CHARGEABLE GAINS
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This article looks at chargeable gains in either a personal or corporate context. This article is relevant to candidates sitting Paper F6 (UK) in 2013
This two-part article is relevant to candidates sitting Paper F6 (UK) in either the June or December 2013 sittings, and is based on tax legislation as it applies to the tax year 201213 (Finance Act 2012)。
Question 3 of Paper F6 (UK) focuses on chargeable gains in either a personal or a corporate context, and will be for 15 marks. A small element of chargeable gains may also be included in any of the other questions.
PERSONAL CHARGEABLE GAINS
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 takes it over at its value at the time of death.
Example 1 On 19 May 1998 Jorge purchased an acre of land for 20,200. He died on 20 June 2012, 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 Jorgeˇs 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 exempted. The most important exempt assets as far as Paper F6 (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 or ordinarily resident in the UK for a particular tax year and state how a personˇs residence status establishes whether or not they are liable to CGT.
A person will be resident in the UK during a tax year if they are present in the UK for 183 days or more.
A person will also be treated as resident if they make substantial visits to the UK, with visits averaging 91 days or more over four consecutive tax years.
Ordinary residence is not precisely defined, but a person will normally be ordinarily resident in the UK if this is where they habitually reside.
A person is liable to CGT on the disposal of assets during any tax year in which they are either resident or ordinarily resident in the UK.
Basic computation For individuals the basic CGT computation is quite straightforward.
Example 3 Andy sold a factory on 15 February 2013 for 320,000. The factory was purchased on 24 January 1994 for 164,000, and was extended at a cost of 37,000 during March 2004. During May 2006 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 5,800 in connection with the disposal.
Andyˇs taxable gain for 201213 is as follows:
Disposal proceeds 320,000
Cost
164,000
Enhancement expenditure 37,000
Incidental costs (3,600 + 5,800)
9,400
_______ (210,400)
________ Chargeable gain 109,600
Annual exempt amount
(10,600) _______
Taxation gain
99,000 _______
The factory extension is enhancement expenditure as 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 term ˉchargeable gainˇ refers to the gain before deducting the annual exempt amount, while the term ˉtaxable gainˇ refers to the gain after deducting the annual exempt amount.
Capital losses Capital losses are set off against any chargeable gains arising in the same tax year, even if this results in the annual exempt amount being wasted. Any unrelieved capital losses are carried forward, but in future years they are only set off to the extent that the annual exempt amount is not wasted.
Example 4 For the tax year 201213 Nim has chargeable gains of 17,600. He has unused capital losses of 16,700 brought forward from the tax year 201112.
Chargeable gains 17,600
Capital losses brought forward
(7,000) _______
Chargeable gains
10,600 Annual exempt amount (10,600)
_______ Taxable gains Nil
_______
The set off of the brought forward capital losses is restricted to 7,000 (17,600 10,600) so that chargeable gains are reduced to the amount of the annual exempt amount.
Nim therefore has capital losses carried forward of 9,700 (16,700 7,000)。
Rates of CGT The rate of CGT is linked to the level of a personˇs taxable income. Taxable gains are taxed at a lower rate of 18% where they fall within the basic rate tax band of 34,370, and at a higher rate of 28% where they exceed this threshold. Remember that the basic rate 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 201213 will be payable on 31 January 2014. Payments on account are not required in respect of CGT.
Example 5 For the tax year 201213 Adam has a salary of 40,105, and during the year he made net personal pension contributions of 4,400. On 15 August 2012 Adam sold an antique table and this resulted in a chargeable gain of 17,400.
For the tax year 201213 Bee has a trading profit of 58,105. On 20 August 2012 she sold an antique vase and this resulted in a chargeable gain of 18,600.
For the tax year 201213 Chester has a salary of 36,105. On 25 August 2012 he sold an antique clock and this resulted in a chargeable gain of 23,800.
Adam Adamˇs taxable income is 32,000 (40,105 less the personal allowance of 8,105)。 His basic rate tax band is extended to 39,870 (34,370 + 5,500 (4,400 x 100/80))， of which 7,870 (39,870 32,000) is unused.
