Tax Lecture 3 Capital Gains Tax See chapters

Tax Lecture 3 Capital Gains Tax See chapters 6 & 7

The basics • Tax arises on disposal of a capital asset • e. g. Buy holiday home for £ 100, 000 • Sell it later for £ 150, 000 • Capital Gain made of £ 50, 000 • Various reliefs/exemptions may reduce or eliminate the gain • Taxed as if top slice of income

Must be a disposal • Disposal = change of ownership or loss of interest, e. g. by sale, exchange or gift • If a part disposal, then apportion (p 27) • Includes receiving capital sum as payment for loss, damage, etc (p 28) • Value shifting, e. g. changing rights on shares • Loss or destruction, or asset becomes valueless

Chargeable asset • All forms of property, whether in UK or not • Includes options and other incorporeal property, foreign currency and created property (eg goodwill) • See list of exempt assets, especially ‘principal private residence’, betting winnings, damages for personal injury, chattels sold for less than £ 6, 000

‘Gain’ = profit • CGT is payable on the gain made on disposal • Gain = what it sold for less what it cost • e. g. country cottage bought for £ 100, 000, sold for £ 150, 000. Gain is £ 50, 000 • But can reduce gain by taking into account incidental costs, cost of improvements, etc

Calculating the gain (p 28) • Consideration on disposal (or market value) • Less deductible expenditure – Initial expenditure • cost of acquisition • incidental expenses – Subsequent expenditure • e. g. improvements – Incidental costs of disposal

Example (country cottage) • • Consideration on disposal = Less Cost of acquisition 100, 000 Incidental acquisition costs Extension 28, 000 Incidental disposal costs Total allowable expenditure Gain = 19, 000 150, 000 1, 000 2, 000 131, 000

Exemptions and reliefs • See Introduction to Tax chapter 7 p 31

Indexation p 31 • Allowance against effects of inflation between 1982 and 1998 - frozen in 1998. • All allowable expenditure can be indexed from the date in which it was incurred (or 1982, if later) until 31. 3. 98 • The allowance is calculated by a formula related to the Retail Price Index (RPI) • In practice, now use Table - see front of manual

Example p 32 • Asset acquired August 1990 for £ 150, 000 • Enhancement expenditure January 1991 of £ 20, 000 • Sold June 2007 for £ 280, 000

Unindexed gain • Consideration received 280, 000 • Less – acquisition cost – enhancement – total (150, 000) (20, 000) (170, 000) • Unindexed gain 110, 000

Indexation allowance • • • Unindexed gain = 110, 000 Indexation allowance Look in the table for the multipliers 1. Acquis’n cost: 150, 000 x 0. 269 = (40, 350) 2. Enhancement: 20, 000 x 0. 249 = (4, 980) Taxable indexed gain = 64, 670

Tapering p 33 • Replaces indexation as from 5. 4. 98 • (If asset owned before then both indexation and tapering apply) • Reduces the gain because only a percentage of it is taxable • Use tapering after indexation • To calculate, need to work out number of full years asset held since 6. 4. 98 then refer to table

See example p 33 - 34 (follows on from indexation example) • • Indexed gain = £ 64, 670 Asset sold June 2007 so No. of years held since 5. 4. 98 = 9 If business asset, 9 years means 25% chargeable • Gain = £ 64, 670 x 25% = £ 16, 167. 50 • If non-business, 10 years means 60% chargeable • Gain = £ 64, 670 x 60% = £ 38, 802. 00

Note combined effect of indexation and tapering • Unindexed gain = £ 110, 000 • After indexation = £ 64, 670 • After tapering = £ 38, 802. 00 or £ 16, 167. 50 • Note, too, how much more leniently business assets are treated.

Annual exemption • Eg £ 16, 167. 50 brought forward • Apply annual exemption £ 9, 200 (Each taxpayer receives tax free gains) • Leaves £ 6, 967. 50

How much tax? • The gain is added to her income for the year • If the combined figure is within the basic rate, the CGT rate is 20% • To the extent that the gain falls within the higher rate band, it is taxed at 40% • When payable?

Finishing off • Assume higher rate taxpayer (ie at 40%) • So £ 6, 967. 50 x 40% = £ 2, 787 • Tax to be paid is £ 2, 787

Practice question • Sofia sold a beach house in Cornwall in August 2007 for £ 320, 000 (second home, non-business asset) • She purchased it in February 2000 for £ 100, 000 • Calculate the CGT payable on the profit she has made, assuming the gain all falls within the higher rate band (40%)

Answer 1. Consideration received Less initial cost 320, 000 100, 000 220, 000 2. No indexation as no ownership prior to 5/4/98 3. Taper – 7 years non-business asset 75% of the £ 220, 000 chargeable = 165, 000 4. Less annual exemption £ 9, 200 = 155, 800 5. Calculate CGT – 40% of 155, 800 = £ 62, 320

Other general reliefs p 35 • Principle private residence - Must be the taxpayer’s only or main residence Taxpayer may choose which property is principal residence if they own more than one • Transfers between spouses (hold over) • Death of an individual

Business Reliefs • Introduction to Tax ch 7 page 37

Replacement of business assets • E. g. sell business premises and buy new premises (see list of assets covered) • Any gain made on the sale is subject to CGT, but no tax payable at that time • Gain is ‘rolled over’ into new asset, and CGT will be payable when new asset is sold • Time limits: acquisition of new asset must be within one year before or four years after disposal of old asset

Example • • • Premises bought in 1990 for £ 100, 000 Sold 2002 for £ 150, 000. Gain = £ 50, 000 Buy new premises for £ 220, 000 in 2002 Sell in 2006 for £ 300, 000. Gain = £ 80, 000 If first gain rolled over, no CGT in 2002 On sale of second premises, acquisition cost deemed to be 220, 000 - 50, 000 = 170, 000 • Gain = 300, 000 - 170, 000 = 130, 000 • (Greater gain = more tax at that time)

Transfer business to company • Changing a sole trader or partnership business into limited company • Sell assets to company in consideration for shares in that company • Disposal for CGT but no CGT payable • Gain rolled over until shares in new company sold • Base value of shares reduced by amount of held over gain

Entrepreneur relief • Roll over CGT liability on any capital gain by buying qualifying shares (with no financial limit) • Original gain rolled over until the shares are sold • Introduced to encourage wealthy individuals to invest in growing private companies • (see tax handbook for other types of CGT relief and income tax relief under this head)

Gifts of business assets s. 165 TCGA 1992 pg 39 • NB CGT payable on sales at an undervalue and gifts, e. g. parent gives family business to children or sells it to them for less than its market value • But gain may be held over until transferee disposes of the assets • Works like other holdover/rollover reliefs: the transferee’s acquisition cost is reduced by the amount of the held over gain

Next lecture • Trading Income • VAT • Stamp Duty • Chps 5, 11 and 12