Now that we have concluded our study of the income tax computation we can
consider the capital gains tax computation. The two must be kept separate.
Capital gains arise when taxpayers dispose of assets, such as investments or
capital assets used in the business. If, for example, you buy a picture for
£10,000, hang it on your wall for 20 years and then sell it for £200,000, you
will have a capital gain.
In this chapter, we see when a capital gain will be liable to tax and how to work
out gains and losses.
We also look at some special cases where the rules are modified because of the
relationship between the disposer and the acquirer of an asset; without such
rules, people could do deals with their relatives to avoid tax.
We also look at how chargeable gains on partnership assets are dealt with.
In the following chapters, we will look at the special rules for certain types of
assets and at what reliefs are available.
|2||Chargeable gains and capital gains tax liabilities in situations involving further overseas aspects and in relation to closely related persons and trusts together with the application of additional exemptions and reliefs|
|(a)||The contents of the Paper F6 study guide for chargeable gains under headings:||2|
|||C1 The scope of the taxation of capital gains|
|||C2 The basic principles of computing gains and losses|
|||C5 The computation of capital gains tax|
|(b)||The scope of the taxation of capital gains:||3|
|(i)||Determine the tax implications of independent taxation and transfers between spouses|
|Identify the occasions when a capital gain would arise on a partner in a partnership on the disposal of a partnership asset|
|(d)||The basic principles of computing gains and losses:||3|
|(i)||Identify connected persons for capital gains tax purposes and advise on the tax implications of transfers between connected persons|
|(ii)||Advise on the impact of dates of disposal and conditional contracts|
|(iii)||Evaluate the use of capital losses in the year of death|
|(e)||Gains and losses on the disposal of movable and immovable property:||3|
|(i)||Advise on the tax implications of a part disposal, including small part disposals of land|
Taxpayers normally plan major disposals of capital assets so you may get a question asking when would be the best time to make a disposal. You need to know the rules about the date of disposal, and then you need to be able to quantify any tax savings that might result from delaying or advancing a sale.
This chapter mainly revises topics covered in Paper F6. The examination team has identified essential underpinning knowledge from the F6 syllabus which is particularly important that you revise as part of your P6 studies. In this chapter, the relevant topics are:
|C2||The basic principles of computing gains and losses|
|(a)||Compute and explain the treatment of capital gains||2|
|(b)||Compute and explain the treatment of capital losses||2|
|C5||The computation of capital gains tax|
|(a)||Compute the amount of capital gains tax payable||2|
The new topics in this chapter include carry back losses in the year of death, business partnerships, and small disposals of land.
The changes in 2015/16 from the material studied at F6 level in 2014/15 are the increase in the annual exempt amount from £11,000 to £11,100 and the change to the method of computing the market value of quoted shares which is required where such shares are gifted.
1 Chargeable and exempt persons, disposals and assets
For CGT to apply, there needs to be a chargeable person, a chargeable disposal and a chargeable asset.
|For a chargeable gain to arise there must be:
• A chargeable person; and
• A chargeable disposal; and A chargeable asset
otherwise no charge to tax occurs.
Exam focus point
1.1 Chargeable persons
The following are chargeable persons:
- Companies Trustees
We will look at the taxation of chargeable gains on companies later in this Text.
Persons who are not resident in the UK are usually exempt persons. We deal with overseas aspects of CGT later in this Text.
1.2 Chargeable disposals
|A chargeable disposal occurs on the date of the contract or when a conditional contract becomes unconditional.|
The following are chargeable disposals:
- Sales of assets or parts of assets
- Gifts of assets or parts of assets
- Receipts of capital sums following the surrender of rights to assets
- The loss or destruction of assets
A chargeable disposal occurs on the date of the contract (where there is one, whether written or oral), or the date of a conditional contract becoming unconditional. This may differ from the date of transfer of the asset. However, when a capital sum is received on a surrender of rights or the loss or destruction of an asset, the disposal takes place on the day the sum is received.
