Over the years since the introduction of capital gains tax (CGT) in 1965, there have been a number of different regimes applying to the tax. Initially there was a flat rate of 30%, which has now reduced to either 10% or 20%.
Indexation relief was subsequently introduced so as to provide a broad mechanism by which capital gains attributable purely to inflation would not be taxed. There was, for a time, a regime under which gains were added to income and charged to tax at income tax rates but as from 5 April 2008, a form of the original flat rate regime was re-introduced. At the same time, indexation relief was abolished for personal taxpayers, so that the system no longer recognises the unfairness of taxing gains purely attributable to inflation.
There are currently four flat rates on all assets apart from residential property capital gains tax. A 10% rate applies to those whose gains on all assets apart from residential property for a year are lower than the higher rate income tax threshold when added to gross income for the year. A 20% rate applies to all those who are higher rate income tax payers. A combination of the two flat rates applies where gains are partly within and partly in excess of the higher rate tax threshold when added to other income. Where the gain is on a residential property these rates are 18% and 28% respectively.
A 28% rate without relief for inflation can be seen as a heavy and perhaps excessive charge on gains and it will always be worth looking into possibilities for reducing the liability. Mitigation of capital gains tax can work in a number of ways and these can fall under three broad headings which are: exemptions, reliefs and making best use of available tax rates.
This is a useful exemption available for gains on any assets by which the gain may be ‘held over’ into a subscription for shares in an unquoted trading company which qualifies for SEIS purposes. Hold over relief enables the gain realised on an asset to be matched with an amount invested in the newly acquired asset, in this case the unquoted shares. Any capital gain which qualifies for hold over into an SEIS investment becomes completely exempt from capital gains tax, so long as the SEIS investment is held for the three year period, with no event taking place in that time to cause withdrawal of reliefs on the shares. There are very detailed conditions applicable and hence professional advice should be obtained before an investment is made.
With effect from the 2013/14 year onward, 50% of a gain is eligible for the exemption, up to annual investment limit of £100,000. Please note that you must subscribe for shares at a value at least equal to the gain made to get the full investment relief. There is a one year carry-back relief, so the investor can claim the carry back relief for an investment made in 2016/17 and treat the investment as having been made in 2015/16.
Historically, those who left the United Kingdom to become resident abroad, for tax purposes, escaped the capital gains tax net if they sold assets after departure. There was no charge to capital gains tax when a person became non-resident (subject to some very limited exceptions). In some other countries, an ‘exit charge’ applies. Going non-resident therefore provided a means of avoiding the tax completely. However, new rules extending the scope of capital gains tax to apply to non-residents disposing of UK residential property came into effect from April 2015. These rules only apply to gains arising from that date.
It is necessary to remain non-resident for a considerable period of time if the liability to tax is to be fully avoided on the non-excluded assets. There are provisions in the capital gains tax legislation which apply to those who become temporarily non-resident, defined as residence for fewer than five tax years between the year of departure and the year of return. Those who fail this test will find that capital gains realised whilst non-resident, in respect of assets held when they left the United Kingdom, will become chargeable in the year of return to the UK.
As is well known, the gain on a property which has been a person’s principal private residence, is exempt from capital gains tax. The rules contain apportionment provisions so that if a property was not the main residence throughout the period of ownership, then only part of the gain would be exempt. In all cases the final eighteen months of ownership are treated as exempt where there is any period of time during which PPE applies however. Prior to 6 April 2014 this period of exemption was three years and this level of exemption remains if the person is going into care.
Where someone buys a holiday home it will normally be advisable to submit an election for the second property to be treated as principal private residence for a short period of time, say one week or one month. This will then provide at least the eighteen months of exemption for that property, even though the election will be switched back to the original main residence after the short period for which it applies. This is essentially the means by which Members of Parliament have rather notoriously dealt with capital gains tax issues on their constituency properties. It should be noted that these elections must be submitted within two years of the second property being used as a residence. After that time limit it is no longer possible to make the election. From 6 April 2015 any residence owned by a UK or non-UK residents will only be capable of qualifying for the PPR if it is located in a territory in which the individual, their spouse of civil partner is resident or, where it is located in a different territory, the individual meets a ‘day count test’ in relation to the residence.
This applies where a business asset is sold and a capital gain arises. In very broad terms, it is possible to claim rollover relief if the proceeds are invested in a further business asset which is bought within one year before, or three years after the disposal. Subject to certain conditions, the gain can be ‘rolled over’ depending on the extent of the reinvestment so that the tax is not payable until the new asset is sold. This can be particularly helpful if a person has been using an office building for a business and the building is then sold and alternative premises acquired. The relief also covers the situation where a person moves house and both their old and new houses are (or were) used partly for business purposes. In this instance the trading proportion could be eligible for relief.
