Capital Gains Tax as an Unfair Tax That Has Too Many Exemptions - Essay Example

? Taxation Law By Due Capital Gains Tax is a tax chargeable on capital gains. Capital gains are profits realized on disposal of capital assets. Capital assets are those assets that are not held for consumption. These assets include stocks, bonds or real estates. There has been a debate as to whether capital gains tax is a fair tax. Due to the complexities of the exemptions that are granted under the head of capital gains, it has often been expected that the taxpayers are likely to find many loopholes in the law and avoid tax. The rules regarding exemptions are such that rich people often find ways to avoid taxes by making investments in certain specified areas hence paying even less taxes than the poor. This defies the canon of equality put forward by Adam Smith. According to canon of equality, the rich should pay more taxes than the poor, or at least, in proportion to their income. Capital gains tax allows many exemptions and allowable deductions and the rich are able to make the most out of them. Further, according to the canon of certainty, the measurement of taxes should be easily understandable and the taxpayer should not be uncertain about the calculation and determination of tax liability. Capital gains tax is very complicated and often tends to confuse the taxpayers a lot. Capital Gains Tax was introduced in the UK in 1962. It was introduced so that avoidance of tax could be curtailed. Taxpayers used the distinction between income and capital, and made their profits under the head of capital because it was free from tax. A flat rate of tax of 30% was introduced in 1965 on all capital gains, but it failed because taxpayers on whom the greater rate of tax was applicable still had an incentive to realize their profits under capital gains. On the other hand, the taxpayers who were subject to lower rates of tax ended up paying more if they had realized a profit under capital gain. Further, there was no allowance for inflation. This meant that the gains that had a significantly low present value, or had ceased to be “gains” were also charged to tax. Therefore, capital gains tax has been problematic since its very inception. The problem of impact of inflation on capital gains tax was curtailed very much due to a system of indexation that was introduced in 1982. This system was supposed to have made the capital gains tax very fair. However, once the inflation itself was brought under control, the value of this system started to diminish. Therefore, a new system called Taper’s Relief was introduced in which the capital gain was reduced according to the period of taxpayer’s ownership of the asset. This relief did not prove to be successful in the long-run and was abandoned. It was somewhat useful to the business sector which is why it was demanded to be reinstated. In response, a different type of relief called Entrepreneur’s Relief was introduced. This relief applies where a whole or part of a business is sold. It also applies to the disposal of assets of the business after it has stopped. The disposals must be made by individuals who were involved in the running of the business. Entrepreneur’s relief is also applicable on gains on disposals of shares in a trading company. However, the individual making the disposal must have been an employee of the company and own at least five per cent of the ordinary share capital of the company. Entrepreneur’s Relief requires that a clear distinction is to be made between ‘business asset’ and a ‘non-business asset’. One of the biggest problems with this relief is that it is more generous for ‘business assets’ and less for ‘non-business assets’. It is almost impossible to explain why this differentiation has been made. The definition of capital assets involves cars and houses for personal use. These are the most valuable and personal assets of common people. It has often been debated whether it is right to tax the gains obtained by selling of these assets. Probably the biggest relief under capital gains is the exemption from tax on gains realized upon selling of ‘only or main residence’. However, it is not considered that sometimes, a taxpayer sells his other piece of property out of necessity. Even if a piece of property is not his ‘only or main residence’, it might be the case that capital gain tax puts him in a very difficult position. Capital gains tax does not consider the possibility of dire financial condition of the taxpayer. In a sharp contrast, a taxpayer can sell a business asset with ease without having to worry about high capital gain tax. He gets much more exemptions and deductible allowances just because the asset in question is a business asset. This situation blatantly defies the canon of equality. Capital gains tax seems to be an unfair tax overall. However, there has to be way to manipulate this tax in a better manner. It cannot be foregone altogether because the astute taxpayers would find ways to convert their incomes to capital gains or at least represent their incomes in this way. This would allow them to avoid tax completely. It would be extremely hurtful for the economy. It is possible to apply a flat rate on all capital gains and the distinction between ‘business assets’ and ‘non-business assets’ is removed. However, the flat rate can be beneficial for those paying high rates of tax and harmful for those paying low rates. Those paying low rates would have to pay a higher rate if they realize their profits as capital gains. A flat rate would be fixed and would always be subjected to this problem. Therefore, it would always be a failure, and a more subtle approach is required. Capital gains tax must be such that works in accordance with the rate of tax that each individual pays. Taxpayers should not be allowed to unfairly benefit either way. Also, they should not be unnecessarily burdened. Hence, a harmonized approach turns out to be the best solution. References Lads, D. & Chowdry M., ‘Capital Gains Tax’, Taxation Principles and Policy. 2007. Taxation of Chargeable Gains Act 1992 (UK) para 3-6 Taxation of Chargeable Gains Act 1992 (UK) s 222 Read More