2020 INNOVATION TRAINING. Capital Taxes Update and Planning. 26 September 2016

Transcription

1 2020 INNOVATION TRAINING Capital Taxes Update and Planning 26 September 2016 Martyn Ingles FCA CTA Ingles Tax and Training Ltd No responsibility for loss occasioned to any person acting or refraining from action as a result of the material in these notes can be accepted by the author or 2020 Innovation Training Limited 2020 Innovation Training Limited 6110 Knights Court Solihull Parkway Birmingham Business Park Birmingham B37 7WY Tel. +44 (0) Fax +44 (0) info@the2020group.com Website: Capital Taxes Update and Planning September 2016 Page 1

2 Capital Taxes Update and Planning 1. PRINCIPAL PRIVATE RESIDENCE EXEMPTION Basic Rules Periods of non-occupation Letting Relief Election where there is more than one main residence Test of residence for PPR The garden and grounds Married couples and Principal private residences Availability of relief to Trusts and Estates Capital Gains on Non-Residents from 2015/ GIFT RELIEF Gift of business assets (Holdover)(s165 TCGA 1992) Restriction by non businesses assets Gifts on which there is an immediate IHT charge (s260 TCGA) Self settlement anti-avoidance REPLACEMENT OF BUSINESS ASSETS (ROLLOVER) Introduction Used in Trade Qualifying Assets Groups of Companies Reinvestment in Depreciating Assets CGT RELIEF ON INCORPORATION Entrepreneurs relief restricted on incorporation Impact of new lower CGT rates from 2016/ Alternative strategies on incorporation Relief under Section 162, TCGA 1992 (incorporation relief) Relief under Section 165 TCGA 1992 (gift of business assets) CGT incorporation relief on property transfers SECURING 10% TAX ON THE SALE OF THE BUSINESS Overview of Entrepreneurs relief Entrepreneurs Relief - Disposal of shares Meaning of trading company and trading group Business Premises owned outside the company Entrepreneurs relief: contrived structures Recent Cases Involving Entrepreneurs Relief LIQUIDATIONS AND OTHER CAPITAL DISTRIBUTIONS A distribution made in a winding-up A repayment of share capital (including share premium) Purchases of own shares (for unquoted companies) New Legislation in Finance Act HMRC response to non-statutory clearance applications CAPITAL TAX PLANNING USING EIS AND SEED EIS Overview of Enterprise Investment Scheme (EIS) Qualifying Trading Company Qualifying individuals for EIS Capital Taxes Update and Planning September 2016 Page 2

3 7.4 Seed EIS (SEIS) Paying 20% CGT Instead Of 28% On The Sale Of Property CAPITAL GAINS BY COMPANIES Substantial shareholdings exemption Meaning of trading company and trading group The subsidiary exemptions Transfers within a 75% Group Appropriation to and from trading stock IHT REFRESHER AND BASIC PLANNING Inheritance Tax Overview Take Advantage of Lifetime Exemptions Inheritance Tax on gifts between spouses Reduced IHT rate if leave 10% to charity Gifts out of Income? Potentially Exempt Transfers (PETs) Chargeable Lifetime Transfers Cumulation Interaction of Lifetime and Death Rates Inheritance tax taper relief Transfer of the IHT Nil Rate Band to Spouse Additional Main Residence Nil Rate Band (RNRB) Downsizing Business Property Relief Danger Areas Regarding Business Property Relief DISCLAIMER AND COPYRIGHT No responsibility for loss occasioned to any person's action or refraining from action as a result of reliance upon any information in the material can be accepted by the speaker. Tax legislation and case law are complicated and these course notes should not be regarded as offering a complete explanation of every topic covered. Capital Taxes Update and Planning September 2016 Page 3

4 1. PRINCIPAL PRIVATE RESIDENCE EXEMPTION 1.1 Basic Rules An individual is exempt from capital gains tax on all or part of a gain on the disposal of his only or main residence. The exemption applies to the disposal of, or of an interest in: a dwelling house or part of a dwelling house which is, or has at any time in his period of ownership been, his only or main residence, or land which he has for his own occupation and enjoyment with that residence as its garden or grounds In certain circumstances trustees may claim exemption for the only or main residence of a beneficiary under a settlement (see below). The exemption may also apply to separate buildings in the grounds of the dwelling house such as a bungalow built on the land as a residence for the caretaker of the house and his wife physically separate from the main house. On its ultimate sale it was held that the gain on the bungalow was tax free as in its ordinary usage, the word dwelling house or residence could comprise several buildings not physically joined together and a staff flat with its own access could accurately be described as part of the larger house. In Batey v Wakefield (1981) Fox LJ stated:... what one is looking for is the entity which in fact constitutes the residence of the taxpayer. The bungalow comprised part of that entity, thus the capital gains tax exemption applied on the sale of it. Exemption is also extended to a dwelling house owned by an individual who lives in job-related accommodation but intends to live in the house in the future. 1.2 Periods of non-occupation Where the house has been the owner s only or main residence throughout the whole period of ownership, the exemption will extend to the whole of any gain arising on disposal. For this purpose the benefit of the exemption extends in respect of any part of the last 18 months (36 months up to 5 April 2014) of ownership, even though the house had then ceased to be used as a residence by the owner. This provision is to allow a reasonable time for the old residence to be sold having acquired a new residence. In respect of disposals after 5 April 1988, any period of ownership before 31 March 1982 is ignored. Certain other periods of absence from the property may also be ignored in computing the period to which the exemption applies. In three cases periods of absence are disregarded and the house is still regarded as the individual s only or main residence as long as he occupied it as such at some time both before and after the period. In these three cases period of absence means a period during which the house was not the individual s only or main residence and throughout which he had no residence or main residence eligible for relief. a) a single period of absence up to a maximum of three years, or shorter periods of absence which do not exceed a total of three years for any reason; b) any period of absence, however long, provided that throughout the whole period of absence the individual worked in an employment or office, all the duties of which he performed abroad. c) a period of absence up to a maximum of four years, whether at one time, or spread over different periods of absence totalling in all not more than four years, during which the individual was prevented from residing in his house in consequence of the individual being required to work elsewhere in the UK. Capital Taxes Update and Planning September 2016 Page 4

