The present UK system of Capital Gains Tax (CGT) was introduced in 1965 by the Finance Act. The intention back then was simply to tax individuals on the realisation (liquidation) of assets. However, the secondary effect was a tax on the inflationary appreciation in value of these assets.
A definition of Capital Gains Tax could be:
‘A tax on chargeable gains when an individual disposes of assets’
Each UK resident has an allowance that enables him/her a certain amount of tax relief on CGT. Any amount over and above the allowance will be charged at the appropriate rate. The current rates can be found on the website of the HMRC on this link.
To be regarded as a UK resident:
- A person must spend at least 6 months of a tax year in the UK or have a residence in the UK (whether it is used or not, or owned or not).
- The person must have spent at least 3 years continually in the UK.
- For a company to be considered resident in the UK, it must be incorporated in the UK or have its registered office and main correspondence address in the UK.
People and companies exempt from CGT are:
- Local Authorities
- Trade Unions
- Non-residents, not having a business in the UK.
- Registered Charities
- Pension funds
The definition of ‘Disposal’ is (in the words of HMRC):
‘An asset is disposed of whenever its ownership changes or whenever the owner divests himself of his rights in or interests over that asset, for example by sale, exchange or gift’.
This includes the sale of a leasehold property interest, receiving substantial insurance money or gifts. However, it does not include death.
To calculate the amount of Capital Gains a taxpayer will be taxed upon, the following should be subtracted from the eventual amount received:
- The cost of original acquisition.
- Any expenditure made to improve the quality of the asset that has been disposed of. This has to be an ‘identifiable change’ in the asset value.
- Any costs incurred by the owner in defending or establishing his right to ownership of the asset. For example, if someone has to incur legal costs to prove inherited ownership of a deceased relative’s property.
So to use an example, a person sells their second property that was bought 5 years ago. From the eventual sum the property sells for, the value at purchase, the amount spent on it to increase value and any legal costs incurred when the owner had to establish a boundary are subtracted. The remaining sum is the amount that will be taxed. Subsequently, it is the amount of gain that is taxed, not the value that is received.
Calculating the amount of CGT payable on the net gain, can be quite complicated. This is because there are 2 different rates of CGT, an individual allowance and Entrepreneurs relief to consider. However, I’ll do my best to explain using another example:
Amount subject to CGT – £50,000
Individual CGT exemption allowance – £10,100 (for tax year 2010-2011)
Subtotal liable for CGT – £39,900
Entrepreneurs Relief allows all gains that qualify* to be taxed at 10% (for June 2010 onwards). Therefore from the initial sum of £50,000, a CGT tax bill of £3,990.00 would be likely†.
Note * to qualify for Entrepreneurs relief, the capital must have come from the disposal of a business asset, not a personal one. There is also now (from April 2011) a lifetime limit of £10m.
Note † this figure is merely a guide. It should not be relied upon and professional advice should be sought.
An alternative relief to Entrepreneurs Relief is Business Asset Roll-Over Relief. This applies to capital income from the sale of a business asset such as a property, provided the capital is used to purchase another business property or certain type of asset. If it ‘leaves’ the company, it will be subject to CGT.