Chargeable gains, part 1

This two part article is relevant to candidates sitting the TX-UK exam in the period 1 June 2020 to 31 March 2021, and is based on tax legislation as it applies to the tax year 2019–20 (Finance Act 2019).

Scope of capital gains tax (CGT)

CGT is charged when there is a chargeable disposal of a chargeable asset by a chargeable person.

A chargeable disposal includes part disposals and the gift of assets. However, the transfer of an asset upon death is an exempt disposal. A person who inherits an asset will take it over at its value at the time of death.

EXAMPLE 1
On 19 May 2005, Jorge purchased a hectare of land for £20,200. He died on 20 June 2019, and the land was inherited by his son William. On that date, the land was valued at £71,600.

• The transfer of the land on Jorge’s death is an exempt disposal.
• William will take over the land with a base cost of £71,600.

All forms of property are chargeable assets unless exempt. The most important exempt assets as far as TX-UK is concerned are:

• certain chattels (see later)
• motor cars
• UK Government securities (gilts)

In determining whether or not an individual is chargeable to CGT, it is necessary to consider their residence status.

EXAMPLE 2
Explain when a person will be treated as resident in the UK for a particular tax year, and state how a person’s residence status establishes whether or not they are liable to CGT.

Subject to not meeting any of the automatic non–resident tests, the following people will be treated as resident:

• A person who is in the UK for 183 days or more during a tax year.
• A person whose only home is in the UK.
• A person who carries out full time work in the UK.

A person can also be treated as resident if they have more UK ties than is permitted according to the number of days they are in the UK during a tax year.

A person is liable to CGT on the disposal of assets during any tax year in which they are resident in the UK.

Basic computation

For individuals, the basic CGT computation is quite straightforward.

EXAMPLE 3
Andy sold a factory on 15 February 2020 for £320,000. The factory was purchased on 24 January 2001 for £164,000, and was extended at a cost of £37,000 during March 2011. During May 2013, the roof of the factory was replaced at a cost of £24,000 following a fire.

Andy incurred legal fees of £3,600 in connection with the purchase of the factory, and legal fees of £5,400 in connection with the disposal.

Andy’s taxable gain for 2019–20 is:

• The factory extension is enhancement expenditure because it has added to the value of the factory.
• The replacement of the roof is not enhancement expenditure, being in the nature of a repair.
• Note that the standardised terms ‘chargeable gain’ or ‘chargeable gains’ refer to the gain(s) before deducting the annual exempt amount and any brought forward capital losses. The terms ‘taxable gain’ or ‘taxable gains’ refer to the gain(s) after deducting the annual exempt amount and any brought forward capital losses.

Capital losses

Capital losses are set off against any chargeable gains arising in the same tax year before deducting the annual exempt amount. This order of set off can lead to the annual exempt amount being wasted.

Any unrelieved capital losses are carried forward, but in future years they are set off against any chargeable gains after deducting the annual exempt amount. This means that brought forward capital losses will not waste the annual exempt amount.

EXAMPLE 4
For the tax year 2019–20, Nim has chargeable gains of £18,000 and capital losses of £15,800.

Nim’s taxable gains for 2019–20 are:

There are no capital losses to carry forward and Nim has wasted £9,800 (12,000 – 2,200) of her annual exempt amount for 2019–20.

If the capital losses of £15,800 had instead been brought forward from the tax year 2018–19, then Nim’s taxable gains for 2019–20 would have been:

• After deducting the annual exempt amount, only £6,000 of the brought forward capital losses are used.
• Nim in this case would have capital losses carried forward of £9,800 (15,800 – 6,000).

Rates of capital gains tax

The rate of CGT is linked to the level of a person’s taxable income. Taxable gains are taxed at a lower rate of 10% where they fall within the basic rate tax band of £37,500, and at a higher rate of 20% where they exceed this threshold.

However, for chargeable gains arising from the disposal of residential property, the lower rate is 18% and the higher rate is 28%. These residential property rates apply where a gain arising from the disposal of residential property is not fully covered by the principal private residence exemption (see later in this article).

Remember that the basic rate tax band is extended if a person pays personal pension contributions or makes a gift aid donation.

CGT is collected as part of the self-assessment system, and is due in one amount on 31 January following the tax year. Therefore, a CGT liability for the tax year 2019–20 will be payable on 31 January 2021. Payments on account are not required in respect of CGT.