Special rules apply if one or both of the properties is leasehold and the lease runs for less than 60 years.
If an asset was not used for business purposes throughout the period of ownership, only an appropriate proportion of the gain can be rolled over. However it is possible to reset the rollover clock by transferring the asset to a spouse who then uses the asset in a business for the whole of his or her period of ownership up to sale. The spouse will then achieve full rollover relief.
This relief was introduced from 6 April 2008.
The relief is available when an individual makes a ‘qualifying business disposal’ which typically falls into one of the following categories:
In order to qualify for the relief an individual must meet all the qualifying conditions for a full year prior to the gain arising.
Gains which qualify for entrepreneurs’ relief are charged at a rate of 10%.
The total amount of entrepreneurs’ relief is limited to a ‘lifetime’ limit of £10 million of gains. Therefore the actual amount of relief available will depend initially on the extent to which gains relate to disposals of qualifying assets and then the total amount of relief previously received on qualifying gains.
There have been recent changes to the rules, aimed at facilitating disposals of businesses to family members. If you are considering a business disposal, or think that ER may apply, we would recommend that you discuss your particular circumstances with us, so we may confirm the position.
Acquisitions of shares in non-listed companies after 17 March 2016 can qualify for IR on later disposals. Such qualifying gains will be taxed at a rate of 10%. There are conditions attaching: the shares must have been newly issued after 17 March 2016, there must be no connections with the company (e.g. employed or connected to employee), and the shares must be held for at least 3 years. The shares must also be ordinary, fully paid-up shares in a trading company (or the holding company of a trading group).
Where a person sets up a new company in order to conduct a trade which qualifies under the enterprise investment scheme rules (EIS), so long as the funding for the company is in the form of a subscription and/or shares, this subscription will be eligible for hold-over relief for other gains, along similar lines to those described above for SEIS. So for example, if some quoted shares are sold realising a gain of £200,000 and within three years of that sale, the person invests £200,000 in a subscription for shares in a new trading company, the gain can be ‘held-over’ against the subscription. The gain does not then become taxable until such time as the shares in the new trading company are disposed of. If the shares are retained until the death of the shareholder, the held-over gain never becomes taxable. The shares will usually qualify for 100% business property relief from inheritance tax as well.
It should be noted that the conditions for EIS reliefs are very detailed and professional advice should be taken in every case before going ahead. Qualifying companies must not engage in a long list of activities, including farming, property dealing, managing hotels or nursing homes.
Normally, on a gift of an asset, the donor is treated as if the asset had been sold for full market value at the time of the gift. This does not apply to gifts to charities. For business assets, gains may be held over. In other cases, it is possible to hold-over the gain by transferring the asset into a trust from which the transferor, his or her spouse and infant children are excluded from benefit. If the trustees later transfer the asset out to the original intended beneficiary, once again hold-over relief applies. By this means, therefore, a gift of an asset can be made to an adult family member without capital gains tax liability arising. This is normally only suitable for gifts within the transferor’s available inheritance tax nil rate band (£325,000) as gifts into trust are chargeable transfers for inheritance tax purposes.
As the rates of capital gains tax are geared to the level of the taxpayer’s income, it is clearly best, wherever possible, to realise gains within a year when gross income plus the gains will not exceed the higher rate income tax threshold. Another important point to remember is that losses cannot be carried back for capital gains tax purposes and so if a loss arises is to be utilised, gains must be realised in the same year that the loss arises or a later year as losses carry forward to offset future gains.
If a person has an asset which has become valueless, it is possible to make a claim for the loss on that asset to be treated as having been realised. This particular claim can be backdated for up to two years.
If, say, a husband has some shares showing a large accrued gain and his wife has some shares standing at a large loss and both want to sell the holdings, the best tax result will be achieved if one transfers his or her shares to the other before they are sold. The transfer is neutral for capital gains tax purposes but on sale the loss will then be deductible from the gain.
Alternatively if the wife has no losses but just has her annual CGT exemption available for the year, a transfer of some of the shares to her by the husband before the sales take place can reduce the overall tax liability. Sufficient shares could be transferred so that she could then sell them and realise gains to use up her CGT exemption.
Spousal transfers can also be useful if either party has a lower tax rate which is likely to apply.
Please note that this Memorandum is not intended to give specific technical advice and it should not be construed as doing so. It is designed to alert clients to some of the issues. It is not intended to give exhaustive coverage of the topic.
Professional advice should always be sought before action is either taken or refrained from as a result of information contained herein.