Adamˇs taxable gain of 6,800 (17,400 less the annual exempt amount of 10,600) is fully within the unused basic rate tax band, so his CGT liability for 201213 is therefore 1,224 (6,800 at 18%)。
Bee Beeˇs taxable income is 50,000 (58,105 8,105)， so all of her basic rate tax band has been used. The CGT liability for 201213 on her taxable gain of 8,000 (18,600 10,600) is therefore 2,240 (8,000 at 28%)。
Chester Chesterˇs taxable income is 28,000 (36,105 8,105)， so 6,370 (34,370 28,000) of his basic rate tax band is unused. The CGT liability for 201213 on Chesterˇs taxable gain of 13,200 (23,800 10,600) is therefore calculated as follows:
6,370 at 18% 1,147
6,830 at 28%
1,912 _______
3,059 _______
In each case, the CGT liability will be due on 31 January 2014.
Entrepreneursˇ relief A reduced CGT rate of 10% applies if a disposal qualifies for entrepreneursˇ relief. This rate applies regardless of the level of a personˇs taxable income. Entrepreneursˇ 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 an individual has at least a 5% shareholding in the company and 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 10m of qualifying gains that a person makes during their lifetime. Gains in excess of the 10m limit are taxed as normal at the 18% or 28% rates.
Assets must have been owned for one year prior to the date of disposal in order to qualify, and the qualifying conditions must have been met for a similar period.
Example 6 On 15 October 2012 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 companyˇs incorporation on 1 January 2002. She had held 60,000 shares since 1 January 2002.
Bon had been the sales director of Alphabet Ltd since 1 February 2012, having not previously been an employee of the company. She had held 25,000 shares since 1 February 2012.
Cherry had never been an employee or a director of Alphabet Ltd. She had held 12,000 shares since 27 July 2005.
Dee had been an employee of Alphabet Ltd since 1 May 2003. She had held 3,000 shares since 20 June 2004.
删 Aloiˇs disposal qualified for entrepreneursˇ 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 one year prior to the date of disposal.
删 Bonˇs disposal did not qualify for entrepreneursˇ relief because she only acquired her shareholding and became a director on 1 February 2012. The qualifying conditions were therefore not met for one year prior to the date of disposal.
删 Cherryˇs disposal did not qualify for entrepreneursˇ relief because she was not an officer or an employee of Alphabet Ltd.
删 Deeˇs disposal did not qualify for entrepreneursˇ relief because her shareholding of 3% (3,000/100,000 x 100) was less than the minimum required holding of 5%.
Example 7 On 25 January 2013 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 2006, 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 201213.
Michaelˇs CGT liability for 201213 is as follows:
Chargeable gain 800,000
Annual exempt amount
(10,600) _______
789,400 _______
Capital gains tax: 789,400 at 10%
78,940 _______
Although chargeable gains that qualify for entrepreneursˇ 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 entrepreneursˇ 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 that do not qualify for entrepreneursˇ relief. This approach will save CGT at either 18% or 28%, compared to just 10% if used against chargeable gains that 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 entrepreneursˇ relief and other gains separate.
Example 8 On 30 September 2012 Mika sold a business that she had run as a sole trader since 1 January 2006. The disposal resulted in the following chargeable gains:
Goodwill 260,000
Freehold office building
370,000 Freehold warehouse 170,000
_______ 800,000
_______
The assets were all owned for more than one year prior to the date of disposal. The warehouse had never been used by Mika for business purposes.
Mika has taxable income of 4,000 for the tax year 201213. She has unused capital losses of 28,000 brought forward from the tax year 201112.
Mikaˇs CGT liability for 201213 is as follows:
Gains qualifying for entrepreneursˇ relief 260,000
Goodwill
370,000 Freehold office building _______
630,000 _______
Other gains
Freehold warehouse 170,000
Capital losses brought forward
(28,000) _______
142,000
Annual exempt amount (10,600)
_______ 131,400
_______ Capital gains tax: 630,000 at 10% 63,000
131,400 at 28%
36,792 _______
Tax liability
99,792 _______
The capital losses and the annual exempt amount are set against the chargeable gain on the sale of the freehold warehouse as this does not qualify for entrepreneursˇ relief.