EXAMPLE 5
For the tax year 2019–20, Adam has a salary of £44,000, and during the year he made net personal pension contributions of £4,400. On 15 June 2019, Adam sold an antique table and this resulted in a chargeable gain of £21,000.

For the tax year 2019–20, Bee has a trading profit of £60,000. On 20 August 2019, she sold an antique vase and this resulted in a chargeable gain of £19,800.

For the tax year 2019–20, Chester has a salary of £43,500. On 25 October 2019, he sold a residential property and this resulted in a chargeable gain of £47,000.

Adam
Adam’s taxable income is £31,500 (44,000 less the personal allowance of 12,500). His basic rate tax band is extended to £43,000 (37,500 + 5,500 (4,400 x 100/80)), of which £11,500 (43,000 – 31,500) is unused.

Adam’s taxable gain of £9,000 (21,000 less the annual exempt amount of 12,000) is fully within the unused basic rate tax band, so his CGT liability for 2019–20 is therefore £900 (9,000 at 10%).

Bee
Bee’s taxable income is £47,500 (60,000 – 12,500), so all of her basic rate tax band has been used. The CGT liability for 2019–20 on her taxable gain of £7,800 (19,800 – 12,000) is therefore £1,560 (7,800 at 20%).

Chester
Chester’s taxable income is £31,000 (43,500 – 12,500), so £6,500 (37,500 – 31,000) of his basic rate tax band is unused. The CGT liability for 2019–20 on Chester’s taxable gain of £35,000 (47,000 – 12,000) is therefore:

In each case, the CGT liability will be due on 31 January 2021.

Where a person has both residential property gains and other gains, then the annual exempt amount and any capital losses should initially be deducted from the residential property gains. This approach will save CGT at either 18% or 28%, compared to either 10% or 20% if used against the other gains.

However, how any unused basic rate tax band is allocated between chargeable gains does not make any difference to the overall CGT liability (since the differential is 10% in both cases).

EXAMPLE 6
For the tax year 2019–20, Douglas does not have any income. On 15 June 2019, he sold an antique vase and this resulted in a chargeable gain of £18,800. On 28 August 2019, he sold a residential property and this resulted in a chargeable gain of £39,500.

Douglas’ CGT liability is:

Capital gains tax:

• The annual exempt amount is set against the residential property gain.
• The CGT liability could alternatively be calculated as:

Entrepreneurs’ relief

A reduced CGT rate of 10% applies if a disposal qualifies for entrepreneurs’ relief. This rate applies regardless of the level of a person’s taxable income. Entrepreneurs’ relief can be claimed when an individual disposes of a business or a part of a business as follows:

• A disposal of the whole or part of a business run as a sole trader. Relief is only available in respect of chargeable gains arising from the disposal of assets in use for the purpose of the business. This will exclude chargeable gains arising from investments.
• The disposal of shares in a trading company where a 5% shareholding satisfies the relevant conditions and the individual is also an officer or an employee of the company. Provided the limited company is a trading company, there is no restriction to the amount of relief if it holds non-trading assets such as investments.

The relief covers the first £10 million of qualifying gains which a person makes during their lifetime. Gains in excess of the £10 million limit are taxed as normal at the 10% or 20% rates.

For disposals on or after 6 April 2019, the qualifying conditions must be met throughout a period of two years prior to the date of disposal in order for entrepreneurs’ relief to be available.

Finance Act 2019 also increased the conditions required to satisfy the 5% shareholding but this is not examinable. In the exam if you are informed that the shareholding is 5% or above you may assume all the relevant conditions are met for this holding.

Additional provisions were made for shareholders where the shareholding was diluted to below the required 5% as a result of a new share issue. These provisions are not examinable.

EXAMPLE 7
On 15 October 2019, the four shareholders of Alphabet Ltd, an unquoted trading company, all sold their shares in the company. Alphabet Ltd has a share capital of 100,000 £1 ordinary shares.

Aloi had been the managing director of Alphabet Ltd since the company’s incorporation on 1 January 2009. She had held 60,000 shares since 1 January 2009.

Bon had been the sales director of Alphabet Ltd since 1 February 2018, having not previously been an employee of the company. She had held 25,000 shares since 1 February 2018.

Cherry had never been an employee or a director of Alphabet Ltd. She had held 12,000 shares since 27 July 2012.

Dee had been an employee of Alphabet Ltd since 1 May 2010. She had held 3,000 shares since 20 June 2011.