5 1.3 Letting Relief The exemption for gains on the disposal of an only or main residence is extended where the owner has let all or part of the dwelling house as residential accommodation. The chargeable gain is reduced by the lesser of: an amount equal to the exemption of the gain in respect of occupation by the owner, and the gain attributable to the let period, not otherwise exempted, and 40,000 This additional exemption applies to gains arising from a residential letting of the entire residence, that is, to periods of non-occupation by the owner, as well as to lettings of part of the residence whilst the owner is still in occupation. There is no requirement for the owner to reoccupy it as a main residence following the period of letting. 1.4 Election where there is more than one main residence Generally a taxpayer can only have one main residence in respect of which a claim for exemption can be made. Where a person has two or more residences, such as a house or flat in a town and another dwelling in the country or elsewhere, the question as to which is his main residence may not be easy to decide. The question of fact will still arise even where one residence is owned and another one is rented. For this purpose the owner may conclude the matter himself, by making an election stating which one is his main residence, and the period during which it has been his main residence. In the event that no such notice is given, the inspector may make a determination of which dwelling house is the main residence, either for the whole period of ownership or for specified parts of it. The notice must be served within two years of the beginning of the period to which the notice relates. The interpretation of this time limit has been considered in Griffin v Craig-Harvey, where the dispute centred on the period referred to in the phrase beginning of that period. It was held that the period referred to is the period of ownership of the two or more properties concerned, so that the two-year period begins to run from the time when it first becomes necessary for the inspector to decide, subject to election by the taxpayer, which of two or more residences is the taxpayer s main residence. A notice once served may be subsequently varied by serving a further notice as the occasion arises (as for instance, when a new residence is acquired) but such a notice should be served within two years of the occurrence of the change; if it is served later, it only has effect in respect of a period beginning two years before its service. This election, in conjunction with the rule concerning the last 36 months provided an interesting planning opportunity as illustrated in the Inland Revenue s Capital Gains Tax Manual, now updated for the current 18 month period: Example 1 (based on HMRC example) The example given is of George who own two houses Surbiton and Devon. He makes an election in favour of Surbiton as his main residence within the time limit. He then sold his Devon house on 1 January 2015 for a big gain. Now he s made his election for Surbiton so if he doesn t do anything, that substantial gain on Devon is going to be taxable. So what he does is that on the Capital Taxes Update and Planning September 2016 Page 5

6 1 st of February 2015 he varies his election in favour of Surbiton onto the Devon property and he backdates that variation by 2 years. The election made on Devon on 1 st February 2015 is effective as from 1 st February Then he varies his election a week later on the 15 th February and switches it back to Surbiton. But the last 18 months of ownership of the Devon house is now exempt. So if he owned the Devon property for 4 ½ years he s exempted a third of the gain by making the election plus any period of actual residence before then. The price of his doing that is simply to de-exempt the Surbiton property for that 2 week period while the election was in force. This is officially approved planning for tax avoidance (and used by MPs!) Note that only the last 18 months would qualify where the disposal is on or after 6 April Test of residence for PPR There must be actual residence of the second property, what does that mean? The CGT Manual gives the following guidance to inspectors: The test of residence is one of quality rather than quantity of occupation. A dwelling house must have become its owner s home. So no minimum qualifying period of occupation can be relied upon to constitute residence. This point was expressed by Millett J in Moore v Thompson (61TC15) in the following terms. `It is clear that the Commissioners were alive to the fact that even occasional and short residence in a place can make that a residence; but the question was one of fact and degree for the Commissioners'. Every case must be decided on its own facts. Under the Representation of the People Act 1948 entitlement to vote in Parliamentary elections is given to persons resident in a constituency on a qualifying date. In Fox v Stirk, Ricketts v Registration Officer for the City of Cambridge [1970] 3 All ER 7 the Court of Appeal considered whether students should be regarded as resident in the constituency of the University they attended. Lord Denning M.R. commented that `I derive three principles. The first principle is that a man can have two residences. He can have a flat in London and a house in the country. He is resident in both. The second principle is that temporary presence at an address does not make a man resident there. A guest who comes for the weekend is not resident. A short stay visitor is not resident. The third principle is that temporary absence does not deprive a person of his residence. If he happens to be away for a holiday or away for the weekend or in hospital, he does not lose his residence on that account'. Lord Widgery commented that `This conception of residence is of the place where a man is based or where he continues to live, the place where he sleeps and shelters and has his home' CGT Private Residence Relief Quality of Residence A recent First Tier Tribunal case considered this concept of quality of residence. Mr Springthorpe (S) was divorced in He sold his former matrimonial home in November 1998 and began staying with his brother. In November 1999 he purchased a house which was in very poor condition. He began renovating it and in July 2000 he let it to students. He sold it in M Springthorpe v HMRC TC 832 Capital Taxes Update and Planning September 2016 Page 6

