Contractors, do a Rishi – and navigate the balance between income tax and CGT adeptly

In the intricate world of taxation, the financial affairs of public figures often come under scrutiny.

Prime minister Rishi Sunak, a prominent figure in UK politics, on Friday disclosed details of his income and tax payments. His tax return is here.

Let’s delve into the nuances of his financial situation, particularly focusing on the distinction between capital gains and income tax – a distinction PSC contractors would be wise to take note of, writes chartered accountant Anthony Mellor of Mellor & Co.

Overview: income tax vs. capital gains tax (CGT)

Before we dissect Rishi Sunak’s tax affairs, let’s establish a fundamental understanding of these two types of taxes:

1. Income Tax

What is it? Income tax is levied on an individual’s earnings, including salaries, wages, and other forms of income.

Rates: The UK income tax rates vary based on income levels, with higher earners paying a larger percentage.

Applicability: Everyone who earns income is subject to income tax.

2. Capital Gains Tax (CGT)

What is it? CGT is imposed on the profit made from selling assets such as property, stocks, or businesses.

Rates: The CGT rate depends on the type of asset and the individual’s overall income.

Applicability: Individuals who realise capital gains through asset sales are liable for CGT.

Rishi Sunak’s Tax Profile

1. Income Tax

Rishi Sunak’s income tax payments reveal that he paid £163,364 in tax on a total income of £432,884 during the financial year 2022-23. This aligns with the standard income tax principles applicable to all taxpayers.

2. Capital Gains Tax

Here’s where it gets interesting. Sunak’s capital gains from a US-based investment fund amounted to approximately £1.8 million.

However, his effective tax rate on this substantial capital gain was only 23%, resulting in a tax payment to HMRC of £359,2403. That seemingly low rate didn’t go down well on social media with those untrained in tax, allowances, and HMRC compliance.

But it’s a fair question - Why the low-ish CGT rate?

• Location Matters

The US-based investment fund may have potentially benefited from favourable tax treatment, impacting the overall tax liability.

• Double Taxation

Sunak’s dividends (received from UK companies) are subject to ‘double taxation.’ Let me explain - these dividends are paid out of company profits, which have already been taxed by HMRC at the corporate level (usually at 25%). The additional tax on dividends further reduces the effective return for investors, and the reduction in the tax-free dividend allowance (made under his own watch as PM) from April 6th 2024, further turns the screws on dividends.

Contractors and marginal rates

Sunak’s situation highlights the challenges faced by limited company contractors. Those earning over £50,000 may soon encounter a combined tax burden of 65% or even 70% if they hit the higher income bands.

Contractors, like Sunak, must navigate the delicate balance between income tax and CGT with common sense. Such navigating is very much required with an effective corporation tax rate of 26.5% now potentially in play.

Unsurprisingly, the former chancellor has provided a good example of efficient tax planning…

Rishi Sunak’s tax affairs provide a glimpse into the complexities of wealth management, tax planning, and the interplay between income tax and capital gains tax.

As the PM, his financial decisions are under scrutiny, but they also serve as a reflection of broader tax policies affecting all taxpayers.

In the ever-evolving landscape of taxation, understanding the fine print is crucial for both public figures and everyday contractors. Whether it’s bananas or pounds, the numbers matter, and the taxman keeps a watchful eye. Oh, and as Rishi with his accountants (Evelyn Partners), clearly recognise, effective tax ‘planning’ means acting ahead of time, so acting ‘in-year’ and way before the reporting dates and deadlines – and not least for PSCs, using pension contribution allowances.