The timing of a disposal should be carefully considered bearing in mind these rules. For example, an individual may wish to accelerate a gain into an earlier tax year to obtain earlier loss relief or to delay a gain until a later tax year when an unused annual exempt amount may be available.
Where a disposal involves an acquisition by someone else, their date of acquisition is the same as the date of disposal.
Transfers of assets on death are exempt disposals. The heirs inherit assets as if they bought them at death for their then market values, but there is no capital gain or allowable loss on death. It is possible to vary or disclaim inherited assets. The CGT effect of such a variation or disclaimer is dealt with later in this Text.
1.3 Chargeable assets
All forms of property, wherever in the world they are situated, are chargeable assets unless they are specifically designated as exempt.
The following are exempt assets (gains not taxable, losses not usually allowable losses, the few exceptions are explained in this Text).
- Motor vehicles suitable for private use
- National Savings & Investments certificates and premium bonds
- Foreign currency bank accounts held by individuals, trustees and personal representatives
- Decorations awarded for bravery (unless purchased)
- Damages for personal or professional injury
- Gilt-edged securities (eg Treasury Stock)
- Qualifying corporate bonds (QCBs)
- Certain chattels
- Debts (except debts on a security)
- Investments held in individual savings accounts (ISAs)
There are also exemptions for enterprise investment scheme (EIS) shares, the seed enterprise investment scheme (SEIS), and venture capital trust (VCT) shares (see earlier in this Text).
2 Computing a gain or loss
|A gain or loss is computed by taking the proceeds and deducting the cost. Incidental costs of acquisition and disposal are deducted together with any enhancement expenditure reflected in the state and nature of the asset at the date of disposal.|
2.1 Basic calculation
A gain (or an allowable loss) is generally calculated as follows.
|Less incidental costs of disposal||(400)|
|Less allowable costs||(21,000)|
Usually the disposal consideration is the proceeds of sale of the asset, but a disposal is deemed to take place at market value:
- Where the disposal is not a bargain at arm’s length
- Where the disposal is made for a consideration which cannot be valued Where the disposal is by way of a gift.
Special valuation rules apply for shares (see later in this Text).
Incidental costs of disposal may include:
- Valuation fees
- Estate agency fees Advertising costs Legal costs.
Allowable costs include:
- The original cost of acquisition
- Incidental costs of acquisition
- Capital expenditure incurred in enhancing the asset.
Enhancement expenditure is capital expenditure which enhances the value of the asset and is reflected in the state or nature of the asset at the time of disposal, or expenditure incurred in establishing, preserving or defending title to, or a right over, the asset. Excluded from this category are:
- Costs of repairs and maintenance
- Costs of insurance
- Any expenditure deductible from trading profits
- Any expenditure met by public funds (for example council grants).
Joanne bought a piece of land as an investment for £20,000. The legal costs of purchase were £250.
Joanne sold the land in December 2015 for £35,000. She incurred estate agency fees of £700 and legal costs of £500 on the sale.
Calculate Joanne’s gain on sale.
|Proceeds of sale||35,000|
|Less costs of disposal £(700 + 500)||(1,200)|
|Net proceeds of sale||33,800|
|Less costs of acquisition £(20,000 + 250)||(20,250)|
3 CGT payable by individuals 6/15, 12/14
|CGT is usually payable at the rate of 18% or 28% depending on the individual’s taxable income. Individuals are entitled to an annual exempt amount.|
One of the competencies you require to fulfil Performance Objective 15 Tax computations and assessments of the PER is to prepare or contribute to the computation or assessment of tax computations for individuals. You can apply the knowledge you obtain from this section of the text to help to demonstrate this competence.
In general, individuals are liable to CGT on the disposal of assets situated anywhere in the world if, for any part of the tax year of disposal, they are resident in the UK. ‘Residence’ has the same meaning as for income tax purposes (see earlier in this Text). Trustees also pay CGT on their gains.