7 HMRC formed the opinion that the house had never been S's principal private residence and issued an amendment to S's self-assessment for 2005/06. S appealed, contending that the house had been his principal private residence between November 1999 and July 2000, when he began living with a widow. The First-Tier Tribunal dismissed S's appeal, finding that he had 'failed to discharge the burden of proof' that he had occupied the house as his residence. The Judge observed that the electricity bills had been minimal, there had been no cooking facilities, and 'the gas had been switched off until March 2000 with the result that there was no hot water available for washing'. To the extent that S had occupied the house, 'he did so for the purpose of renovating the property rather than occupying it as his home which he expected to occupy with some degree of continuity'. 1.6 The garden and grounds What amount of garden and grounds that is covered by the exemption has been the subject of much case law over the years. The legislation specifies an area (inclusive of the site of the dwelling house) of up to 0 5 of a hectare or such larger area as the Commissioners concerned may in any particular case determine, on being satisfied that, regard being had to the size and character of the dwelling house, the larger area is required for its reasonable enjoyment. It is this second limb within the legislation that is open to interpretation by the courts. In Lewis v Rook (1992) the issue on appeal was whether a gardener s cottage situated 175 metres from the main house on an estate of 10 5 acres was part of the taxpayer s dwelling house for the purposes of the principal private residence exemption. The Court of Appeal approved the close proximity test referred to in Batey v Wakefield and held that the test to be applied was whether the cottage was appurtenant to and within the curtilage of the main house, so as to be part of the entity which, together with the main house, constituted the taxpayer s dwelling house. In this case the cottage did not meet those criteria and the principal private residence exemption was therefore not available in respect of the gain on its sale Sale of part of the garden Care needs to be taken when it comes to the sale of part of the garden, and as with many transactions the timing of the transactions can have a significant impact on the taxation treatment. It has been held that as far as the inclusion of the garden and grounds is concerned, the provisions look only to the present and provide, in relation to land, an exemption where there is occupation of the garden at the moment of the disposal and not where it is disposed of at a time when the taxpayer no longer owns the house to which the garden is attached. (Varty v Lynes (1976)) The garden and grounds up to half a hectare qualify automatically and without any further conditions provided that they re sold off either with the house or before the house is sold. The one problem area is where there s firstly a disposal of the house and then subsequently a disposal of land within the half hectare. In those circumstances the exemption does not apply to the land because at the time of the disposal it is not in use for the purposes of the house as a residence Curtilage The case of Skerrits v Dept. of Environment (2001) concerned whether a stable block 200 yards from the main mansion house was within the curtilage of that property. In that case everything depended upon the layout of the particular buildings and also their design. So there are questions here of unity of design and concept and also to a degree of proximity but the court held that on those facts there was no difficulty in saying that the stable block 200 yards away from the mansion fell within the curtilage of the mansion. Capital Taxes Update and Planning September 2016 Page 7

