Tax Lecture 3

Capital Gains TaxSee 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 = 150,000• Less• Cost of acquisition 100,000• Incidental acquisition costs 1,000• Extension 28,000• Incidental disposal costs 2,000• Total allowable expenditure 131,000• Gain = 19,000

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 received280,000

• Less– acquisition cost (150,000)– enhancement (20,000)– total (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 320,000 Less initial cost 100,000

220,0002. No indexation as no ownership prior to 5/4/983. Taper – 7 years non-business asset 75% of the £220,000 chargeable = 165,0004. Less annual exemption £9,200 = 155,8005. 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 all 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 assetss.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