An individual pays CGT on any taxable gains arising in the tax year. Taxable gains are the net chargeable gains (gains minus losses) of the tax year reduced by unrelieved losses brought forward from previous years and the annual exempt amount.
The annual exempt amount applies each tax year. For 2015/16 it is £11,100. It is the last deduction to be made in the calculation of taxable gains. An individual who has gains taxable at more than one rate of tax may deduct any allowable losses and the annual exempt amount for that year in the way that produces the lowest possible tax charge. We will look at this topic in detail later in this Text when we consider entrepreneurs’ relief.
3.2 Calculating CGT
Taxable gains (other than those qualifying for entrepreneurs’ relief) are chargeable to capital gains tax at the rate of 18% or 28% depending on the individual’s taxable income for the tax year.
To work out which rate applies, follow these rules:
Remember that the basic rate band limit will usually be £31,785 for 2015/16 but the limit will be increased by the gross amount of personal pension contributions.
Mo has taxable income of £24,775 in 2015/16. He made personal pension contributions of £200 (net) per month during 2015/16. In December 2015, he makes a chargeable gain of £28,200.
Calculate the CGT payable by Mo for 2015/16.
|Less: annual exempt amount||(11,100)|
|Basic rate band limit||31,785|
|Add: personal pension contributions £(200 × 12) = £2,400 × 100/80||3,000|
|Increased basic rate limit||34,785|
|£(34,785 – 24,775) = £10,010 (unused basic rate band) @ 18%||1,802|
|£(17,100 – 10,010) = £7,090 @ 28%||1,985|
|Total CGT payable||3,787|
There is also a special 10% rate of tax for gains for which the taxpayer claims entrepreneurs’ relief. We will look at this situation later in this Text.
3.3 Allowable losses
Deduct allowable capital losses from chargeable gains in the tax year in which they arise. Any loss which cannot be set off is carried forward to set against future chargeable gains. Losses must be used as soon as possible (subject to the following paragraph). Losses may not normally be set against income (unless they arise on the disposal of certain unquoted trading company shares – see earlier in this Text).
Allowable losses brought forward are only set off to reduce current year chargeable gains less current year allowable losses to the annual exempt amount. No set-off is made if net chargeable gains for the current year do not exceed the annual exempt amount.
3.4 Example: the use of losses
- George has chargeable gains for 2015/16 of £13,000 and allowable losses of £6,000. As the losses are current year losses they must be fully relieved against the £13,000 of gains to produce net gains of £7,000, despite the fact that net gains are below the annual exempt amount.
- Bob has gains of £15,000 for 2015/16 and allowable losses brought forward of £6,000. Bob restricts his loss relief to £3,900 so as to leave net gains of £(15,000 3,900) = £11,100, which will be exactly covered by his annual exempt amount for 2015/16. The remaining £2,100 of losses will be carried forward to 2016/17.
- Tom has chargeable gains of £11,000 for 2015/16 and losses brought forward from 2014/15 of £4,000. He will not use the losses in 2015/16 and will carry forward all of his losses to 2016/17. His gains of £11,000 are covered by his annual exempt amount for 2015/16.
3.5 Losses in the year of death 12/14
Losses arising in the tax year in which an individual dies can be carried back to the previous three tax years, later years first, and used so as to reduce gains for each of the years to an amount covered by the appropriate annual exempt amount. Only losses in excess of gains in the year of death can be carried back.
Joe dies on 1 January 2016. His chargeable gains and allowable loss have been as follows.
Gain/(loss) Annual exempt
2015/16 2,000 11,100
2014/15 11,200 11,000 2013/14 9,000 10,900
2012/13 28,000 10,600
How will the loss be set off?
The £10,000 net loss which arises in 2015/16 will be carried back. We must set off the loss against the 2015/16 gains first even though the gains are covered by the 2015/16 annual exempt amount.
£200 of the loss will be used in 2014/15. None of the loss will be used in 2013/14 (because the gains for that year are covered by the annual exempt amount), and so the remaining £9,800 will be used in 2012/13. Repayments of CGT will follow.