8 1.6.3 Grounds in excess of 0.5 hectares Where the gardens and grounds exceed 0.5 hectares it is important to assemble appropriate evidence to support the view that it is required for reasonable use or enjoyment. There it s a question of getting suitable evidence, usually from estate agents, as to the desirability of the house with or without that additional area of land, and here it has to be stressed that the test is that one looks to the character of the dwelling house. The recent case of Longson v Baker (2001) concerned the denial of relief in respect of the paddocks surrounding a large property. Although it was agreed that the exemption applied to the stables and outbuildings the Court regarded the 7.5 hectares of paddock land as rather more than is required for the reasonable enjoyment of the property having regard to its size and character as permitted by S222(3) TCGA The Revenue s position is that in all cases where land is sold for comprehensive redevelopment, that is to say the existing house is levelled and the entirety is redeveloped - 8 houses to the acre or whatever it is - their position is that one simply spreads the consideration evenly over the entirety, so that the apportionment is purely by acreage. Apportionment involves looking at the separate values of the parts comprised in the disposal and deciding how the totality should be split between them. One should have regard to features such as ransom strips and in many experts views the Revenue s steadfast resistance to the concept of differential apportionment is misguided. 1.7 Married couples and Principal private residences Spouses (and now civil partners) are normally able to have only one residence between them which can qualify for relief from CGT on the disposal of a "principal private residence". Thus when a couple marry and each have their own residence they will either move into one of the two residences or purchase a new matrimonial home for their joint occupation. This means that the main residence exemption will no longer apply in respect of one or more of those properties. Note that where the property has been the main residence of the taxpayer in the past the last 3 years will continue to attract the exemption and consideration should be given to disposing of the property within the 3 year period for the gain to completely exempted. Another method of sheltering this gain would be to let the property to take advantage of letting relief of up to 40, Main residences following separation When a couple separate the family home will cease to be the main residence of the spouse who leaves it. His or her share on any calculated gain on subsequent sale will be chargeable to the extent that it relates to the period of non-residence. Again the last 36 month rule would be relevant here even if the departing spouse acquires a new residence. There is an important Inland Revenue Concession D6 covering absences of more than 3 years following separation or divorce, but this only applies where the property is eventually transferred to the spouse remaining in it as part of the financial settlement, and an election has not been made for a new qualifying main residence by the spouse moving out in the meantime. The private residence exemption can be preserved on divorce if a court order known as a Mesher order is made, under which the sale of the home is postponed, with a spouse and children remaining in occupation until a specified event, such as the children reaching a specified age or ceasing full-time education. This is treated as a trust, and occupation of the property by a trust beneficiary qualifies for the private residence exemption. Thus on the sale of the Capital Taxes Update and Planning September 2016 Page 8

9 family home by the trustees the resulting gain would be covered by the private residence exemption. 1.8 Availability of relief to Trusts and Estates Trustees can also claim principal private residence relief under the terms of s225 of TCGA The exemption applies to gains accruing to trustees on the disposal of a house if during the period of their ownership of it the house has been occupied as his or her only or main residence by a person entitled to occupy it under the terms of the settlement. Previous advice would always be that any new settlement drafted contains express wording allowing beneficiaries to occupy the property in this way. Where a beneficiary is in such occupation of settled property as his only or main residence, the notice of selection of the house to be the beneficiary s main residence, must be a joint notice signed by the beneficiary and the trustees. For example, a taxpayer has had a main residence and intends to sell it shortly. He can let it for up to 3 years before sale without jeopardising his main residence relief by using the last 36 month rule. But if he could not find a buyer by the end of the 3 year period the classic advice would have been to transfer it to the trustees of a life interest settlement for himself to avoid losing the relief. That transfer would have triggered a disposal which would not give rise to a chargeable gain by virtue of the last 36 month rule, the trustees would then take on the property at the then current market value and a buyer could be found within the next few months. And hopefully there would be little, if any, additional gain which would be triggered by the trustees on the subsequent sale. Another planning point concerning trusts is where a property standing at a large potential gain is transferred to a settlement for the benefit of the children who would occupy the property as main residence under the terms of the settlement whilst studying at university for example. The classic advice would be for the couple to create a discretionary trust then make a gift of the flat to the trustees on terms that allow a beneficiary to occupy it and of course their son would be one of the beneficiaries and they would be also included. Son then moves in, makes the flat his home while he s in London. The parents would make a holdover election for capital gains tax purposes, so they d pass the gain from having bought the flat to the date of the gift into the trust. The trustees would then sell the flat that has been the main residence of a beneficiary, so the special trust relief is due and that covers the gain the trustees themselves have made, plus the heldover gain from the parents, there was previously nothing to stop that and therefore the whole of the actual gain from the date when the flat was first bought would have been exempt because it s been the main residence of the beneficiary. After that, assuming the trust has got the right powers, then the trustees could appoint the cash out to the parents or the children as required as a capital distribution. Unfortunately the type of planning outlined above which made use of the private residence relief available to trustees was blocked from 10 December The effect of the new provisions is that private residence relief will not be available in certain circumstances where the disposal in question is made on or after 10th December 2003 by an individual or the trustees of a settlement. These circumstances arise where the computation of the amount of any gain arising on the disposal has to take account of gifts relief obtained under section 260 of the TCGA in respect of an earlier disposal. 1.9 Capital Gains on Non-Residents from 2015/16 At Autumn Statement 2013 the Government announced that it will charge capital gains tax (CGT) on gains made by non-residents disposing of UK residential property, from April The charge came into effect in April 2015 and applies only to gains arising from that date. Capital Taxes Update and Planning September 2016 Page 9

