Learning Outcomes
This article outlines the fundamental principles for calculating capital gains tax (CGT) in England and Wales. It details how to determine chargeable gains arising from the disposal of assets and identifies the main types of expenditure that can be deducted. Key reliefs available to reduce CGT liability are also introduced. After reading this article, you should understand the core steps in calculating a capital gain or loss, recognise common allowable deductions, and identify the basic operation of major reliefs relevant to the SQE1 assessment.
SQE1 Syllabus
For SQE1, you are required to understand the practical calculation of CGT for individuals and unincorporated businesses. This involves applying the rules for calculating gains, identifying allowable deductions, and recognising the availability and effect of main reliefs and exemptions.
As you work through this article, remember to pay particular attention in your revision to:
- the method for calculating gains and losses on asset disposals
- identifying and applying allowable deductions such as acquisition and disposal costs, and improvement expenditure
- understanding the application and effect of key reliefs, particularly Business Asset Disposal Relief (BADR) and the Annual Exemption
- distinguishing between different types of assets and disposals relevant to CGT.
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- What is the basic formula for calculating a capital gain?
- Which of the following costs might be an allowable deduction when calculating a capital gain?
a) The original purchase price of the asset.
b) Fees paid to a solicitor for handling the purchase.
c) Costs of routine maintenance during ownership.
d) Costs of building an extension that increased the asset's value. - True or false? The Annual Exemption can be carried forward if unused in a tax year.
- What is the main benefit of Business Asset Disposal Relief (BADR)?
Introduction
Capital Gains Tax (CGT) is levied on the profit (gain) realised upon the disposal of certain assets. For SQE1 candidates, a firm understanding of how to calculate these gains and what deductions are permissible is essential. This involves understanding the components of the calculation: disposal proceeds, acquisition costs, and allowable expenditures. Additionally, awareness of key reliefs can significantly alter the final tax liability. This article focuses on these core calculation principles and allowable deductions as they apply to individuals and unincorporated businesses within the scope of the SQE1 syllabus.
The Basic CGT Calculation
The fundamental calculation for determining a capital gain or loss involves subtracting the allowable costs associated with an asset from the proceeds received upon its disposal.
Identifying a Chargeable Disposal
A disposal event triggers CGT. This typically involves selling an asset, but also includes gifting, swapping, or receiving compensation (like an insurance payout) for an asset. The asset disposed of must also be a chargeable asset.
Key Term: Chargeable Asset
Most forms of property owned by an individual or business, including land, buildings, shares (outside ISAs/PEPs), and valuable personal possessions (chattels worth over £6,000). Specific exemptions apply, notably an individual's main private residence.
Calculating the Gain
The basic steps are:
- Determine Disposal Proceeds: This is usually the sale price received. For gifts or sales at an undervalue (except to connected persons), market value is typically substituted.
- Deduct Acquisition Cost: This is the original price paid for the asset, including any incidental costs of acquisition.
- Deduct Allowable Expenditure: Costs incurred during ownership that increase the asset's value or relate to its disposal can be deducted.
The result of this calculation (Disposal Proceeds - Acquisition Cost - Allowable Expenditure) is the basic gain or loss before considering reliefs.
Key Term: Disposal Proceeds
The amount received (or deemed market value) for the disposal of a chargeable asset, less any incidental costs directly related to the disposal (e.g., estate agent or legal fees on sale).Key Term: Acquisition Cost
The original cost of acquiring the asset, plus any incidental costs directly related to the acquisition (e.g., stamp duty, legal fees on purchase).
Allowable Deductions
Certain expenditures incurred on the asset during the period of ownership, or in the process of acquiring or disposing of it, can be deducted from the gain.
Key Term: Allowable Expenditure
Costs that can be deducted when calculating a capital gain. These primarily include the acquisition cost, incidental costs of acquisition and disposal, and improvement expenditure.
Incidental Costs of Acquisition and Disposal
These are costs directly associated with buying or selling the asset.
- Acquisition Costs: Examples include surveyors' fees, legal fees, and Stamp Duty Land Tax (SDLT) paid on the purchase of property.
- Disposal Costs: Examples include estate agents' commission, advertising costs, and legal fees incurred on the sale.
Improvement Expenditure
This refers to capital expenditure incurred during ownership that increases the value of the asset, provided the improvement is reflected in the asset's state or nature at the time of disposal.
- Examples: Cost of building an extension to a property, significant improvements to machinery.
- Exclusions: Routine maintenance, repairs, insurance costs, or any expenditure allowable as a deduction against income tax are generally not allowable improvement expenditure for CGT.
Worked Example 1.1
Anya bought an investment property in 2015 for £200,000, incurring £3,000 in legal fees and £6,000 in SDLT. In 2018, she spent £40,000 building an extension. In 2023, she sold the property for £350,000, paying £5,000 in estate agent fees and £2,000 in legal fees. Calculate Anya's basic gain.
