Hiking capital gains tax would harm small businesses

A blanket increase in CGT rates would not only affect gains on publicly quoted stocks or investments in second homes, it could also impact investors who have taken much more significant risks with their capital to back small, growing companies to achieve their potential, says Claire Madden

It’s looking inevitable that Labour will win the forthcoming general election, but while there’s almost no doubt about the result, there’s still plenty of uncertainty over what it will mean for business investment – notably in small and medium-sized enterprises (SMEs) that power the UK economy.

After ruling out increasing income tax, VAT and  national insurance (NI), Labour has left the possibility of hiking capital gains tax (CGT) wide open. On the face of it, there are good reasons to do so: public sector investment is in dire need of a boost and any future government must raise the money somehow. Plus, CGT is perceived by many as something that only affects the wealthy, so it won’t scare away many floating voters.

Nothing is ever that simple, though. A blanket increase in CGT rates would not only affect gains on publicly quoted stocks or investments in second homes, it could also impact investors who have taken much more significant risks with their capital to back small, growing companies to achieve their potential. If they can’t enjoy the proceeds, there’s no compelling reason for people to put their cash at stake in this way.

Indeed, early results of recent research we conducted among high net worth private investors suggests that almost half (49 per cent) would reduce their allocations to equities (public as well as private) if CGT was equalised with income tax, as has been mooted.

This could be disastrous for SMEs, who often find it hard to access funding from traditional sources on terms that suit their needs. Private capital is filling the gap. Figures from the British Venture Capital Association (BVCA)  show that private capital investors supported 1,500 UK businesses to the tune of over £20bn last year, and nine in ten were SMEs. Well over a quarter (29 per cent) of the total UK private equity and venture capital funds raised came from private individuals – the very people who would be hit by a CGT rise if it come into force.

Entrepreneurs would also have reason to think twice about putting in long hours and making all the personal sacrifices needed to build their businesses, taking on more risk by opening new offices or employing more people, if they weren’t going to be adequately rewarded for their success later on.

Is it even worth it? Ironically, a rise in CGT could in fact cause tax receipts to decline, HMRC forecasts have suggested. Its estimates indicate that a 10 percentage point increase in the higher rate could decrease the tax take by £170m in 2024-25, £1.1bn in 2025-26 and £2.1bn the following year. Not good news for Labour’s public spending plans.

A decline in business investment could throw the future of UK SMEs in doubt, and with it their ability to create jobs and contribute in a meaningful way to tax receipts through corporation tax, NI and employee’s income taxes. Given that SMEs account for three-fifths of the employment and around half of turnover in the UK private sector, according to the Federation of Small Businesses , that could end up hurting us all.

Claire Madden is managing partner at Connection Capital