30,370 (34,370 4,000) of Mikaˇs basic rate tax band is unused, but this is set against the gains qualifying for entrepreneursˇ relief of 630,000 even though this has no affect on the 10% tax rate.
Married couples Transfers between spouses do not give rise to any chargeable gain or capital loss. The same treatment applies to transfers between same-sex partners in a registered civil partnership.
Example 9 Bill and Cathy Dew are a married couple. They disposed of the following assets during the tax year 201213:
On 10 July 2012 Bill and Cathy sold a house for 380,000. The house had been purchased on 1 December 2009 for 290,000, and has never been occupied as their main residence.
On 5 August 2012 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. Billˇs shareholding had been purchased on 21 September 2010 for 48,000.
On 7 October 2012 Cathy sold the 20,000 1 ordinary shares in Elf plc that had been transferred to her from Bill. The sale proceeds were 70,000.
Bill and Cathy each have taxable income of 50,000 for the tax year 201213.
Jointly owned property
The chargeable gain on the house 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. Bill Dew CGT liability 201213
House
45,000 Annual exempt amount (10,600)
_______ 34,400
_______ Capital gains tax: 34,400 at 28% 9,632
_______
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. Cathy Dew CGT liability 201213
House
45,000
Ordinary shares in Elf plc
Disposal proceeds 70,000
(48,000)
_______
Cathy Dew CGT liability 201213
22,000 _______
67,000 Annual exempt amount (10,600)
_______ 56,400
_______ Capital gains tax: 56,400 at 28% 15,792
_______
Billˇs original cost is used in calculating the chargeable gain on the disposal of the shares in Elf plc.
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.
Example 10 On 16 February 2013 Joan sold three acres of land for 285,000. She had originally purchased four acres of land on 17 July 2011 for 220,000. The market value of the unsold acre of land as at 16 February 2013 was 90,000.
The cost relating to the three acres of land sold is 167,200 (220,000 x 285,000/375,000 (285,000 + 90,000))。
The chargeable gain on the land is therefore 117,800 (285,000 167,200)。
The base cost of the remaining acre 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 11 On 20 February 2013 Furgus sold an acre of land for 130,000. He had originally purchased four acres of land on 13 April 2001 for 210,000. During January 2013 Furgus spent 22,800 clearing and levelling all four acres of land. The market value of the unsold three acres of land as at 20 February 2013 was 350,000. Furgus incurred legal fees of 3,200 in connection with the disposal.
Furgusˇ chargeable gain for 201213 is as follows:
Disposal proceeds 130,000
Cost
56,875
Enhancement expenditure 6,175
Incidental costs
3,200
_______ (66,250)
_______ 63,750
_______
The cost relating to the acre of land sold is 56,875 (210,000 x 130,000/480,000 (130,000 + 350,000))。
The cost of clearing and levelling the land is enhancement expenditure. The cost relating to the acre of land sold is 6,175 (22,800 x 130,000/480,000)。
The incidental costs relate entirely to the acre of land sold, and so they are not apportioned.
Chattels Special rules apply to chattels. A chattel is tangible moveable property.
Example 12 On 18 August 2012 Gloria sold an antique table for 5,600 and an antique clock for 7,200. The antique table had been purchased on 27 May 2011 for 3,200, and the antique clock had been purchased on 14 June 2011 for 3,700.
The antique table is exempt from CGT because the gross sale proceeds were less than 6,000.
The chargeable gain on the antique clock is restricted to 2,000 (7,200 6,000 = 1,200 x 5/3) as this is less than the normal gain of 3,500 (7,200 3,700)。
Where a 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 then no capital loss will be available at all.
Example 13 Giles sold the following assets during the tax year 201213:
On 3 February 2013 he sold an antique table for 4,700. The table had been purchased on 2 May 2002 for 10,200.
