An overview of some issues surrounding CGT
In order for a person to be liable to capital gains tax on the sale of a property, they must either be resident or ordinarily resident in the UK (TCGA 1992, s2).
The asset must be a chargeable asset, ie anything that is not an exempt asset. Exempt assets are usually wasting assets, such as cars that are likely to be disposed of at a loss.
The disposal could be by way of a sale or gift, or by destruction.
Death is not an occasion of charge for capital gains tax (TCGA 1992, s62) (although a loss in the year of death can be carried back to the three years prior to death).
Personal representatives also have an annual exemption for the year of death and the two following years.
A company is also a chargeable person (TCGA 1992, s8), but company gains are chargeable to corporation tax and the rules for computing the gain are slightly different, as companies can claim indexation allowance on their base costs.
Gifts between husband and wife or between civil partners are treated as made at a value that incurs neither gain nor loss, provided that they have not separated and still live together (TCGA 1992, s58).
Every individual has an annual exemption for capital gains tax. The value of this is £10,900 for 2013/14 (TCGA 1992, s3). If the individual pays higher or additional rate income tax on his income, the rate of capital gains tax is 28 per cent.
To the extent that his income and chargeable gain are below the higher rate threshold, the gain is charged at 18 per cent (TCGA 1992, s4). The basic rate band is extended by any pension contributions and gift aid donations.
Since 6 April 2014 the amount of pension contributions or other deductions is now limited to £40,000.
In calculating a gain, the base cost is the cost of purchase (including stamp duty land tax if the property was purchased after 5 April 1986) or market value at March 1982, if this is earlier.
The cost will also include enhancement expenditure if it is reflected in the value of the asset at the time of disposal.
Also deductible is the cost of defending the title to the property - for example, a dispute with a neighbour in a boundary dispute and any costs (solicitors, estate agents etc) incurred in the disposal of the property.
Where the property is a business asset, entrepreneur’s relief may be available. This applies where there is a
This applies to sole traders or partners selling their business, or part of it.
It was understood to include furnished holiday letting, but HMRC now rejects claims.
This has been supported by the decision of the Upper Tribunal in the case of the personal representatives of Nicolette Vivian Pawson Deceased [2013] UKUT 050 (TCC) [HMRC v Pawson], which held that furnished holiday letting was investment income, and the property was an investment.
This reversed the First-Tier Tribunal decision in 2011, which held that, as a substantial amount of work was carried on in maintaining the property and arranging lettings, they were carrying on a business. There is a move to have the case listed at the Court of Appeal.
Entrepreneur’s relief is also available to company directors and employees who hold a ‘material stake’ (at least 5 per cent of the voting rights) in the company they work for. The claim must be made on or before the first anniversary of the 31 January following the year of assessment of the qualifying disposal.
Gains are charged at 10 per cent and are eligible for disposals up to £10m. This is the lifetime limit for the person making the disposal, but gains made before 6 April 2008 do not affect this.
If an individual has made a gain which exceeded the lifetime limit at the time of the disposal, only the gain up to the lifetime limit in force at the time will be eligible for entrepreneurs relief.
However, future disposals after any increases to the limit will qualify for relief, subject to the revised limit.
Material disposals of business assets are defined as:
The business or asset must have been owned by the taxpayer for at least a year before the disposal or cessation and, in relation to a cessation, the disposal must be made within three years following the cessation.
In the case of a disposal of shares, the company must have been the taxpayer’s ‘personal trading company’. The company must be trading and the taxpayer must have had at least 5 per cent of the ordinary shares and voting rights in the company, for at least one year; the taxpayper must also work for the company.
A ‘trading company’ is a company carrying on trading activities whose activities do not include, to a substantial extent, activities other than trading activities.
HMRC considers ‘substantial extent’ to mean more than 20 per cent, although it does recognise that a company may have an isolated year of poor trade (in the case of turnover) or may not recognise intangible assets in its balance sheet (in the case of assets).
An associated disposal is where:
If a trader has a personal company, owns the building from which it trades and sells his/her shares at the same time as the building, both will be eligible for entrepreneur’s relief.
This would also apply if the disposal and use were by a partnership.
Associated disposals have restricted relief if the asset had not been used in the business for its entire period of ownership, or if the owner had charged rent for the use of the asset.
If a husband owned 3 per cent of the shares in a business and his wife owned 2 per cent, the 5 per cent requirement would not be satisfied.
However, if the wife transferred her 2 per cent to her husband he would have to wait a year before disposing of them, if he wished to claim entrepreneur’s relief.
If they jointly owned a factory where the business was carried on by only the husband and the factory was sold, only the husband could claim entrepreneur’s relief.