10 Unlike other countries that collect tax on gains relating to disposals of residential property located within their jurisdiction, the UK does not generally charge CGT on disposals by non-residents. This means that any gain made by a non-resident individual on UK residential property is either taxed in the individual s country of residence, or not taxed at all. In contrast, UK resident individuals are subject to CGT on disposals of any residential property that is not their primary residence, including on the gains made on any residential property they own abroad. The taxation of gains made on residential property that is owned in other ways by UK persons through trusts, companies and funds is either subject to UK CGT, or UK corporation tax (CT), depending on the nature of the investment and the structure involved Non-UK Resident CGT Charge Following consultation in summer 2014 the Government has legislated that from 6 April 2015 non-uk resident individuals, trusts, personal representatives and narrowly controlled (close) companies will be subject to Capital Gains Tax (CGT) on gains accruing on the disposal of UK residential property on or after that date. This has been legislated in section 37 and Schedule 7 to Finance Act Non-resident individuals will be subject to tax at the same rates as UK taxpayers (28% or 18% on gains above the annual exempt amount). Non-resident companies will be subject to tax at the same rates as UK corporates (20%) and will have access to an indexation allowance. In order to calculate the amount chargeable the gain will be computed with reference to the market value at 6 April Alternatively it will also be possible to elect to compute the gain on a time-apportioned basis with only the post 6 April 2015 portion being chargeable. Example 2 Frau Merkel lives in Germany but bought a holiday cottage in England in April 2005 for 500,000 which she uses for 2 weeks a year. She sells the cottage in April 2020 for 650,000. The market value of the cottage on 6 April 2015 was 550,000. The gain computed with reference to 6 April 2015 value was 100,000. The time apportioned gain based on cost was 150,000 x 5/15 = 50,000 An election to use the time apportionment basis is thus beneficial Private residence relief for non-residents the 90 day test In order to limit the availability of private residence relief on the disposal of residential property by non-residents, from 6 April 2015 an individual will only be able to claim private residence relief on a property situated in a territory in which they are not resident if they have spent at least 90 days in the property during the tax year concerned. Like the statutory residence test days are counted based on occupation at midnight, referred to by some as the Cinderella test. For married couples the 90 day occupation rule will be based on their combined period of occupation during the tax year concerned, although it will not be possible to count the same day twice. Full details are set out in section 39 and Schedule 9 to Finance Act Note that this change will affect UK residents who claim PPR against a foreign property, as well as non-residents disposing of UK residential property. Capital Taxes Update and Planning September 2016 Page 10

11 2. GIFT RELIEF 2.1 Gift of business assets (Holdover)(s165 TCGA 1992) Up until 13 March 1989 there was a general relief for gifts of any asset. This was replaced by a requirement that the asset concerned was a business asset. The relief applies where the transferor (individual or trustee) makes a disposal other than at arms length to a transferee, and the two parties make a joint claim for the gain to be held over. Where the transferee are the trustees of a settlement only the settler is required to sign the claim. An asset is eligible for hold over relief if either it is, or is an interest in, an asset used for the purposes of a trade, profession or vocation carried on by the transferor, his personal company or a member of a trading group of which the holding company is his personal company), or it consists of shares or securities of a trading company, or of the holding company of a trading group, where either the shares etc. are neither listed on a recognised stock exchange nor dealt in on the Unlisted Securities Market (now closed) or the trading company or holding company is the transferor s personal company. For these purposes, an individual s personal company is a company the voting rights in which are exercisable, as to not less than 5%, by that individual. For 2003/04 onwards, trading group, holding company and trading company have the same meanings for these purposes as they do for the purposes of taper relief, now entrepreneurs relief. For 2002/03 and earlier years, they had the same meanings as for the purposes of retirement relief. Hold over relief is no longer available where the disposal is a transfer of shares or securities after 8 November 1999, and the transferee is a company. (For disposals between 6 April 2003 and 20 October 2003 this anti-avoidance measure was inadvertently repealed but reinstated by Finance Act 2004) Where the disposal is at an undervalue and some consideration is received by the transferor, the amount of consideration received that exceeds the original cost of the asset cannot be held over but is chargeable (less taper) on the transferor. 2.2 Restriction by non businesses assets In the case where the shares gifted comprise the individual s personal company, or the shareholding is 25% or more, the amount of gain that may be held over is restricted to the following proportion: Market value chargeable business assets (CBA) Market value chargeable assets (CA) Thus where the company has significant investments not being held for trading purposes it may not be possible to hold over the entire gain, which may result in capital gains tax being payable. Traditionally goodwill has been treated as one of the company s chargeable business assets, however since the intangible fixed assets regime was introduced by Schedule 29 Finance Act 2002 new goodwill created or acquired on or after 1 April 2002 is no longer treated as a chargeable asset. This can have a significant impact on the MV CBA fraction. Example 3 Mr Bloggs, who owned 55% of the shares in Bloggs Trading Ltd, gave his son Joe a 10% shareholding reducing his shareholding to 45%. Capital Taxes Update and Planning September 2016 Page 11