Answer:
Disposal Proceeds: £350,000 - £5,000 (estate agent) - £2,000 (legal fees) = £343,000
Acquisition Cost: £200,000 + £3,000 (legal fees) + £6,000 (SDLT) = £209,000
Improvement Expenditure: £40,000
Basic Gain = £343,000 (Net Proceeds) - £209,000 (Acquisition Cost) - £40,000 (Improvement) = £94,000
Application of Reliefs and Exemptions
Annual Exemption (AE)
Individuals have an annual exempt amount, meaning they can realise gains up to this threshold each tax year without paying CGT.
Key Term: Annual Exemption
The amount of capital gain an individual can realise in a tax year without being liable for CGT. This allowance cannot be carried forward if unused. (For 2023/24, this was reduced to £6,000, and further reduced to £3,000 from April 2024).
Revision Tip
The Annual Exemption amount changes frequently. Always check the current rate applicable for the relevant tax year in the SQE1 assessment. The AE is deducted after calculating the gain but before applying the tax rate.
Business Asset Disposal Relief (BADR)
Formerly known as Entrepreneurs' Relief, BADR reduces the rate of CGT payable on qualifying business disposals.
Key Term: Business Asset Disposal Relief (BADR)
A relief that reduces the CGT rate to 10% on qualifying gains from the disposal of certain business assets, up to a lifetime limit (currently £1 million).
Qualifying Disposals for BADR typically include:
- Disposal of all or part of a trading business carried on as a sole trader or partner (minimum 2-year ownership).
- Disposal of shares in a trading company where the individual holds at least 5% of ordinary share capital and voting rights, is an employee or officer, and these conditions have been met for at least two years prior to disposal.
Worked Example 1.2
Ben, a higher-rate taxpayer, sells his 10% shareholding in a qualifying trading company, where he has worked as a director for 5 years. He bought the shares for £50,000 and sells them for £250,000. He has made no other disposals this tax year and has his full £1 million BADR lifetime allowance available. Calculate his CGT liability (using the 2023/24 AE of £6,000).
Answer:
Basic Gain = £250,000 (Proceeds) - £50,000 (Cost) = £200,000
This is a qualifying disposal for BADR.
Gain after AE = £200,000 - £6,000 = £194,000
CGT Liability = £194,000 x 10% (BADR rate) = £19,400
Ben uses £194,000 of his £1 million lifetime BADR allowance.
Other Key Reliefs (Brief Overview)
- Rollover Relief: Allows deferral of CGT on the disposal of qualifying business assets if proceeds are reinvested in new qualifying business assets within a specific timeframe (usually 1 year before to 3 years after disposal). Shares are generally not qualifying assets for this relief.
- Hold-Over Relief (Gift Relief): Allows the gain on a gift (or sale at undervalue) of business assets or certain shares to be 'held over', meaning the donor pays no CGT, and the recipient effectively inherits the donor's acquisition cost, deferring the tax until the recipient disposes of the asset.
- Incorporation Relief: Allows deferral of CGT when an unincorporated business (sole trader/partnership) is transferred to a company in exchange for shares.
Exam Warning
Be careful to distinguish between the different reliefs and their specific conditions. For example, Rollover Relief applies to specific qualifying business assets (often excluding shares), while BADR has broader applicability including shares under specific conditions. Hold-Over Relief requires a gift element.
Losses
If the calculation results in a loss (allowable costs exceed disposal proceeds), this loss can be offset against chargeable gains arising in the same tax year. Any remaining losses can usually be carried forward indefinitely to offset against gains in future tax years. Losses must be offset against gains before deducting the Annual Exemption.
Key Point Checklist
This article has covered the following key knowledge points:
- CGT is charged on the gain arising from the disposal of a chargeable asset.
- The basic gain is calculated as Disposal Proceeds less Acquisition Cost less Allowable Expenditure.
- Allowable Expenditure includes incidental costs of acquisition and disposal, and qualifying improvement expenditure.
- Key reliefs can reduce or defer the chargeable gain, including the Annual Exemption (AE) and Business Asset Disposal Relief (BADR).
- The AE is an annual tax-free allowance for individuals which cannot be carried forward.
- BADR provides a reduced 10% CGT rate for qualifying business disposals, up to a lifetime limit.
- Rollover Relief and Hold-Over Relief allow for the deferral of CGT under specific conditions related to reinvestment or gifts of business assets.
- Capital losses can be offset against gains in the same year or carried forward.
Key Terms and Concepts
- Chargeable Asset
- Disposal Proceeds
- Acquisition Cost
- Allowable Expenditure
- Annual Exemption
- Business Asset Disposal Relief (BADR)
