicity.

Assumptions:

  • An entrepreneur founds a business and grows it organically (without external investment) over 15 years at a steady rate of 20% a year.
  • In year one her turnover is £500,000.
  • She has one employee for every £100,000 of revenue.
  • Employees are paid on average £30,000 which means that about £7,300 is taken as Tax and National Insurance.
  • She pays Corporation Tax on her profits which are 20% of revenue but ploughs any profit over a £ 100,000 back into the business.
  • When she sells the business, she sells it for 5x profits in year of sale.

In this relatively simple scenario, the business would be sold for £6,419,592.

Is it right that this payment should be taxed at 50%?

Consider this.

  • Over this time the entrepreneur has paid over £10,805,000 in wages.
  • She has provided employment for 64 people. Jobs that were not there before.
  • She has paid over £1,800,000 in Corporation Tax.
  • She has paid over £2,629,000 in PAYE and National Insurance. (Plus another £1,383,000 in employer contribution that I forgot to include in original post. Thanks Tim at BDO).
  • She has taken £1,500,000 out of the business during this time. (Although this is likely to be far less as in the early years she would not have taken out the full £100,000 as she would have been likely to reinvest this into the business).

So, having created 64 jobs, paid over £16,700,000 to the state and to employees, having taken an enormous risk and probably worked 100 hour weeks to get to the point she has, she then pays another £3,200,000 to the state leaving her with the same amount. The scenario could be so different. She could have gone bust after 10 years and been left with nothing, (she will still have paid her taxes). Entrepreneurs have to take big risks – they mortgage their properties, they survive on as little as possible, they do what they need to do to make things happen in their business.

If politicians decide to penalise entrepreneurs for making the sacrifices they do then they are not going to get my vote.

Give entrepreneurs a break. They work hard, take risks and create wealth and employment. The least they deserve is a break when it comes to an exit. (And, when they exit they are FAR more likely to use that money to do something else that creates wealth than any other section of the community).

You can download the spreadsheet that I put together to produce these numbers here. It is not completely accurate – it is a rule of thumb and if anyone wants to refine it, please feel free to do so. Capital Gains Tax Calculation

You can see here how the two things have been treated historically by Labour and Conservative governments.

Make your own mind up about who you vote for.

– – – – –

If you are the founder or CEO of a growth business and you want to know how to get into a position where you are faced with the problems of paying Capital Gains Tax, come along to our BLN Growth Forum on 15th July. Hear what these people have to say about how they grew their organisations:

  • Tudor Brown, founder & President of ARM Holdings
  • Mark Zaleski, as CEO, led QXL Ricardo to $1.1 billion exit, CEO/Chairman of DailyMotion
  • Michael Ross, visionary founding CEO of Figleaves.com, co-founder of eCommera
  • Terry Burt, founder & CEO of 2e2 one of the fastest growing IT service providers in Europe with 1,500+ employees
  • David Harbord, CEO of Warehouse Express
  • Mark Sebba, CEO, Net a Porter
  • Martin Leuw, CEO of IRIS, has led its growth from revenues of £9m to over £130m p.a.
  • Hermann Hauser, Amadeus Capital Partners, big thinking founding investor in 7 $billion companies
  • David Soskin, Chair of MySupermarket.co.uk, CheapFlights.com and Swapit.co.uk
  • Head of Corporate Development, AVG
  • Henri Winand, CEO, Intelligent Energy
  • Russell Buckley, CEO EMEA, VP Alliances, AdMob, Sold to Google in 2009 for $750 million
  • Al Gosling, CEO and Founder, The Extreme Group

The BLN Growth Forum is supported by BDO and Ideaspace.

8 responses to “The absurdity of confusing Capital Gains Tax (CGT) with Income Tax”

  1. Mark Birch says:

    The leadership debate last night exposed the Liberal Democrats for what they are. Entertaining sideshow but of no use in a real world government. The data from previous governments is fascinating. It actually seems that Labour has been more friendly to entrepreneurs than Tories.

  2. Tim Ferris says:

    Mark, the good news (for me) is that you’re not about to put me out of business! The bad news is I think you have significantly underestimated the amount of tax collected along the way based on these facts. Firstly, I think the total tax and NI on each employee is likely to be higher – I wonder if you’ve overlooked the employer’s NI at 12.8%? And then of course NI is going up from April 2011. Then in year 8, when profits begin to exceed £300K, the rate of corporation tax will rise (each extra £ over £300K will effectively be taxed at 29.75% in years 8 to 15. Finally, you haven’t factored in the tax liability which would arise if our entrepreneur takes any of the profit out of the business – depending on how she takes it and when, it could be expensive. For example, the higher rate tax on a dividend could be up to 36% of the net dividend, i.e. up to £541K on the whole £1.5m accumulated profit. Obviously, with professional advice, it may be possible for our entrepreneur to mitigate the tax burden, both on exit and before (spot the sales pitch).

    One can only hope that, if any changes are made to the CGT system by whatever government we have after next week, they are accompanied by extensive entrepreneurs reliefs.

  3. Tim,

    That is why I would always seek professional advice from a professional person, not me…! Very good point. If you want to download the spreadsheet, make any changes, I would be happy to amend the spreadsheet and the post. It would be fair to say that BDO know a little more than me about this stuff. Doesn’t stop me getting angry about it though!!!

    Grrrr.