• Aloi’s disposal qualified for entrepreneurs’ relief because she was a director of Alphabet Ltd, had a shareholding of 60% (60,000/100,000 x 100), and these qualifying conditions were met for two years prior to the date of disposal.
• Bon’s disposal did not qualify for entrepreneurs’ relief because she only acquired her shareholding and became a director on 1 February 2018. The qualifying conditions were therefore not met for two years prior to the date of disposal.
• Cherry’s disposal did not qualify for entrepreneurs’ relief because she was not an officer or an employee of Alphabet Ltd.
• Dee’s disposal did not qualify for entrepreneurs’ relief because her shareholding of 3% (3,000/100,000 x 100) was less than the minimum shareholding requirement of 5%.

EXAMPLE 8
On 25 January 2020, Michael sold a 30% shareholding in Green Ltd, an unquoted trading company. The disposal resulted in a chargeable gain of £800,000. Michael had owned the shares since 1 March 2013, and was an employee of the company from that date until the date of disposal.

He has taxable income of £8,000 for the tax year 2019–20.

Michael’s CGT liability for 2019–20 is:

Although chargeable gains which qualify for entrepreneurs’ relief are always taxed at a rate of 10%, they must be taken into account when establishing which rate applies to other chargeable gains. Chargeable gains qualifying for entrepreneurs’ relief therefore reduce the amount of any unused basic rate tax band.

The annual exempt amount and any capital losses should be initially deducted from those chargeable gains which do not qualify for entrepreneurs’ relief (giving preference to any residential property gains). This approach will save CGT at 20% (18% or 28% if residential property gains are involved), compared to just 10% if used against chargeable gains which do qualify for relief.

There are several ways of presenting computations involving such a mix of gains, but the simplest approach is to keep gains qualifying for entrepreneurs’ relief and other gains separate.

EXAMPLE 9
On 30 September 2019, Mika sold a business which she had run as a sole trader since 1 January 2013. The disposal resulted in the following chargeable gains:

The assets were all owned for more than two years prior to the date of disposal. The warehouse had never been used by Mika for business purposes.

Mika has taxable income of £8,000 for the tax year 2019–20. She has unused capital losses of £28,000 brought forward from the tax year 2018–19.

Mika’s CGT liability for 2019–20 is:

• The annual exempt amount and the capital losses are set against the chargeable gain on the sale of the freehold warehouse because this does not qualify for entrepreneurs’ relief.
• £29,500 (37,500 – 8,000) of Mika’s basic rate tax band is unused, but this is set against the gains qualifying for entrepreneurs’ relief of £630,000 even though this has no effect on the 10% tax rate.

Married couples

Transfers between spouses (and between partners in a registered civil partnership) do not give rise to any chargeable gain or capital loss.

EXAMPLE 10
Bill and Cathy are a married couple. They disposed of the following assets during the tax year 2019–20:

• On 10 July 2019, Bill and Cathy sold a residential property for £380,000. The property had been purchased on 1 December 2016 for £290,000. No principal private residence exemption is available.
• On 5 August 2019, Bill transferred his entire shareholding of 20,000 £1 ordinary shares in Elf plc to Cathy. On that date the shares were valued at £64,000. Bill’s shareholding had been purchased on 21 September 2017 for £48,000.
• On 7 October 2019, Cathy sold the 20,000 £1 ordinary shares in Elf plc which had been transferred to her from Bill. The sale proceeds were £70,000.

Bill and Cathy each have taxable income of £60,000 for the tax year 2019–20.

Jointly owned property

• The chargeable gain on the residential property is £90,000 (380,000 – 290,000).
• Bill and Cathy will each be assessed on £45,000 (90,000 x 50%) of the chargeable gain.

The transfer of the 20,000 £1 ordinary shares in Elf plc to Cathy does not give rise to any chargeable gain or capital loss, because it is a transfer between spouses.

Bill’s original cost is used in calculating the chargeable gain on the disposal of the shares in Elf plc.

It may be the case that one spouse has not utilised their annual exempt amount and/or basic rate tax band for a particular tax year. It could therefore be beneficial to transfer an asset to that spouse before its disposal, or to put an asset into joint names prior to disposal.

EXAMPLE 11
For the tax year 2019–20, Jane is a higher rate taxpayer but her husband Claude does not have any taxable income. During March 2020, Jane is going to dispose of a residential property, and this will result in a chargeable gain of £120,000.