4 Valuing assets
Market value must be used in certain capital gains computations. There are special rules for shares and securities.
4.1 General rules
Where market value is used in a chargeable gains computation (see Section 2 above), the value to be used is the price which the assets in question might reasonably be expected to fetch on a sale in the open market.
4.2 Shares and securities
The market value of quoted shares is the lower of the two prices shown in the Stock Exchange Daily Official List plus one-half of the difference between those two prices.
Unquoted shares are harder to value than quoted shares. HMRC have a special office, Shares and Assets Valuation, to deal with the valuation of unquoted shares.
5 Connected persons
Disposals between connected persons are always deemed to take place for a consideration equal to market value. Any loss arising on a disposal to a connected person can be set only against a gain arising on a disposal to the same connected person.
5.1 Definition and effect
A transaction between ‘connected persons’ is treated as one between parties to a transaction otherwise than by way of a bargain made at arm’s length. This means that the acquisition and disposal are deemed to take place for a consideration equal to the market value of the asset, rather than the actual price paid. In addition, if a loss results, it can be set only against gains arising in the same or future years from disposals to the same connected person and the loss can only be set off if he or she is still connected with the person sustaining the loss.
Key term Connected person. An individual is connected with:
- Their spouse/civil partner
- Their relatives (brothers, sisters, ancestors and lineal descendants)
- The relatives of their spouse/civil partner
- The spouses/civil partners of their and their spouse/civil partner’s relatives
- Their business partners, partners’ spouses/civil partners and partners’ relatives
- The trustees of a trust of which the individual is the settlor
5.2 Assets disposed of in a series of transactions
A taxpayer might attempt to avoid tax by disposing of their property piecemeal to persons connected with them. For example, a majority holding of shares might be broken up into several minority holdings, each with a much lower value per share, and each of the shareholder’s children could be given a minority holding.
To prevent the avoidance of tax in this way, where a person disposes of assets to one or more persons, with whom they are connected, in a series of linked transactions, the disposal proceeds for each disposal will be a proportion of the value of the assets taken together. Thus in the example of the shareholding, the value of the majority holding would be apportioned between the minority holdings. Transactions are linked if they occur within six years of each other.
6 Married couples and civil partners 12/13
Spouses/civil partners are treated as separate people. Transfers of assets between spouses/civil partners give rise to neither a gain nor a loss.
Spouses/civil partners are taxed as two separate people. Each has an annual exempt amount, and losses of one spouse/civil partner cannot be set against gains of the other.
Disposals between spouses/civil partners who are living together give rise to no gain and no loss, whatever actual price (if any) was charged by the person transferring the asset to their spouse/civil partner. This means that there is no chargeable gain or allowance loss and the transferee takes over the transferor’s cost. The no gain/ no loss treatment does not apply to employee shareholder shares (see earlier in this Text).
Since transfers between spouses/civil partners are on a no gain no loss basis, it may be beneficial to transfer the whole or part of an asset to the spouse/civil partner with an unused annual exempt amount or with taxable income below the basic rate limit. The transferee spouse then makes a disposal to a third party, either alone (if the whole asset is transferred) or jointly with the transferor spouse (if only part of the asset is transferred). It is very important that the transferee spouse/civil partner does not have any arrangement to pay back their net proceeds of sale to the transferor spouse/civil partner. If such an arrangement is in place, HM Revenue and Customs may contend that the no gain no loss disposal was not valid and treat the transferor spouse as making the entire disposal.
Harry has taxable income of £60,000 in 2015/16 and makes chargeable gains of £20,000 in 2015/16 on share disposals. His wife, Margaret, has taxable income of £4,275 in 2015/16 and has no chargeable assets. Harry bought a plot of land for £150,000 in 2012. He gave it to Margaret when it was worth £180,100 on 10 May 2015. Margaret sold it on 27 August 2015 for £188,200. The land does not qualify for entrepreneurs’ relief.