  4. For the sake of clarity, the 50% Capital Gains Tax (CGT) number comes from the Liberal Democrat Manifesto.

    http://network.libdems.org.uk/manifesto2010/libdem_2010_money.pdf

    “Taxing capital gains at the same rates as income, so that all the money you make is taxed in the same way.”

    Fair? When you ‘earn’ money on the Lottery, you don’t pay any tax. FFS.

  5. Wille says:

    You’re missing another point that is key to me:

    Equating Capital Gains to Income is absurd from the point of view that it assesses a gain you built up over 15 years in this example as income in a single year!

    That alone is to me the epitome of unfairness: If you’ve spent 15 years pouring in blood, sweat and tears into something, and they don’t even give you the right to acknowledge that the gain has been built up over that period is just plain wrong.

  6. @tomall

    Fantastic post by @MarkLittlewood on ‘absurdity of confusing Capital Gains Tax (CGT) with Income Tax’ http://is.gd/bOLjq

    @wfaler

    A great example from @marklittlewood about tax, illustrating why ‘fair’ is such a weasel word: http://bit.ly/azO2KG (via @NeilDavidson)

    @NeilDavidson

    A great example from @marklittlewood about tax, illustrating why ‘fair’ is such a weasel word: http://bit.ly/azO2KG

    @BDO_Cambridge

    RT @marklittlewood The absurdity of confusing Capital Gains Tax (CGT) with Income Tax http://bit.ly/9crb13

    @martinstillman

    RT @marklittlewood The absurdity of confusing CGT with Income Tax http://bit.ly/9crb13 OR maybe this should be entitled “whos incentive”

    @Major_Grooves

    @MarkLittlewood Thanks. That’s mad! I really should read these manifestos. LibDem just lost my vote. Shame. Now I have to vote Tory. Pah.

    @incomesearch101

    RT @marklittlewood Capital Gains Tax is NOT Income Tax #Leadersdebate http://bit.ly/cDAHa5: RT @marklittlewood Cap… http://bit.ly/aAbx3H

    about 8 hours ago via twitterfeed

    @DarrenBLN

    RT @marklittlewood Capital Gains Tax is NOT Income Tax #Leadersdebate http://bit.ly/cDAHa5

  7. Andrew says:

    Interesting, although the original quote doesn’t specify that the capital gains and income tax rates ‘meet’ through a rise in capital gains tax. What about if income tax comes down as the method of equalizing them?

  8. @firsttutors says: RT @marklittlewood The absurdity of confusing Capital Gains Tax (CGT) with Income Tax http://bit.ly/9crb13

    @Molebu says: RT @WilHarris: http://bit.ly/azO2KG – CGT unfairness to an #entrepreneur explained clearly and candidly. 50% CGT (via @davidpeto)

    @canny_lass says: RT @sparky000: An incisive look at CGT. We all knew the entrepreneurs got shafted, but this is the big picture: http://bit.ly/azO2KG (vi …

    @rtt says: http://bit.ly/azO2KG CGT unfairness to an #entrepreneur explained clearly and candidly. 50% CGT no thank you! (via @davidpeto => @WilHarris)

    @sparky000 says: An incisive look at CGT. We all knew the entrepreneurs got shafted, but this is the big picture: http://bit.ly/azO2KG (via @WilHarris)

    @hugh_waters says: RT @davidpeto: RT @MarkLittlewood: http://bit.ly/azO2KG – CGT unfairness to an #entrepreneur explained clearly and candidly. 50% CGT – …

    @WilHarris says: http://bit.ly/azO2KG – CGT unfairness to an #entrepreneur explained clearly and candidly. 50% CGT – no thank you! (via @davidpeto)

    @alcartwright says: If you’ve got your own business & considering a libdem vote, read this first: http://bit.ly/c7DeIu (RE: CGT) (via@willcritchlow) #ukelection

    @davidpeto says: RT @MarkLittlewood: http://bit.ly/azO2KG – CGT unfairness to an #entrepreneur explained clearly and candidly. 50% CGT – no thank you!

    @alcartwright says: If you’ve got your own business & considering a libdem vote, read this first: http://bit.ly/c7DeIu (RE: CGT) (via@willcritchlow)

    @craigkillick says: (via @willcritchlow ) http://bit.ly/c7DeIu (and why I could not vote Lib Dem having worked hard all my life)

    @joodoo9 says: @tairona great to see you at w/e – this article backs up your point about Lib dems not being great for entrepreneurs http://bit.ly/c7DeIu

    @MarkLittlewood says: Thx for RT http://bit.ly/azO2KG @richardtyler Labour & Conservative CGT/Tax rates surprised me too. http://bit.ly/byWHnf

    @willcritchlow says: I like lib dem policies like zero income tax

    @richardtyler says: RT @MarkLittlewood: @mikebutcher @richardtyler @iaindodsworth Some numbers around the CGT/Income Tax idiocy http://bit.ly/azO2KG

    @DarrenBLN says: RT @marklittlewood The absurdity of confusing Capital Gains Tax (CGT) with Income Tax http://bit.ly/9crb13

    @joshuamarch says: RT @maxniederhofer: RT @MarkLittlewood Well the Lib Dems certainly aren’t very entrepreneur friendly! http://bit.ly/c7DeIu < Love the … –

    @maxniederhofer says: RT @MarkLittlewood Well the Lib Dems certainly aren't very entrepreneur friendly! http://bit.ly/c7DeIu < Love the example. Tax is key.