12 The market value of the company s assets were as follows: Freehold factory and office 300,000 Fixed plant and machinery 50,000 Goodwill 1,250,000 Investment property 150,000 Other net assets (non chargeable) 250,000 Total market value of business 2,000,000 If the goodwill of the business is old pre 1 April 2002 goodwill the MV CBA restriction would be: MV Factory, offices, plant plus goodwill = 1,600,000 MV Factory, offices, plant, goodwill and investments = 1,750,000 i.e. 91.4% However, if the goodwill of the business is new post 1 April 2002 goodwill the MV CBA restriction would be: MV Factory, offices plus plant = 350,000 MV Factory, offices, plant and investments = 500,000 i.e. 70% If the 10% shareholding was worth say 40,000 and the shares had a base cost of 10 Mr Bloggs would have a gain of 39,990. If the goodwill is old goodwill the gain held over by s165 would be 36,551, leaving 3,439 chargeable. If the goodwill is new the gain chargeable would be 11,997. The resulting gain would be eligible for entrepreneur s relief but nevertheless a small amount of capital gains tax would be payable where the goodwill is new goodwill. 2.3 Gifts on which there is an immediate IHT charge (s260 TCGA) This provision provides for the resulting gain on the transfer of any asset to be held over in circumstances where there is an immediate charge to inheritance tax. The most common example is where the transfer is to or out of a discretionary trust although Finance Act 2006 has extended this to most lifetime transfers of assets to trust, including A&M settlements and interest in possession trusts, previously treated as PETs. (The only exception now would be transfers to a trust for a disabled person). Note that the relief is still available where no inheritance liability results, for example where the value transferred falls within the nil rate band. Relief is available under s260 TCGA 1992 for disposals to the trustees or by trustees where the transfer is a chargeable transfer within the meaning of the Inheritance Tax Act This relief can be used where the asset transferred does not qualify for gift of business holdover under s165 TCGA, for example a plot of land, a second home, or a buy to let property. Example 4 Cliff owns an investment property which cost 60,000 in 1995 and is currently valued at 300,000. He wishes to transfer the property to his adult daughter Elizabeth but transferring the property would result in a 240,000 capital gain and a substantial CGT liability as he is a higher rate taxpayer. One alternative would be to transfer the property to a trust for the benefit of Elizabeth. Such a transfer would be chargeable to inheritance tax but as the value falls within the 325,000 nil band no IHT would be payable (assuming his nil rate band is unused). This would allow an s260 holdover claim to be made so that no CGT is payable by Cliff on the transfer. After a period of at least 3 months the property could be appointed to Elizabeth absolutely by the trustees. Again this transfer would be subject to IHT (exit charge) but again no IHT would be payable as the IHT charge would be based on Capital Taxes Update and Planning September 2016 Page 12

13 the initial principal charge rate 0% as the initial value was below 325,000. Because the transfer is charged to IHT nil) it would be possible to claim s260 holdover a second time on the transfer to Elizabeth. Her base cost for subsequent disposal would be Cliff s original 60,000 but the transfer will have been achieved without a CGT liability. 2.4 Self settlement anti-avoidance As a result of changes in Finance Act 2004, announced in the 2003 pre-budget Report and taking effect from 10 December 2003, no hold over is now available where the settlor has an interest in a trust to which an asset is transferred so a gain would crystallise upon the transfer to the trust. This has effectively blocked the use of a self-settlement to eliminate tainted taper where for example a shareholding did not qualify for business asset taper during the period 6 April 1998 to 5 April A further measure bites where the settlor, or spouse, acquires an interest in the trust at any time in the six years following the year in which the asset was settled. Where the original hold over was on or after 10 December 2003 there will now be a clawback of any hold over relief claimed in the year in which the settlor acquires the interest. Note that Finance Act 2006 extended the definition of settlor interested trusts to include trusts for the benefit of minor (U18) unmarried children. 3. REPLACEMENT OF BUSINESS ASSETS (ROLLOVER) 3.1 Introduction This relief can be claimed where a person carrying on a trade disposes of a qualifying asset that has been used in the trade (the old asset) and uses the proceeds to purchase another qualifying asset to be used in the trade (the new asset). The aim of the relief is: To reduce the gain on disposal of the old asset to nil; and The base cost of the new asset is reduced by the same sum. The trade must be a trade as specified in the statute which includes every trade, manufacture, adventure, or concern in the nature of a trade. A company who lets property or carries on an investment business is not trading and, therefore, is unable to claim rollover relief. 3.2 Used in Trade In order to qualify for rollover relief, the new asset must be taken into use and used only for the purposes of the trade. Rollover relief is not available unless the asset is actually so used. The intention to use the new asset for the purpose of the trade is not sufficient. It is the use of the asset at acquisition which determines the availability for rollover relief. However, it has been confirmed by the Inland Revenue that if there is a commercial justification for the asset being unused immediately after its acquisition, rollover relief may be allowed. Temperley v Visibell [1974] STC 64 Campbell Connolly & Co Ltd v Barnett [1994] STC Qualifying Assets Qualifying assets include: Any building or part of a building or a permanent or semi-permanent structure in the nature of a building, occupied (as well as used) only for the purposes of a trade; Capital Taxes Update and Planning September 2016 Page 13