If 50% ownership of the property is transferred to Claude prior to its disposal, this will enable his annual exempt amount and basic rate tax band for 2019–20 to be utilised. The CGT saving for the couple will be £7,110:

Part disposals

When just part of an asset is disposed of, then the cost must be apportioned between the part disposed of and the part retained (by reference to the current market value).

EXAMPLE 12
On 16 February 2020, Joan sold three hectares of land for £285,000. She had originally purchased four hectares of land on 17 July 2018 for £220,000. The market value of the unsold hectare of land as at 16 February 2020 was £90,000.

• The cost relating to the three hectares of land sold is £167,200 (220,000 x 285,000/(285,000 + 90,000)).
• The chargeable gain on the land is therefore £117,800 (285,000 – 167,200).
• The base cost of the remaining hectare of land is £52,800 (220,000 – 167,200).

With part disposals, care must be taken with enhancement expenditure and incidental costs as these may relate to the whole asset or just to the part being disposed of.

EXAMPLE 13
On 20 February 2020, Furgus sold a hectare of land for £130,000. He had originally purchased four hectares of land on 13 April 2008 for £210,000. During January 2020, Furgus spent £22,800 clearing and levelling all four hectares of land. The market value of the unsold three hectares of land as at 20 February 2020 was £350,000. Furgus incurred legal fees of £3,200 in connection with the disposal.

Furgus’ chargeable gain for 2019–20 is:

• The cost relating to the hectare of land sold is £56,875 (210,000 x 130,000/(130,000 + 350,000)).
• The cost of clearing and levelling the land is enhancement expenditure. The cost relating to the hectare of land sold is £6,175 (22,800 x 130,000/480,000).
• The incidental costs relate entirely to the hectare of land sold, and so they are not apportioned.

Chattels

Special rules apply to chattels. A chattel is tangible moveable property.

Wasting chattels (except chattels eligible for capital allowances) are exempt from CGT. Non-wasting chattels (and chattels eligible for capital allowances) are only exempt if both bought and sold for less than £6,000.

EXAMPLE 14
On 18 August 2019, Gloria sold an antique table for £5,600 and an antique vase for £7,200. The antique table had been purchased on 27 May 2018 for £3,200 and the antique vase had been purchased on 14 June 2018 for £3,700.

• The antique table is exempt from CGT because the gross sale proceeds and cost were less than £6,000.
• The chargeable gain on the antique vase is restricted to £2,000 ((7,200 – 6,000) x 5/3) because this is less than the normal gain of £3,500 (7,200 – 3,700).

Where a non-wasting chattel is sold at a loss and the sale proceeds are less than £6,000, then the amount of allowable capital loss will be restricted. If capital allowances have been claimed on a chattel, then no capital loss will be available at all.

EXAMPLE 15
Giles sold the following assets during the tax year 2019–20:

On 3 February 2020, he sold an antique table for £4,700. The table had been purchased on 2 May 2009 for £10,200.

On 12 March 2020, he sold machinery for £22,600. The machinery had been purchased on 1 June 2016 for £34,000. Giles claimed capital allowances totalling £11,400 in respect of this machinery.

Table

• The table has been sold for less than £6,000, so the proceeds are deemed to be £6,000 (rather than £4,700).
• The allowable capital loss is therefore £4,200 (6,000 – 10,200).

Machinery

• The cost of £34,000 is reduced by the capital allowances claimed of £11,400, giving an allowable cost of £22,600.
• Since the proceeds are also £22,600, the disposal is on a no gain, no loss basis.

Wasting assets

A wasting asset is one which has a remaining useful life of 50 years or less. The cost of such an asset must be adjusted for the expected depreciation over the life of the asset.

EXAMPLE 16
On 31 March 2020, Mung sold a copyright for £9,600. The copyright had been purchased on 1 April 2015 for £10,000 when it had an unexpired life of 20 years.

The chargeable gain on the copyright is:

The cost of £10,000 is depreciated based on an unexpired life of 20 years at the date of acquisition and an unexpired life of 15 years at the date of disposal.

Insurance proceeds

If an asset is lost or destroyed, then the receipt of insurance proceeds is treated as a normal disposal. However, relief is available if the insurance monies are used to purchase a replacement asset within a period of 12 months.