Calculate any chargeable gains arising to Harry and Margaret in respect of the land and show the tax saving arising from the transfer between Harry and Margaret, followed by the disposal by Margaret, compared with Harry directly disposing of the land in August 2015.
The disposal from Harry to Margaret is a no gain no loss disposal. Harry has no chargeable gain, and the cost for Margaret is Harry’s original cost.
The gain on the sale by Margaret is:
Proceeds of sale 188,200
Less cost (150,000) Gain 38,200
Margaret’s gain will be reduced by her annual exempt amount to £27,100 (£38,200 – £11,100). Margaret also has £(31,785 – 4,275) = £27,510 of her basic rate band remaining. She will therefore pay CGT at 18% on the taxable gain. In contrast, Harry would have paid CGT on £38,100 at 28%.
The tax saving is therefore:
Tax saved on annual exempt amount £11,100 @ 28% 3,108 Tax saved at basic rate £27,100 @ (28 – 18)%
Tax saving on disposal by Margaret instead of Harry
This tax saving will only be obtained if Margaret does not have an agreement to pay back the net proceeds of sale to Harry.
7 Business partnerships
On the disposal of a partnership asset, the gain or loss is apportioned to partners in their capital profit sharing ratio.
When a business partnership disposes of an asset, any chargeable gain or allowable loss is apportioned to the partners in their capital profit sharing ratio.
8 Part disposals 12/14, 12/12
On a part disposal, the cost must usually be apportioned between the part disposed of and the part retained. On a small part disposal of land, there is no chargeable gain and the net proceeds of disposal are deducted from the cost of the land retained.
8.1 Basic rule
The disposal of part of a chargeable asset is a chargeable event. The chargeable gain (or allowable loss) is computed by deducting from the disposal value a fraction of the original cost of the whole asset.
|The fraction is:
A value of the part disposed of
A B value of the part disposed of market value of the remainder
In this fraction, A is the proceeds (for arm’s length disposals) before deducting incidental costs of disposal.
Formula to learn
The part disposal fraction should not be applied indiscriminately. Any expenditure incurred wholly in respect of a particular part of an asset should be treated as an allowable deduction in full for that part and not apportioned, such as incidental selling expenses, which are wholly attributable to the part disposed of.
Mr Heal owns a 4 hectare plot of land which originally cost him £150,000. He sold one hectare in July 2015 for £60,000. The incidental costs of sale were £3,000. The market value of the 3 hectares remaining is estimated to be £180,000. What is the gain on the sale of the one hectare?
|Less disposal costs||(3,000)|
|Net proceed of sale||57,000|
|Less cost (see above)||(37,500)|
The amount of the cost attributable to the part sold is £150,000 = £37,500
8.2 Land: small part disposal proceeds
Where the consideration for a part disposal of land does not exceed 20% of the market value of the entire holding of land prior to the part disposal, a chargeable disposal does not take place. The taxpayer must make a claim by the first anniversary of 31 January following the end of the tax year. The net disposal proceeds are deducted from allowable expenditure when computing a gain on a later disposal of the remaining land.
Bertha buys 10 acres of land for £20,000. She sells 11/2 acres for £5,000 in July 2015 and disposal costs amount to £50. Market value of the land immediately prior to the disposal is £30,000. You are required to show Bertha’s CGT position.
The consideration (£5,000) is less than 20% of market value (20% of £30,000 = £6,000). Bertha may therefore claim for the relief to apply. As a result, no chargeable disposal takes place in July 2015.
Allowable cost of the land retained is:
Cost of 10 acres 20,000
Deduct: net proceeds of part disposal (£5,000 – £50) )
Allowable expenditure of land retained
There are two further conditions to meet before this relief can apply:
- proceeds from the part disposal do not exceed £20,000; and
- aggregate proceeds from the part disposal and any other disposals of land (including buildings) in the same tax year do not exceed £20,000.
