Basis of charge

Capital Gains Tax: Basis of Charge

Capital Gains Tax (CGT) is levied on the profit that arises when a chargeable person disposes of a chargeable asset. In the United Kingdom, CGT affects individuals, trustees, and personal representatives when they sell, gift, exchange, or otherwise dispose of assets. Understanding the basics on which CGT is charged is necessary for legal professionals dealing with asset transactions and for those preparing for the SQE1 FLK1 exam.

Chargeable Persons and Assets

Chargeable Persons

In the UK, CGT applies to certain individuals and entities, including:

• Individuals (such as sole traders and partners)
• Trustees
• Personal representatives of deceased persons

It's important to note that companies typically pay Corporation Tax on their gains instead of CGT.

An individual's residency and domicile status can significantly impact their CGT obligations, especially concerning assets located outside the UK. For instance, non-residents may still be liable for CGT on the disposal of UK property.

Chargeable Assets

Chargeable assets include a diverse range of property, which comprises:

• Real property: land and buildings
• Shares and securities
• Business assets
• Personal possessions worth more than £6,000 (excluding cars)
• Certain contractual rights

However, some assets are exempt from CGT, such as:

• Private motor vehicles
• Gifts to charities
• UK government gilts and qualifying corporate bonds
• Foreign currency held for personal use

Chargeable assets are valuable items you own that could produce a profit when sold. But not every gain falls under CGT—some assets slip through the tax net due to specific exemptions.

Calculation of Chargeable Gains

Calculating a capital gain involves several steps:

1. Identify the disposal event: sale, gift, exchange, or loss of an asset.
2. Determine the disposal proceeds: the amount received or the market value if the transaction wasn't at arm's length.
3. Calculate the allowable costs:
   • Acquisition cost: what you originally paid for the asset.
   • Improvement expenditure: costs of enhancing the asset.
   • Incidental costs: expenses like legal fees and commissions when buying or selling.
4. Compute the gain: subtract the allowable costs from the disposal proceeds.
5. Apply any relevant reliefs or exemptions.
6. Deduct the Annual Exempt Amount: £12,300 for individuals in the 2023/24 tax year.

Example: Calculating a Chargeable Gain

Let’s consider John, who sells a commercial property. The details are:

• Sale price: £500,000
• Purchase price: £300,000
• Enhancement costs: £50,000 (e.g., adding an extension)
• Legal fees:
  • Purchase: £5,000
  • Sale: £7,000

Calculation:

1. Disposal proceeds: £500,000
2. Less allowable costs:
   • Purchase price: £300,000
   • Enhancement costs: £50,000
   • Legal fees: £5,000 + £7,000 = £12,000
   • Total allowable costs: £362,000
3. Chargeable gain: £500,000 - £362,000 = £138,000
4. Deduct Annual Exempt Amount: £138,000 - £12,300 = £125,700 (if no other reliefs apply)

John's taxable gain is £125,700, which will be subject to CGT at the applicable rate.

Reliefs and Exemptions

Understanding available reliefs can significantly reduce CGT liability. Key reliefs include:

Principal Private Residence Relief (PPR)

If you sell your main home, you usually don't pay CGT on any profit made. PPR covers:

• Periods when the property was your only or main residence.
• The final nine months of ownership, even if you weren't living there.
• Certain absences, like working abroad, under specific conditions.

Example:

Sarah lived in her house for 10 out of the 12 years she owned it. She moved out and rented it for the last two years. When she sells the house, PPR applies to the time she lived there plus the final nine months, reducing her CGT liability significantly.

Business Asset Disposal Relief (BADR)

BADR reduces the CGT rate to 10% on qualifying business disposals, up to a lifetime limit of £1 million. To qualify:

• Disposal of all or part of a business: as a sole trader or business partner.
• Disposal of shares: in a company where you hold at least 5% of shares and voting rights.
• Ownership period: you must have owned the business assets or shares for at least two years.

Example:

Emma owns 25% of a tech company and has been a director for three years. She sells her shares for a substantial gain. Because she meets the qualifying conditions, she can claim BADR and pay CGT at 10% on the gain.

Roll-over Relief

When you sell a business asset and use the proceeds to buy another business asset, you can defer the CGT charge through Roll-over Relief.

Conditions:

• The new asset must be purchased within one year before or three years after the sale.
• Both the old and new assets must be used in your trading business.
• Relief applies to the amount reinvested.

Example:

Carlos sells a piece of machinery for £100,000, realizing a gain. He buys new machinery for £90,000. Roll-over Relief allows him to defer CGT on the £90,000 reinvested. CGT is only payable on the £10,000 not reinvested.

Hold-over Relief

Hold-over Relief allows you to defer paying CGT when you give away certain business assets or shares.

Example:

Linda gifts farmland used in her farming business to her son. They claim Hold-over Relief, so CGT is deferred until her son sells the land. Her son takes over Linda's original cost basis, postponing the tax charge.

Anti-Avoidance Provisions

To prevent tax avoidance, several rules are in place:

1. Connected Persons Rules: Transactions between connected individuals (like family members) are treated as occurring at market value, regardless of the actual price paid.

   Example: If Mike sells shares worth £50,000 to his sister for £10,000, the sale is deemed to occur at £50,000 for CGT purposes.

2. Bed and Breakfasting Rules: Selling shares to create a loss and repurchasing them within 30 days is ineffective for CGT purposes.

   Example: Jane can't sell her shares at a loss and buy them back the next day to claim a loss for CGT.

3. Transactions in Securities: Rules target arrangements designed to convert income into capital gains to obtain a tax advantage.

4. Transfer of Assets Abroad: Addresses the avoidance of CGT by transferring assets to non-residents.

Practical Applications

CGT is necessary in various legal and financial contexts:

• Corporate Transactions: Structuring sales to maximize tax reliefs.
• Estate Planning: Utilizing reliefs to transfer assets efficiently across generations.
• Property Development: Assessing tax implications for development projects.
• Investment Strategies: Considering CGT when managing investment portfolios.

Example:

Oliver plans to sell his share in a partnership. By carefully timing the sale and considering reliefs like BADR, he can reduce his CGT liability. Additionally, if he reinvests in qualifying assets, Roll-over Relief might defer some tax.

Conclusion

The interaction of CGT reliefs and anti-avoidance rules requires detailed understanding. Reliefs such as Roll-over Relief and Hold-over Relief can defer tax liabilities, offering strategic benefits when disposing of business assets. However, anti-avoidance provisions like the Connected Persons Rules ensure that transactions are conducted at market value for tax purposes, maintaining fairness in the system.

Applying these principles demands precise knowledge of their requirements. For example, claiming Business Asset Disposal Relief necessitates meeting specific ownership and participation criteria over a two-year period. Similarly, the effective use of Principal Private Residence Relief hinges on accurately determining qualifying occupancy periods.

In practice, these concepts often overlap. When transferring assets to family members, both reliefs and anti-avoidance measures may influence the CGT outcome. Legal professionals must meticulously calculate gains, apply appropriate reliefs, and understand how different rules interact to provide accurate advice. Proficiency in these elements is essential for effective tax planning and ensuring compliance within the UK's legal and taxation framework.