Thinktank says low rates of capital gains tax on business income do not encourage them to invest more

The chancellor, Sajid Javid, has been told by Britain’s foremost tax and spending thinktank that tax breaks for business owners give the rich an unfair advantage and fail to boost investment in the UK.

Before Javid’s first budget next month, the Institute for Fiscal Studies (IFS) said low rates of capital gains tax on business income did not encourage companies to invest more in the country but did provide large savings for company owners.

The IFS said entrepreneurs’ relief cost the government about £2.4bn a year in lost income and was not working as intended.

There have been calls in the past to scrap the relief, which gives a reduced 10% rate on capital gains tax to business owners. Javid’s predecessor Philip Hammond tweaked the policy at last year’s budget but refused to scrap it altogether, saying that it encouraged entrepreneurship.

The IFS said: “We do not find any evidence that tax-motivated retention of profits translates into more investment in business capital. If one of the aims of reduced capital gains tax rates on business assets is to incentivise individuals to invest more in their businesses, this evidence suggests they are not working.”

Publishing its analysis on Monday, the thinktank said the policy had helped wealthy business owners avoid higher rates of income tax by paying themselves through their companies.

It said the policy was unfair in that it favoured those who were able to save their income within a company, as they could draw dividends from their business and pay taxes at lower rates than on income. “Lower rates of tax on business income produce large benefits that disproportionately accrue to the rich,” the IFS added.

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First introduced by Labour under Gordon Brown a decade ago, and then aggressively expanded by the Conservatives, entrepreneurs’ relief is designed to encourage people to start small businesses. Although the policy was designed to cost the Treasury up to £200m a year, a greater than expected take-up and expansion under George Osborne, when chancellor, has led it to cost more than 10 times that each year.

John McDonnell, the shadow chancellor, said: “The Conservatives’ tax system seems to have been designed to benefit the rich, and the IFS has made clear that it isn’t leading to increased investment either.

“Labour opposed the Conservatives’ cuts to capital gains tax: in government we will create a progressive tax system that does not hand out billions to the wealthiest in society.”