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Tax Lecture 3

Tax Lecture 3. Capital Gains Tax See chapters 6 & 7. The basics. Tax arises on disposal of a capital asset e.g. Buy holiday home for £100,000 Sell it later for £150,000 Capital Gain made of £50,000 Various reliefs/exemptions may reduce or eliminate the gain

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Tax Lecture 3

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  1. Tax Lecture 3 Capital Gains Tax See chapters 6 & 7

  2. The basics • Tax arises on disposal of a capital asset • e.g. Buy holiday home for £100,000 • Sell it later for £150,000 • Capital Gain made of £50,000 • Various reliefs/exemptions may reduce or eliminate the gain • Taxed as if top slice of income

  3. Must be a disposal • Disposal = change of ownership or loss of interest, e.g. by sale, exchange or gift • If a part disposal, then apportion (p 27) • Includes receiving capital sum as payment for loss, damage, etc (p 28) • Value shifting, e.g. changing rights on shares • Loss or destruction, or asset becomes valueless

  4. Chargeable asset • All forms of property, whether in UK or not • Includes options and other incorporeal property, foreign currency and created property (eg goodwill) • See list of exempt assets, especially ‘principal private residence’, betting winnings, damages for personal injury, chattels sold for less than £6,000

  5. ‘Gain’ = profit • CGT is payable on the gain made on disposal • Gain = what it sold for less what it cost • e.g. country cottage bought for £100,000, sold for £150,000. Gain is £50,000 • But can reduce gain by taking into account incidental costs, cost of improvements, etc

  6. Calculating the gain (p 28) • Consideration on disposal (or market value) • Less deductible expenditure • Initial expenditure • cost of acquisition • incidental expenses • Subsequent expenditure • e.g.improvements • Incidental costs of disposal

  7. Example (country cottage) • Consideration on disposal = 150,000 • Less • Cost of acquisition 100,000 • Incidental acquisition costs 1,000 • Extension 28,000 • Incidental disposal costs 2,000 • Total allowable expenditure 131,000 • Gain = 19,000

  8. Exemptions and reliefs • See Introduction to Tax chapter 7 p 31

  9. Indexation p 31 • Allowance against effects of inflation between 1982 and 1998 - frozen in 1998. • All allowable expenditure can be indexed from the date in which it was incurred (or 1982, if later) until 31.3.98 • The allowance is calculated by a formula related to the Retail Price Index (RPI) • In practice, now use Table - see front of manual

  10. Example p 32 • Asset acquired August 1990 for £150,000 • Enhancement expenditure January 1991 of £20,000 • Sold June 2007 for £280,000

  11. Unindexed gain • Consideration received 280,000 • Less • acquisition cost (150,000) • enhancement (20,000) • total (170,000) • Unindexed gain 110,000

  12. Indexation allowance • Unindexed gain = 110,000 • Indexation allowance • Look in the table for the multipliers • 1. Acquis’n cost:150,000 x 0.269 = (40,350) • 2. Enhancement: 20,000 x 0.249 = (4,980) • Taxable indexed gain = 64,670

  13. Tapering p 33 • Replaces indexation as from 5.4.98 • (If asset owned before then both indexation and tapering apply) • Reduces the gain because only a percentage of it is taxable • Use tapering after indexation • To calculate, need to work out number of full years asset held since 6.4.98 then refer to table

  14. See example p 33 - 34(follows on from indexation example) • Indexed gain = £64,670 • Asset sold June 2007 so • No. of years held since 5.4.98 = 9 • If business asset, 9 years means 25% chargeable • Gain = £64,670 x 25% = £16,167.50 • If non-business, 10 years means 60% chargeable • Gain = £64,670 x 60% = £38,802.00

  15. Note combined effect of indexation and tapering • Unindexed gain = £110,000 • After indexation = £64,670 • After tapering = £38,802.00 or £16,167.50 • Note, too, how much more leniently business assets are treated.

  16. Annual exemption • Eg £16,167.50 brought forward • Apply annual exemption £9,200 (Each taxpayer receives tax free gains) • Leaves £6,967.50

  17. How much tax? • The gain is added to her income for the year • If the combined figure is within the basic rate, the CGT rate is 20% • To the extent that the gain falls within the higher rate band, it is taxed at 40% • When payable?

  18. Finishing off • Assume higher rate taxpayer (ie at 40%) • So £6,967.50 x 40% = £2,787 • Tax to be paid is £2,787

  19. Practice question • Sofia sold a beach house in Cornwall in August 2007 for £320,000 (second home, non-business asset) • She purchased it in February 2000 for £100,000 • Calculate the CGT payable on the profit she has made, assuming the gain all falls within the higher rate band (40%)

  20. Answer • Consideration received 320,000 Less initial cost 100,000 220,000 2. No indexation as no ownership prior to 5/4/98 3. Taper – 7 years non-business asset 75% of the £220,000 chargeable = 165,000 4. Less annual exemption £9,200 = 155,800 5. Calculate CGT – 40% of 155,800 = £62,320

  21. Other general reliefs p 35 • Principle private residence - Must be the taxpayer’s only or main residence Taxpayer may choose which property is principal residence if they own more than one • Transfers between spouses (hold over) • Death of an individual

  22. Business Reliefs • Introduction to Tax ch 7 page 37

  23. Replacement of business assets • E.g. sell business premises and buy new premises (see list of assets covered) • Any gain made on the sale is subject to CGT, but no tax payable at that time • Gain is ‘rolled over’ into new asset, and CGT will be payable when new asset is sold • Time limits: acquisition of new asset must be within one year before or four years after disposal of old asset

  24. Example • Premises bought in 1990 for £100,000 • Sold 2002 for £150,000. Gain = £50,000 • Buy new premises for £220,000 in 2002 • Sell in 2006 for £300,000. Gain = £80,000 • If first gain rolled over, no CGT in 2002 • On sale of second premises, acquisition cost deemed to be 220,000 - 50,000 = 170,000 • Gain = 300,000 - 170,000 = 130,000 • (Greater gain = more tax at that time)

  25. Transfer business to company • Changing a sole trader or partnership business into limited company • Sell all assets to company in consideration for shares in that company • Disposal for CGT but no CGT payable • Gain rolled over until shares in new company sold • Base value of shares reduced by amount of held over gain

  26. Entrepreneur relief • Roll over CGT liability on any capital gain by buying qualifying shares (with no financial limit) • Original gain rolled over until the shares are sold • Introduced to encourage wealthy individuals to invest in growing private companies • (see tax handbook for other types of CGT relief and income tax relief under this head)

  27. Gifts of business assetss.165TCGA 1992pg 39 • NB CGT payable on sales at an undervalue and gifts, e.g. parent gives family business to children or sells it to them for less than its market value • But gain may be held over until transferee disposes of the assets • Works like other holdover/rollover reliefs: the transferee’s acquisition cost is reduced by the amount of the held over gain

  28. Next lecture • Trading Income • VAT • Stamp Duty • Chps 5, 11 and 12

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