They should consider transferring the property to the husband a year before disposal or employing the wife (not necessarily full time) for a year before the disposal.
If the property is only partly disposed of, the gain is calculated using the formula A/(A+B), where A is the gross proceeds of the disposal (before deducting selling expenses) and B is the market value of the remainder at the date of disposal.
A small part disposal occurs where less than 20 per cent of the value of the land at the date of disposal is disposed of and the total proceeds of all the land sales in the year do not exceed £20,000.
A claim must be made under TCGA 1992, s242 to ignore the proceeds when calculating the proceeds for the year and deducting them from the base cost of the remainder.
TCGA 1992, s152 is a relief that permits a trader to defer gains on the disposal of certain business assets, where the proceeds are reinvested in other business assets not necessarily of the same type.
If, for example, a trader sells a factory for £300,000 and reinvests the proceeds in another factory costing £350,000, the gain on the initial sale can be postponed until the new factory is sold.
Had the new property cost only £275,000, the £25,000 not reinvested would be immediately chargeable (subject to the gain on the disposal being at least £25,000).
The reinvestment must be made during the period of one year before and three years after the disposal.
Conditions for the relief:
Qualifying assets include land and buildings, fixed plant and machinery, goodwill, ships aircraft and hovercraft, as well as space stations and satellites and milk, fish and potato quotas.
The relief must be claimed within the time limit, which is four years from the end of the tax year in which the gain arose, or the new asset was purchased, whichever is later. Provisional claims can be allowed.
Rollover relief can be used for reinvestment in a depreciating asset; a lease of less than 50 years would fall within this definition.
An example would be where a factory has been sold and the trader needs to buy another, but cannot find anything suitable immediately.
However, the held-over gain will come into charge at the earliest of three events:
If the lease is sold and the proceeds reinvested in another property or qualifying asset, the gain can be rolled over once more.
Under ESC D45, if the trader dies before the gain is reinvested the gain does not become chargeable, as CGT is not normally charged on death.
The provisions relating to principal private residence relief are to be found in sections 222 to 226 of TCGA 1992.
The relief exempts the entire gain on the disposal of an individual’s only or main residence, if the individual has only one residence and has occupied it throughout the period of ownership.
Gains on a main residence include a dwelling house and adjoining land, provided that the land is not more than half a hectare or such land as is necessary for the enjoyment of the property.
This has given rise to a wealth of case law where the courts have been asked to decide how much land and, indeed, which outbuildings have been necessary or appropriate for the enjoyment of the property.
In the case of Batey v Wakefield (1982) a bungalow in which the caretaker lived was held to be part of the principal private residence in which the owner of the main house lived.
On a disposal of the main house with the bungalow, the gain was entirely exempt.
Conversely, in Markey v Sanders (1987) a three-bedroomed bungalow at the entrance to a small estate owned by the occupier of the main house was held not to be part of the main residence; it was occupied by the gardener and housekeeper.
If there are periods of non-occupation, part of the gain may become chargeable. This will depend on the reason for the non-occupation.
Certain periods of non-occupation are periods of deemed occupation, where the owner is absent but deemed to be living there.
These periods are set out in TCGA 1992, s223 and are applicable only to periods of occupation from 1 April 1982, since assets held at 31 March 1982 had their values rebased at that date for the purposes of capital gains tax.
Periods of deemed absence must be both preceded and succeeded by a period of occupation. The periods of deemed occupation occur when:
A period of absence due to employment (or self-employment) is met where the owner’s absence is due to their spouse or civil partner working away.
Finally, the last 18 months of ownership are always treated as a period of occupation provided that the property has, at some time, been occupied by the owner as a main residence.
ESC D49 applies where a person has acquired a house and has delayed occupying it because certain alterations or redecoration are being carried out.
Provided that this period does not exceed 12 months, it can be treated as occupation.
It is, however, necessary for the owner to actually occupy the property subsequently.
Lettings relief can be given in addition to principal private residence relief and applies where a dwelling house has been let as residential accommodation during a period of absence.
It is only available during periods where the property is not occupied or deemed to be occupied by the owner. Thus, principal private residence relief will always take priority over lettings relief. It is the lowest of:
Lettings relief can reduce a gain to zero, but cannot create a loss.
The rent-a-room scheme applies for income tax when an owner lets part of their home to a lodger and they have shared use of the dwelling.
Tax is only payable to the extent that the rent paid exceeds £4,250 per year.
It is unconnected with lettings relief and does not affect the private residence relief for capital gains tax.
Where an owner has been away from their property due to employment overseas, or working elsewhere, in the latter case they normally have to reoccupy the property after they return.
However, if the owner is unable to reoccupy the property as their employers require them to work elsewhere, section 223 (3B) permits this to be treated as a period of occupation.