14 Any land occupied (as well as used) only for the purposes of a trade; Fixed plant and machinery which does not normally form part of a building, etc; Ships, aircraft and hovercraft; Satellites, space station and space craft (including launch vehicles); [1982] STC 498 Goodwill*; EU entitlement to single farm payments* *Note that with effect from 1 April 2002 capital gains rollover relief is not available for companies reinvesting into intangibles. Instead the new intangibles regime applies. 3.4 Groups of Companies A claim for rollover relief can be made in respect of a disposal made by one member of the group and an acquisition by another member. Section 175 TCGA 1992 Section 170(4) TCGA 1992 For this claim to be made, the group must be a 75% group, however the requirement for there to be a UK parent company was abolished with effect from 1 April Where the company which acquired the new assets leaves the group within six years of acquisition, the rollover gain is crystallised by reference to the market value of the asset at the time it was acquired, not when the company leaves the group. Roll-a-round relief within a group is no longer possible since 28 November Originally, a gain was rolled into an asset acquired from another group member which had been acquired under the no gain / no loss provisions of Section 171. This actually allowed the gain realised on a separate disposal outside the group to be rolled over into the acquisition without any consideration actually leaving the group. 3.5 Reinvestment in Depreciating Assets As with hold over on the gift of business assets the taper relief period is computed by reference to the date of acquisition of the replacement asset where the gain on the old asset is held over. This is the case when a non-depreciating asset such as freehold land and buildings or goodwill is acquired. Where the new asset acquired is a depreciating asset the gain on the old asset, after taper, is deferred and becomes chargeable on the earlier of: The replacement asset ceasing to be used in the trade; The disposal of the replacement asset; and 10 years after the date of acquisition. 4. CGT RELIEF ON INCORPORATION Incorporation is a disposal between connected parties and is treated as a sale at market value by the sole trade/partners to the company and is thus potentially chargeable to CGT. Two reliefs are available to hold over the resulting gain on the transfer of goodwill s162 and s165 TCGA However, the availability of business asset taper, and more recently entrepreneurs relief, has meant that many taxpayers were not Capital Taxes Update and Planning September 2016 Page 14

15 taking advantage of these reliefs but were prepared to pay 10% CGT to benefit from a large loan account with the transferee company by claiming entrepreneurs relief instead. The restriction of entrepreneurs relief on the transfer of goodwill in Finance Act 2015 has meant that we need to revisit the use of the two alternative forms of relief. The choice of which relief is adopted will largely dictate the way the company is incorporated. Each have their own effects on: what is transferred Stamp duty VAT and the choice will depend on: i) existing factors such as attitude of bank to charging securities ii) short/medium term factors - are assets likely to be sold iii) long term - how soon is the business to be sold. The reliefs are mutually exclusive. 4.1 Entrepreneurs relief restricted on incorporation As announced in the Autumn Statement on 3 December 2014 CGT Entrepreneurs relief will no longer be available on disposals of goodwill to a company related to the person(s) making the disposal. This restriction has now been enacted in section 42 Finance Act This measure together with the denial of corporation tax relief for amortisation of the goodwill makes incorporation a much less attractive option for businesses and removes a major incentive to incorporate. The change applies to disposals on or after 3 December Example 5 Mr Jones Pre 3 December 2014 incorporation: Mr Jones set up his business in He made 100,000 profits each year and had his goodwill is valued at 1m. On 30 November 2014, he transferred that goodwill without seeking rollover relief for 1m to Jones Ltd, a company he owns. He paid 100,000 capital gains tax after entrepreneurs' relief on 31 January He can draw 1m tax free from Jones Ltd as the company makes profits in future years. If Jones Ltd continued to make 100,000 profits a year, but amortised the goodwill at 10%, the company would make nil taxable profits. That saves 20,000 corporation tax and could allow Mr Jones to draw the full 100,000. Over ten years the tax would be the 100,000 capital gains tax paid on 1m profits and there is 900,000 net cash in the hands of Mr Jones. Mr Jones Post 3 December 2014 incorporation: Suppose Mr Jones carried out the same plan on 6 December The capital gains tax on 31 January 2016 will be 280,000 on the 1m gain without entrepreneurs' relief. Jones Ltd, not able to claim tax relief on amortising the purchased goodwill, will pay 20,000 corporation tax each year so Mr Jones can draw 80,000. After ten years, the aggregate tax will be 480,000 ( 280,000 capital gains tax plus 200,000 corporation tax). Capital Taxes Update and Planning September 2016 Page 15

