A3.02: CAPITAL GAINS TAX (CGT)

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1 A3.02: CAPITAL GAINS TAX (CGT) SYLLABUS Application of CGT Calculation of gain and CGT rate Exempt assets Exempt disposals Withdrawal or Indexation allowance and taper relief Entrepreneurs relief Annual exemption Capital losses Payment date Application of CGT Capital gains tax (CGT) applies on disposal of most assets, though some are exempt (see below) Disposal usually means a sale, but also includes a lifetime gift, which is treated as a disposal at market value The complete destruction of an asset (eg a property) is also a disposal for CGT purposes, with the result that a loss will generally arise If the asset destroyed was covered by insurance, the amount received from the insurance policy will generally be treated as the disposal proceeds Disposals are in principle one off events rather than regular events Regular sales could imply that they are part of a pattern of trading Any gain arising from trading would be subject to income tax rather than CGT This is an area where there is considerable discretion on the part of the local Inspector of Taxes Generally, treatment as capital gains is more favourable, because of the availability of the annual exemption and the relatively low tax rate CGT does not apply to transfers on death however (though inheritance tax (IHT) may apply) Each person s disposals are treated independently and gains for tax purposes cannot be transferred, even between husband and wife or between registered civil partners For UK residents, CGT applies on disposal of any non-exempt asset, even if located overseas Calculation of gain and CGT rate The gain for CGT purposes is generally the difference between the sale proceeds, or the market price at the time of a lifetime transfer, and the acquisition cost of the asset If an asset is sold for less than the market price and the disposal is not at arm s length (ie it is to someone with a close connection to the seller), the market value is taken as the sale proceeds If an asset was held at 31 March 1982, its value at 31 March 1982 will be taken as the acquisition cost for the purposes of calculating the taxable gain

2 In the past, there have been complications in dealing with such assets, and choices regarding the establishment of the acquisition cost, but there is no longer any choice Dealing costs (on both buying and selling), such as stockbroker fees, or estate agent fees, are deductible in calculating any gain Stamp duty, stamp duty reserve tax or stamp duty land tax are all costs which increase the acquisition cost of assets to which they apply, and also reduce any gain for CGT purposes Improvement costs, for example, building an extension to a buy to let property, are also deducted in calculating the gain Revenue costs, such as routine maintenance of a property are not deducted however (they could be deducted from any rental income for income tax purposes however) For disposals on or after 23 June 2010, the rate of CGT on gains in excess of the annual exemption is 18% to the extent that the gain, when added to income, would fall within the basic rate tax band Any gain (or part of a gain) that falls above the higher rate threshold is taxed at 28% For gains arising on disposals in 2010/11 but before 23 June 2010, the rate is 18%, irrespective of income level Gains arising on disposals in 2010/11 but before 23 June 2010 do not use any part of the basic rate band for the purposes of determining the CGT rate on gains arising on disposals on or after that date The annual exemption can be set against gains arising on or after 23 June 2010 rather than those arising before, so as to reduce the amount subject to tax at 28% Where entrepreneurs relief (see below) applies, the rate of CGT is reduced to 10%, irrespective of income Exempt assets Most investments and investment products are subject to CGT on disposal This includes holding of shares, unit trusts, investment trusts and OEICs (Open-Ended Investment Companies) Property investments other than an individual s main residence (see below) are also subject to CGT However, certain assets are exempt from CGT For many people, a very important exemption is their UK main residence Private motor cars are exempt, as are gambling and lottery winnings Chattels (items of tangible moveable property) valued at no more than 6,000 are exempt, and special rules apply in calculating the gain if their value exceeds 6,000 These special rules limit the gain for tax purposes to 5/3rds of the excess of the disposal proceeds over 6,000 National Savings & Investments products and deposits are also exempt Life assurance policies in the hands of the original owner are exempt This applies to all life policies, whether qualifying or not, and whether protection orientated, (eg term assurance or whole of life) or investment orientated (eg endowment or investment bond)

3 If a life policy is purchased on the second hand market, the new owner is potentially liable for CGT on eventual disposal (whether this is a surrender, death benefit or maturity proceeds) Gilts and most fixed interest securities including qualifying corporate bonds and Building Society Permanent Interest Bearing Shares (PIBS) are also exempt However, holdings of units or shares in gilt and fixed interest unit trusts and OEICs are not exempt from CGT Exemption is two-edged in that although gains are not taxable, losses arising on exempt assets cannot be offset against other gains for CGT purposes Many exempt assets are those (such as private motors cars) where losses are more common than gains, or those (such as gilts) where gains and losses balance out over time Transfers between spouses and RCPs or on death A transfer from one spouse to the other does not trigger a CGT charge It takes place on a no gain, no loss basis, so the receiving spouse takes over the other spouse s acquisition cost and acquisition date This has the effect of transferring any gain already built up to the point of the transfer A similar situation applies to registered civil partnerships Transfers on death are exempt from CGT (though IHT may apply) Withdrawal of indexation allowance and taper relief For disposals prior to 6 April 2008, indexation allowance and/or taper relief were available in some cases to reduce the gain for tax purposes Both have been withdrawn from 6 April 2008 and are no longer relevant in calculating taxable gains Indexation allowance applied where assets were acquired before 6 April 1998, and reduced the taxable gain to reflect inflation, as measured by the Retail Prices Index (RPI) Taper relief reduced the taxable gain according to a scale which was based on the period of ownership of the asset, measured from April 1998 The effect was to reduce the taxable gain, particularly where assets were held for relatively long periods The taper relief reduction was more generous for business assets than non-business assets The removal of indexation allowance and taper relief, and the introduction of a single flat rate of tax means that the CGT liability is increased in some cases and reduced in others Entrepreneurs Relief When taper relief was available, the effective rate of tax on disposal of business assets was often as low as 10% The introduction of a single rate of 18% could therefore have been a significant disincentive for entrepreneurs As a result, a new entrepreneurs relief was introduced for disposals on or after 6 April 2008 Originally, the basis was that the relief reduced gains for tax purposes on certain disposals by 4/9ths, so that the effective rate of tax was 10% For example, if the gain was 90,000, the taxable gain would be reduced by 4/9ths ie by 40,000, to 50,000