8.3 Example: proceeds exceeding £20,000
If, in the previous example, Bertha had made another disposal of land for £15,750 in 2015/16, the relief could not apply since proceeds for the tax year (ie £15,750 + £5,000 = £20,750) would exceed £20,000. The normal part disposal rules would apply.
|||For CGT to apply, there needs to be a chargeable person, a chargeable disposal and a chargeable asset.|
|||A chargeable disposal occurs on the date of the contract or when a conditional contract becomes unconditional.|
|||A gain or loss is computed by taking the proceeds and deducting the cost. Incidental costs of acquisition and disposal are deducted together with any enhancement expenditure reflected in the state and nature of the asset at the date of disposal.|
|||CGT is usually payable at the rate of 18% or 28% depending on the individual’s taxable income. Individuals are entitled to an annual exempt amount.|
|||Market value must be used in certain capital gains computations. There are special rules for shares and securities.|
|||Disposals between connected persons are always deemed to take place for a consideration equal to market value. Any loss arising on a disposal to a connected person can be set only against a gain arising on a disposal to the same connected person.|
|||Spouses/civil partners are treated as separate people. Transfers of assets between spouses/civil partners give rise to neither a gain nor a loss.|
|||On the disposal of a partnership asset, the gain or loss is apportioned to partners in their capital profit sharing ratio.|
|||On a part disposal, the cost must usually be apportioned between the part disposed of and the part retained. On a small part disposal of land, there is no chargeable gain and the net proceeds of disposal are deducted from the cost of the land retained.|
- Give some examples of chargeable disposals.
- Are the following assets chargeable to CGT or exempt?
- Shares (not held in an ISA)
- Victoria Cross awarded to owner
- National Savings & Investments Certificates
- Jed buys a house. He repairs the roof, installs central heating and builds an extension. The extension is blown down in a storm and not replaced. Which of these improvements is allowable as enhancement expenditure on a subsequent sale?
- At what rates do individuals pay CGT on gains not qualifying for entrepreneurs’ relief?
- To what extent must allowable losses be set against chargeable gains?
- Shares in A plc are quoted at 410 – 414. What is the market value for CGT?
- With whom is an individual connected?
- Keith and Jonas have been in partnership for many years sharing income and capital profits in the ratio 3:2. In January 2016, the partnership sold its office building making a chargeable gain of £40,000. What are the gains assessable on Keith and Jonas on the sale?
- 10 acres of land are sold for £15,000, out of a plot of 25 acres. The original cost of the whole plot was £9,000 and costs of sale are £2,000. The rest of the land is valued at £30,000. What is the allowable expenditure?
Answers to quick quiz
- Sales of assets or parts of assets
Gifts of assets or parts of assets
Receipts of capital sums following the surrender of rights to assets Loss or destruction of assets
- (a) Shares – Chargeable
- Car – Exempt as motor vehicle suitable for private use
- Land – Chargeable
- Victoria Cross – Exempt as medal for bravery not acquired by purchase
- National Savings & Investments Certificates – Exempt
- Repairs to roof – not allowable as enhancement expenditure because not capital in nature
Central heating – allowable as enhancement expenditure
Extension – not allowable as not reflected in state of asset at time of disposal.
- 18% and 28%
- Current year losses must be set off against gains in full, even if this reduces gains below the annual exempt amount. Losses brought forward or carried back from year of death, are set off to bring down gains to the level of the annual exempt amount.
- 410 + ½ (414 – 410) = 412
- An individual is connected with:
- their spouse (‘spouse’ includes civil partners)
- their relatives (brothers, sisters, ancestors and lineal descendants)
- the relatives of their spouse
- the spouses of their and their spouse’s relatives
- their business partners, partners’ spouses/civil partners and partners’ relatives
- trustees of a trust of which they are the settlor
- Keith £40,000 3/5 = £24,000
Jonas £40,000 2/5 = £16,000
- £9,000 = £3,000 + £2,000 (costs of disposal) = £5,000