What Is the Difference Between Capital Gains Tax and Income Tax

This guide explains the difference between Capital Gains Tax and Income Tax including what each tax applies to, how rates differ, and how they interact.

Capital Gains Tax and Income Tax are two of the main taxes individuals pay in the UK. Both affect how much tax you owe but they apply to very different types of income and gains. Understanding the difference is essential when planning your finances because the two taxes work differently, have different allowances, use different rates, and follow different reporting rules. In my opinion learning the distinction helps you avoid mistakes, reduce your tax bill legally, and confidently manage investments, property, or self employed income.

This guide explains what Capital Gains Tax is, what Income Tax is, how they differ, when each applies, how they interact with each other, and how to work out which tax you owe. It also covers the most common scenarios where people confuse the two, such as selling assets, receiving dividends, running a business, or renting out property.

What Is Income Tax

Income Tax is a tax on money you earn. This includes income from work, business, pensions, property, savings, and certain benefits.

You pay Income Tax on:

  • Salary or wages

  • Bonuses

  • Overtime

  • Commission

  • Self employed profits

  • Rental profits

  • Dividends

  • Interest and savings income

  • Pension income

  • Some benefits from your employer

  • Some employment benefits in kind

  • Trust income

  • Foreign income

Income Tax is calculated each tax year from 6 April to 5 April.

It does not apply to:

  • ISA interest or dividends

  • Lottery winnings

  • Premium Bond prizes

  • Personal gifts

  • Child Benefit

  • Pension lump sums up to 25 percent

  • Capital gains from selling assets

Income Tax is usually collected through PAYE for employees or through Self Assessment for people with other income such as dividends or rental income.

What Is Capital Gains Tax

Capital Gains Tax (CGT) is a tax on profit you make when you sell or dispose of an asset. It applies when you sell something for more than you paid for it.

You pay CGT on gains from:

  • Shares and investments outside ISAs or pensions

  • Second homes

  • Buy to let property

  • Valuable jewellery

  • Art, antiques, and collectibles

  • Cryptoassets

  • Business assets

  • Land

  • Certain personal possessions worth more than £6,000

CGT is based on the gain not the amount you receive. If you bought an asset for £2,000 and sold it for £5,000 your gain is £3,000.

It does not apply to:

  • Your main home (if fully eligible for Private Residence Relief)

  • Cars for personal use

  • ISAs

  • Pensions

  • Personal items worth £6,000 or less (chattels rule)

  • Certain UK government bonds

  • Gifts between spouses or civil partners

CGT is reported through Self Assessment or through HMRC’s real time CGT service.

The Core Difference Between Income Tax and Capital Gains Tax

The simplest difference is:

Income Tax is paid on income.
Capital Gains Tax is paid on profits from selling assets.

Income Tax applies to money that comes into your household.
CGT applies when the value of something you own increases and you dispose of it.

The two taxes overlap because selling an asset can push your income into a higher tax band which can change your CGT rate.

In my opinion the biggest mistake people make is assuming CGT works the same as Income Tax. The processes are completely different.

The Allowances for Each Tax

Both taxes have annual allowances but they are very different in size and purpose.

Income Tax allowances

  • Personal Allowance: £12,570
    This is the amount of income you can earn before paying Income Tax.

  • Savings Allowance: £1,000 for basic rate taxpayers, £500 for higher rate taxpayers
    This reduces tax on interest.

  • Dividend Allowance: £500
    Reduces tax on dividend income.

  • Marriage Allowance: Transferable portion of the personal allowance in certain cases.

Capital Gains Tax allowance

  • Annual CGT Exemption: £3,000
    This allows you to make gains up to £3,000 tax free in each tax year.

There is no separate savings allowance or dividend allowance for CGT. It is a single annual exemption.

Income Tax allowances are about supporting everyday living.
CGT allowances are about reducing tax on investment gains.

The Tax Rates for Each Tax

Income Tax and CGT use different tax rates depending on your income level and type of income.

Income Tax rates (England, Wales, NI)

  • Basic rate: 20 percent

  • Higher rate: 40 percent

  • Additional rate: 45 percent

Dividends have their own rates:

  • Basic rate: 8.75 percent

  • Higher rate: 33.75 percent

  • Additional rate: 39.35 percent

Capital Gains Tax rates

CGT rates depend on the asset being sold and your Income Tax band.