16 Mr Jones now has 520,000 net cash after ten years (his 800,000 draw less the 280,000 CGT). The company still owes him 200,000, which would take 30 more months to repay so he eventually has 720,000 cash but the company has paid a further 50,000 corporation tax. Over the 12.5 years the total tax paid is 530,000. Also, he would not be able to fund most of his 280,000 capital gains tax by the cash releasable before 31 January Note however the cut in the rates of CGT to 10%/20% from 6 April 2016 makes the sale of goodwill to a limited company worth considering again? 4.2 Impact of new lower CGT rates from 2016/17 Note that the new lower 20% CGT rate for higher rate taxpayers introduced with effect from 6 April 2016 may make the sale of goodwill to your own company attractive again where the sole trader/partner has a high level of profits. Let s assume that the sale of goodwill occurs on 30 June Assuming Mr Jones is a higher rate taxpayer and ignoring the annual CGT allowance there would be 200,000 CGT payable on 31 January This gives a 19 month time lag between the transfer of the goodwill and the payment of CGT and Mr Jones will end up with 800,000 net of tax. The old arguments with HMRC Shares and Assets Valuation division over the valuation of goodwill on incorporation will resume. Note that there would still be no corporation tax deduction for the value of the goodwill acquired by the company and the disallowance will significantly increase the corporation tax liability and limit the company s ability to pay dividends. 4.3 Alternative strategies on incorporation It is still possible to use s162 TCGA 1992 rollover relief (or s165 gift relief) to avoid an immediate capital gain on incorporation. The consideration for an s162 based incorporation has to involve shares issued, so there cannot be a simple cash-free drawing as with an amount outstanding on the sale of the goodwill. Relief under s162 TCGA is automatic if the conditions for the relief are satisfied and an election under s162a is required to disapply the application. The relief requires all of the assets (with the exception of cash) to be transferred to the company with the consideration being wholly or partly in shares. For investment businesses, such as those with property rental portfolios, the position on incorporation generally remains unaltered by the autumn statement changes. They would previously have had a 28% capital gains tax charge on incorporation of the investment properties unless s 162 rollover relief was obtained and the usual absence of goodwill with such businesses normally renders the intangible assets rules irrelevant. It is not possible to prevent a tax charge on incorporation by selling for nil consideration (assuming s 165 did not operate). This is because s17 TCGA 1992 imposes a market value on the sale of chargeable assets where there is not a bargain at arm's length. Another strategy might be to allocate more of the value of the business to properties that are transferred as a part of an incorporation rather than to Capital Taxes Update and Planning September 2016 Page 16

17 goodwill. Note also the restriction only applies to the transfer of goodwill and not other intangibles. Again there may be scope for attributing value to a brand name, manufacturing know how, or other intellectual property, with the balance of the value of the business being attributable to goodwill. The latter will require expert valuation support and the stamp duty land tax position would need to be considered because market value applies the deemed consideration for SDLT purposes on incorporation. 4.4 Relief under Section 162, TCGA 1992 (incorporation relief) Any gain or disposal is rolled over against the value of the shares issued as consideration if: i) all the assets of the business (except cash) are transferred; ii) business is transferred as a going concern; iii) consideration is wholly or partly in shares. Points to consider: all business assets need to be transferred without fail (i.e. cannot hold factory outside) ensure non business assets transferred out prior to incorporation or tax becomes due tax payable on any cash received a share premium account will arise on difference between nominal value of shares issued and assets transferred gain on assets rolled over reduces base cost of shares therefore subsequent sale of shares could be expensive for CGT purposes extract max cash prior to incorporation and reinject to make loan account and help pay accelerated tax on profits on cessation assets transferred received uplift in base value to current MV. Very important if medium term sale considered possible (?) to avoid factory transfer by transferring ownership to spouse who leases factory at full MV to sole trade prior to incorporation stamp duty land tax could be expensive if not properly managed 4.5 Relief under Section 165 TCGA 1992 (gift of business assets) Advantages: those trading assets required by business are gifted to the company and the gain held over from company and issue shares for cash to owners of business by agreement goodwill sold to company for nominal figure or higher figure to create value taxed at 10% by agreement any other assets sold for their base CGT cost consideration for goodwill and assets left on loan account election entered into to hold over gain under S165 debtors and cash kept by sole trader and used to settle creditors and tax etc. Balance injected in company as loan account only those assets needed transferred Stamp duty minimised/eliminated (as no stamp duty on gift element/gifts) very flexible possible to effectively draw out of company 1982 value only - see case study Disadvantages: assets have low base value in company (but is this a disadvantage as high base values get eroded away by taper relief - see below). Capital Taxes Update and Planning September 2016 Page 17

18 shares have low base value (but is this a disadvantage as high base values get eroded away by taper relief - see below). 4.6 CGT incorporation relief on property transfers A number of tax reliefs only apply to trading businesses, whereas other relieving provisions apply to businesses generally, including property businesses. One such provision is relief under TCGA 1992 s162. Mrs EM Ramsey v HMRC(2014) UKUTT Mrs Ramsey owned a large house in Belfast, which was divided into ten flats and let to tenants. In 2004 when the property was owned jointly by herself and her husband, they incorporated their lettings business. This involved transferring the property to a company in return for shares in that company and the couple took advantage of s162 relief to hold over the gains. Following an enquiry, HMRC issued a ruling that no s162 CGT relief was due, on the grounds that the property was an investment and was not a business. The Ramseys were represented at the appeal hearing by their son, who explained the Ramseys spent about 20 hours a week on tasks related to the property, such as maintenance, collecting rents, and cleaning the flats after tenants left. As such he argued the actions carried out by Mr and Mrs Ramsey constituted more than passive receipt of rents, and constituted a business. Judge Huddleston did not agree and the First-tier Tribunal dismissed the Ramseys appeal. The judgement appears to have confused what constitutes a 'business' needed for this CGT relief and the necessary conditions for a trade. Fortunately for many practitioners that have advised on similar transactions the Upper Tribunal allowed the taxpayers appeal. However it would be advisable to ensure that the individuals are actively involved in the rental business and do not merely delegate the day to day operations to a managing agent. Capital Taxes Update and Planning September 2016 Page 18