4 Ignoring any available annual exemption, the CGT payable would be 18% of 50,000 = 9,000, which is 10% of the gain For disposals on or after 23 June 2010, the basis has changed so that the whole of the gain eligible for entrepreneurs relief (after deduction of the annual exemption) is subject to CGT at a reduced rate of 10% This simplifies the position, although it does result in a small increase in tax For example, suppose an individual crystallises a gain of 180,000, which qualifies for entrepreneurs relief On the old basis, the gain would be reduced by 4/9ths to 100,000 and the annual exemption would then be deducted leaving 100,000-10,100 = 89,900 taxable The CGT payable would be 18% = 16,182 On the new basis, the gain of 180,000 is reduced by the annual exemption to 169,900 The CGT payable is then 10% of 169,900 = 16,990 Note that any gain crystallised on or after 23 June 2010 and eligible for entrepreneurs relief is treated as using any balance of the basic rate band before any other gains, and so this may result in other gains being pushed into the 28% rate The relief applies to those who are disposing of an interest in a trading business This includes sole proprietors and partners disposing of their interest It also includes shareholders selling shares in their personal trading company To qualify, the shareholder must be an employee or officer of the company, and hold at least 5% of the ordinary shares, controlling at least 5% of the voting rights The business interest must generally have been owned for at least one year before disposal or the date the business ceases to trade Entrepreneurs relief can be claimed on qualifying gains only up to a ceiling This was originally 1m, but was increased to 2m for disposals on or after 6 April 2010, and then to 5m for disposals on or after 23 June 2010 This is a lifetime allowance and although it may be increased in future years by Treasury Order, there is no automatic increase Although the relief is useful, it is more restrictive than business assets taper relief in some ways An employee owning shares in the company which employs them would have qualified for business assets taper relief under the old rules, but can only benefit from entrepreneurs relief if they have at least a 5% shareholding Collective investments such as unit trust holdings can never qualify for entrepreneurs relief Annual exemption Each individual (irrespective of age) has an annual exemption, currently 10,100 in 2010/11, to set against their capital gains Unlike the income tax personal allowance, it is not reduced for individuals with high levels of income (or high levels of capital gain) The annual exemption is NOT transferable from one person to another, even if they are married or are registered civil partners

5 The annual exemption is applied to total net gains The exemption is a use it or lose it exemption which cannot be carried forward (or back) if not used in any particular tax year Any unused amount CANNOT be set against income Similarly, it is NOT possible for any unused amount of the income tax personal allowance to be set against capital gains The exemption can be applied against gains in whichever way results in the most favourable outcome from the taxpayer s point of view (ie results in the smallest liability) Capital losses Total losses are set against total gains in the tax year in which they arise, and the net gain is subject to CGT (after application of the annual exemption) If a net loss arises, it can be carried forward to be set against future gains In this circumstance, no use can be made of the annual exemption in the year the net loss arose Where losses are carried forward to a later year, the amount claimed in a later year can be restricted by the taxpayer, so that the effect is to reduce gains for tax purposes only to the level of the annual allowance, and no further For example, suppose an individual made two disposals in 2009/10, one resulting in a loss of 15,000, the other in a gain of 10,000 There is a net loss of 5,000 to carry forward, but the 2009/10 annual exemption has not been used In 2010/11, he makes a single disposal, resulting in a gain of 12,000 Of the carried forward loss, 1,900 is set against the gain, leaving a gain of 10,100 for tax purposes, which is fully covered by the 2010/11 annual exemption The remaining 3,100 of the carried forward loss can then be carried forward to later years There is no maximum period for which losses can be carried forward Losses cannot be carried back however As with the annual exemption, losses can be applied against gains in whichever way results in the most favourable outcome from the taxpayer s point of view (ie results in the smallest liability) Payment date CGT is due on 31 January following the end of the tax year in which the disposal occurred Thus, if a disposal is made during the 2010/11 tax year, any CGT arising is due for payment on 31 January 2012 There are no payments on account in respect of capital gains tax, so any tax liability must be paid in a single instalment