On 12 March 2013 he sold machinery for 22,600. The machinery had been purchased on 1 June 2009 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 14 On 31 March 2013 Mung sold a copyright for 9,600. The copyright had been purchased on 1 April 2008 for 10,000 when it had an unexpired life of 20 years.
The chargeable gain on the copyright is as follows:
Disposal proceeds 9,600
Cost (10,000 x 15/20)
(7,500) _______
2,100 _______
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, rollover relief is available if the insurance monies are used to purchase a replacement asset within a period of 12 months.
Example 15 On 20 October 2012 an antique table owned by Claude was destroyed in a fire. The table had been purchased on 23 November 2010 for 50,000. Claude received insurance proceeds of 74,000 on 6 December 2012 and on 18 December 2012 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 16 Continuing with Example 15, 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 201213.
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 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 17 On 1 October 2012 an antique carpet owned by Juliet was damaged by a flood. The carpet had been purchased on 17 November 2008 for 69,000. Juliet received insurance proceeds of 12,000 on 12 December 2012, and she spent a total of 13,400 during December 2012 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 36 months of ownership are always treated as a period of ownership. The following periods of absence are also deemed to be periods of occupation:
Periods up to a total of three years for any reason.
Any periods where the owner is required to live abroad due to their employment.
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.
Example 18 On 30 September 2012 Hue sold a house for 381,900. The house had been purchased on 1 October 1992 for 141,900.
Hue occupied the house as her main residence from the date of purchase until 31 March 1996. The house was then unoccupied between 1 April 1996 and 31 December 1999 due to Hue being required by her employer to work elsewhere in the UK.
From 1 January 2000 until 31 December 2006 Hue again occupied the house as her main residence. The house was then unoccupied until it was sold on 30 September 2012.
The chargeable gain on the house is as follows:
Disposal proceeds 381,900
Cost
(141,900) ________
240,000 Principal private residence exemption (207,000)
________ 33,000
________
The total period of ownership of the house is 240 months (207 + 33)， of which 207 months qualify for exemption as follows: Chargeable months
Exempt months 1 October 1992 to 31 March 1996 (occupied) 42
Chargeable months
Exempt months
1 April 1996 to 31 December 1999 (working in UK)
45
1 January 2000 to 31 December 2006 (occupied) 84
1 January 2007 to 30 September 2009 (unoccupied)
33 1 October 2009 to 30 September 2012 (final 36 months) 36
___ ___
207
33
The unoccupied period from 1 January 2007 to 30 September 2009 is not a period of deemed occupation as it was not followed by a period of actual occupation.
The exemption is therefore 207,000 (240,000 x 207/240)。
Letting relief will extend the principal private residence exemption where a property is let out during a period that does not otherwise qualify for exemption.
Example 19 Continuing with Example 18, assume that Hue let her house out during the periods that she did not occupy it.
The chargeable gain on the house will now be as follows:
Disposal proceeds 381,900
Cost
(141,900) ________
240,000 Principal private residence exemption (207,000)
Letting relief exemption
(33,000) ________
Nil ________
The letting relief exemption is the lower of:
40,000
207,000 (the amount of the gain exempt under the principal private residence rules)
33,000 (the amount of the non-exempt gain attributable to the period of letting (240,000 x 33/240))
Where part of a house is used exclusively for business use then the principal private residence exemption will be restricted.
Example 20 On 30 September 2012 Mae sold a house for 186,000. The house had been purchased on 1 October 2002 for 122,000. Throughout the period of ownership the house was occupied by Mae as her main residence, but one of the houseˇs eight rooms was always used exclusively for business purposes by Mae.
The chargeable gain on the house is as follows:
Disposal proceeds 186,000
Cost
(122,000) ________
64,000 Principal private residence exemption (56,000)
________ 8,000
________
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, and the way in which gains made by limited companies are taxed. It also contains some guidance for when you are answering a chargeable gains question in the exam.
Written by a member of the Paper F6 examining team
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