EXAMPLE 17
On 20 October 2019, an antique table owned by Claude was destroyed in a fire. The table had been purchased on 23 November 2017 for £50,000. Claude received insurance proceeds of £74,000 on 6 December 2019 and on 18 December 2019 he paid £75,400 for a replacement table.

• The insurance proceeds of £74,000 received by Claude have been fully reinvested in a replacement table.
• There is therefore no disposal on the receipt of the insurance proceeds.
• The gain of £24,000 (insurance proceeds of £74,000 less original cost of £50,000) is set against the cost of the replacement table, so its base cost is £51,400 (75,400 – 24,000).

If the insurance proceeds are not entirely reinvested then there will be an immediate chargeable gain.

EXAMPLE 18
Continuing with example 17, assume that the replacement table only cost £71,500.

• The insurance proceeds not reinvested of £2,500 (74,000 – 71,500) are taxed as a chargeable gain in 2019–20.
• The balance of the gain of £21,500 (24,000 – 2,500) is set against the cost of the replacement table, so its base cost is now £50,000 (71,500 – 21,500).

If an asset is damaged, then the receipt of insurance proceeds is treated as a part disposal. However, if all the proceeds are used to restore the asset, then a claim can be made to ignore the part disposal rules.

EXAMPLE 19
On 1 October 2019, an antique carpet owned by Juliet was damaged by a flood. The carpet had been purchased on 17 November 2015 for £69,000. Juliet received insurance proceeds of £12,000 on 12 December 2019 and she spent a total of £13,400 during December 2019 restoring the carpet. Juliet has made a claim to ignore the part disposal rules.

• The insurance proceeds of £12,000 received by Juliet have been fully applied in restoring the carpet.
• There is therefore no disposal on the receipt of the insurance proceeds.
• The revised base cost of the carpet is £70,400 (69,000 – 12,000 + 13,400).

Principal private residences

A gain on the disposal of a principal private residence is exempt where the owner has occupied the house throughout the whole period of ownership. The final 18 months of ownership are always treated as a period of occupation. The following periods of absence are also deemed to be periods of occupation:

a) Periods up to a total of three years for any reason.
b) Any periods where the owner is required to live abroad due to their employment.
c) Periods up to four years where the owner is required to live elsewhere in the UK due to their work.

These deemed periods of occupation must normally be preceded and followed by actual periods of occupation. However, the condition that the period of absence must be followed by a period of occupation is relaxed in the case of b) and c) if the owner is unable to return because they are required to reside elsewhere due to the terms of their employment.

EXAMPLE 20
On 30 September 2019, Hue sold a residential property for £381,900. The property had been purchased on 1 October 1999 for £141,900.

Hue occupied the property as her main residence from the date of purchase until 31 March 2003. The property was then unoccupied between 1 April 2003 and 31 December 2006 due to Hue being required by her employer to work elsewhere in the UK.

From 1 January 2007 until 31 December 2013, Hue again occupied the property as her main residence. The property was then unoccupied until it was sold on 30 September 2019. 

The chargeable gain on the property is:

• The total period of ownership of the property is 240 months (189 + 51), of which 189 months qualify for exemption:

• The unoccupied period from 1 January 2014 to 31 March 2018 is not a period of deemed occupation because it was not followed by a period of actual occupation.
• The exemption is therefore £189,000 (240,000 x 189/240).

Letting relief will extend the principal private residence exemption where a property is let out during a period which does not otherwise qualify for exemption.

EXAMPLE 21
Continuing with example 20, assume that Hue let her property out during the periods which she did not occupy it herself.

The chargeable gain on the property will now be:

The letting relief exemption is the lower of:

• £40,000
• £189,000 (the amount of the gain exempt under the principal private residence rules)
• £51,000 (the amount of the non-exempt gain attributable to the period of letting (240,000 x 51/240)) 

Where part of a property is used exclusively for business use, then the principal private residence exemption will be restricted.

EXAMPLE 22
On 30 September 2019, Mae sold a residential property for £186,000. The property had been purchased on 1 October 2009 for £122,000. Throughout the period of ownership, the property was occupied by Mae as her main residence, but one of the property’s eight rooms was always used exclusively for business purposes by Mae.

The chargeable gain on the property is:

The principal private residence exemption is restricted to £56,000 (64,000 x 7/8).

The second part of the article will cover shares, reliefs, basic CGT planning and the way in which gains made by limited companies are taxed. It also contains some exam guidance and a test of your understanding.

Written by a member of the TX-UK examining team