Shares and investments

  • 10 percent for basic rate taxpayers

  • 20 percent for higher rate and additional rate taxpayers

Residential property (second homes, buy to let)

  • 18 percent for basic rate taxpayers

  • 24 percent for higher rate and additional rate taxpayers

Other chargeable assets

  • 10 percent or 20 percent depending on income

CGT rates are generally much lower than Income Tax which is why people prefer capital gains to income when planning investments.

How the Two Taxes Interact

Although they are separate taxes your Income Tax band affects your Capital Gains Tax rate.

This is because gains are added on top of your taxable income to work out your CGT band.

Example

Income: £40,000
Taxable gain: £10,000
£10,270 of basic rate band remains.
£10,000 gain fits in that band.
CGT rate for shares = 10 percent.

Another example
Income: £50,000
Taxable gain: £20,000
£270 left in the basic rate band.
£270 taxed at 10 percent.
£19,730 taxed at 20 percent.

Income Tax affects CGT but CGT does not affect Income Tax.

How They Are Reported

Income Tax

Collected through:

  • PAYE

  • Self Assessment

  • Tax code adjustments

Capital Gains Tax

Reported through:

  • Self Assessment
    or

  • Real time Capital Gains Tax service

Property CGT must be paid within 60 days of sale.

Income Tax is usually paid monthly or annually.
CGT can be paid immediately or with your annual return depending on the asset.

Do They Ever Both Apply to the Same Asset

Sometimes an asset produces income as well as gains.

Examples include:

Rental property

  • Rental income is subject to Income Tax

  • Selling the property for profit triggers CGT

Shares

  • Dividends are subject to Income Tax

  • Selling the shares triggers CGT

Business assets

  • Profits are subject to Income Tax

  • Selling the business triggers CGT

In my opinion this dual treatment is what confuses most people.

How Losses Are Treated

Income Tax

You cannot offset losses from one type of income against another unless you are trading.
Employment income cannot be offset against trading losses.

Capital Gains Tax

Capital losses can be offset against capital gains.
Unused capital losses can be carried forward indefinitely.

Income Tax losses follow strict rules.
CGT losses are far more flexible.

Examples That Explain the Difference Clearly

Example 1: Selling shares

Profit of £5,000.
Income Tax due: none.
CGT due: possibly depending on allowance.

Example 2: Receiving dividends

Dividends of £5,000.
Income Tax applies.
CGT does not apply.

Example 3: Selling a buy to let

Gain: £40,000.
CGT due.
Rental income taxed separately under Income Tax.

Example 4: Selling your main home

Gain: £100,000.
No CGT due because of Private Residence Relief.
Income Tax does not apply.

Example 5: Being self employed

Profit of £30,000.
Income Tax applies.
CGT not relevant.

These examples show the difference in a practical way.

Common Misunderstandings

Misunderstanding 1: “If I pay Income Tax I do not pay CGT”

Wrong. They apply to different things.

Misunderstanding 2: “I pay CGT on all shares”

Wrong. Shares in ISAs are exempt.

Misunderstanding 3: “CGT is based on total sale proceeds”

Wrong. It is based on profit.

Misunderstanding 4: “I pay CGT on income from stocks”

Wrong. Dividends are income not gains.

Misunderstanding 5: “I pay CGT on my main home”

Wrong if it is fully covered by Private Residence Relief.

Misunderstanding 6: “CGT only applies if I receive the cash”

Wrong. Transfers and gifts count as disposals.

Final Thoughts

The difference between Capital Gains Tax and Income Tax is straightforward once you understand what each tax applies to. Income Tax covers money you earn. Capital Gains Tax covers profit you make when disposing of assets. They have different allowances, different rates, different exemptions, and different reporting rules. However your Income Tax band influences your CGT rate which means both taxes interact.

In my opinion anyone who invests, owns a second property, receives dividends, or runs a business should understand both taxes clearly. Doing so helps you avoid unexpectedly high tax bills, make better use of exemptions, and plan your finances in a smarter, more tax efficient way.