Section 224 requires any period of business use to be brought into charge to capital gains tax.
If the entire property has been a principal private residence at some time, the last 18 months will still be treated as a period of occupation, but the rest of the period must be apportioned between residential occupation and business occupation.
Similarly, if any part of the property has been set aside exclusively for business purposes, the relief must be apportioned between business and private use.
If a person works from home, it is a good idea for the part used for business not to be used exclusively for that purpose.
If a person is entitled to occupy a property as their main residence by virtue of a trust deed, section 225 entitles the trustees to principal residence relief upon the disposal of the residence.
Where a dwelling was occupied by a dependent relative at 5 April 1988 and the relative continues to live there, the property will attract main residence relief on a sale when that residence comes to an end, by virtue of section 226.
A dependent relative is defined as ‘a person incapacitated by old age or infirmity or a widowed mother (no matter what her age or condition). This provision was abolished from 6 April 1988 but remains in place for persons in residence then.
If a person has more than one residence, they can elect which is to be treated as their main residence using section 222(5).
If they choose to do so, they must make the election within two years of the date that they had more than one residence and must actually reside in both dwellings.
Once made, this election can be altered up to two years retrospectively.
If the person fails to nominate a residence, HMRC can decide the position as a matter of fact. This is particularly unfortunate if the person rents their usual residence and owns the other.
If a residence that has been elected ceases to be occupied as a residence, the election will lapse.
The fact that one of the two residences is outside the UK does not exempt it from consideration as a main residence.
A person can normally have only one main residence for principal private residence purposes at a time, but there are two exceptions: where a person has acquired a new residence and nominated that, but has not yet sold the old one, it will remain eligible for relief for the last 18 months of ownership.
The other exception is where, under ESC D49, there is a delay in taking up residence while the property is prepared, both the new residence and the old one can overlap for exemption purposes.
There is also to be a new charge on the disposal of assets where more than 50 per cent of the value derives from UK residential property.This would apply to interests in shares, securities or options.
It is expected that principal private residence relief would be available, for example on disposals by non-resident trustees or personal representatives of deceased persons’ estates.
Non-legislative, but still a change, HMRC has announced that where property is disposed of within three years of death at a figure higher than probate value, it will not permit the taxpayer to elect for the higher value to be substituted for probate value.
This had been permitted previously and would arise where the taxpayer wished to minimise a capital gains tax charge, since the base cost for CGT is probate value. However, following the case of Stonor v IRC, this will no longer be the case.
Property held abroad by a non-UK individual will be liable to the changes mentioned above, but will still remain excluded property for inheritance tax.
Sometimes it is difficult to decide whether a transaction, especially a one-off one, is income or a capital gain.
Examples are:
Pickford v Quirke CA 1927 13 TC 251
An individual (P) was a member of four different syndicates involved in buying and selling cotton mills.
The syndicate acquired shares in a mill-owning company, liquidated it and sold its assets at a profit to a new company.
The Revenue assessed him to income tax on his share of the profits of each syndicate. The Court of Appeal upheld the assessments.
Tucker v Granada Motorway Services Ltd HL 1979 53 TC 92 [1979] STC 393
The rent that a company paid under a lease for a motorway service station with 40 years to run was calculated according to its takings.
It paid the Ministry of Transport as landlord, money in return for tobacco duty being excluded from takings for the purpose of computing the rent.
The company claimed that it should be allowed to deduct the payment in computing its profits.
The claim was rejected by the courts; it was held that the payment was expenditure on making a capital asset (the lease) more valuable and was therefore capital expenditure.
Taylor v Good CA 1974 49 TC 277
A taxpayer purchased a large house at auction; he considered living in it, but his wife refused to do so.
He obtained planning permission to demolish the house and build 90 flats on the land. He sold it to a developer at a profit and was assessed to income tax on the profit.
He appealed and the Court of Appeal held that, on the facts, there was no evidence of an adventure in the nature of trade.
Marson v Morton Ch D 1986, 59 TC 381
Four brothers bought some land, on which planning permission had been granted. They had not previously invested in land.
Following an unsolicited offer, they sold the land at a profit and the Inland Revenue issued an income tax assessment on the profit.
The brothers appealed on the grounds that they had held the land as an investment. The commissioners allowed their appeal and the court upheld that decision.
Kirkby v Hughes Ch D 1992, 65 TC 532
The revenue assessed a builder to income tax in respect of the sale of three properties that he had built or improved.
He contended that each of the properties had been bought with the intention of occupying them as a private residence. The General Commissioners dismissed his appeal, pointing out that the houses were too big for one person’s residence and that the periods of occupation were short, deciding that the profits were chargeable to income tax.
The court upheld that decision.