The background to Capital Gains Tax
Capital Gains Tax (CGT) was introduced in 1965 at a flat rate of 30% above the annual exempt amount. This meant basic rate income tax payers incurred a higher rate of tax on capital gains than on income while higher rate tax payers paid a lower rate. The anomaly was addressed in 1988 when capital gains were combined with income and taxed at the individual’s marginal rate of income tax. There were various tinkerings with the system over the years such as taper relief and indexation but these were both abolished in 2008 and a flat rate of 18% introduced. The last major overhaul to the system was in 2010 when the flat rate was replaced with a 2 tier system (see table below).
The current Capital Gains Tax regime:
|Higher or additional
|Gains qualifying for
Entrepreneurs * relief
|6 April 2015 - 5 April 2016
Which asset disposals attract CGT?
|Tax rate for trustees
|6 April 2015 - 5 April 2016
A capital gain arises when you sell or dispose of an asset which has increased in value. The key factor is that you no longer own it so this includes giving away, transferring or exchanging assets as well as receiving compensation for loss. The latter would include an insurance pay-out for a physical item which has been lost or destroyed, for example a valuable antique. Life and critical illness policy pay-outs, on the other hand, are free of CGT. You only have to pay Capital Gains Tax on your overall gains above your tax-free allowance (the annual exempt amount).
‘Chargeable assets’ include:
- Most personal possessions worth £6,000 or more, apart from your car
- Property that isn’t your main home
- Your main home if you have let it out, used it for business or it’s very large
- Investments outside an ISA or Pensions wrapper
- Business assets
What profits are free of CGT?
- Gains below the annual tax-free allowance
- Your principal private residence (PPR) which is your main home
- Gifts to spouses, civil partners or a charity
- Capital gains within an ISA/pensions wrapper
- UK government gilts and Premium Bonds
- Betting, lottery or pools winnings
There is a grace period of 18 months between leaving your main home and selling it which extends to 36 months for the disabled or those moving into a long-term care home. Additionally, you are allowed to be away from your PPR for work (up to 4 years in the UK; no restriction if abroad) or any other reason (up to 3 years) and still qualify for relief as long as you re-occupy the property as your PPR after the absence.
What if I make a loss rather than a profit?
You can report losses on chargeable assets to HM Revenue and Customs (HMRC) by including it on your tax return. You don’t have to report losses straight away – they can be claimed up to 4 years after the end of the tax year that you disposed of the asset and set against total taxable gains. These are called ‘allowable losses’.
Therefore, if your total taxable gains, after deducting losses, in a particular tax year still exceed the tax-free allowance, you can deduct any unused losses from previous tax years. However, you can’t deduct a loss from giving, selling or disposing of an asset to a family member unless you’re offsetting a gain from the same person. This also applies to ‘connected people’ such as business partners.
Keeping records for the taxman.
It is important to keep records to work out your gains and fill in your tax return and you should keep them for at least a year after the Self Assessment deadline. This includes receipts, bills and invoices that show the date and the amount you paid for an asset plus any additional costs incurred such as fees for professional advice, Stamp Duty and improvement costs.
To establish the market value you received for the asset keep any contracts for buying and selling the asset such as those from solicitors or stockbrokers along with copies of any valuations. This includes payments you receive later in instalments or compensation if the asset was damaged. If you don’t have records because they’ve been lost, stolen or destroyed you must attempt to recreate them.
Is CGT payable on death?
When someone dies Inheritance Tax is usually paid by the estate of the deceased person. The beneficiaries will only need to pay Capital Gains Tax if they subsequently dispose of the asset and the cost price will be deemed to be the market value at date of the benefactor’s death.
What if I have assets abroad or live outside the UK?
When you are UK resident your overseas gains will be taxable in the UK. Therefore, even if gains have already been taxed in another country they will still be liable to tax in the UK. You must declare the gains on a tax return but dual taxation relief may be available. There are special rules for people who are UK domiciled or have dual residence.
If you are non-resident in the UK you will have to pay CGT on gains you make on residential property in the UK. However, you will not incur tax on other UK assets, for example shares in UK companies, unless you return to the UK within 5 years of leaving.
Should I be concerned about it?
Although a tax free allowance of £11,100 p.a. sounds quite generous if you build up savings over many years and then need to cash them in for a specific purpose you could find yourself facing a large CGT bill. Unused losses can be carried forward but unused gains cannot. While many people would consider themselves fortunate to be in the position of having made substantial gains on their investment, careful planning can ensure that you do not face an unexpectedly large bill in any one tax year.
So what action can I take to minimise the burden?
One of the easiest ways to avoid a potential exposure to CGT is to put your savings in an ISA wrapper which also ensures they are free of income tax. However, if you have used your ISA allowance and have investments or other assets with capital gains above the annual allowance there are some strategies that can help:
How do I calculate my CGT bill?
- Firstly, you could try and phase your sales over more than one tax year. By locking in some profits just before the end of one tax year and more at the start of the next tax year the amount you can take tax free is doubled in a short time.
- Secondly, you can offset any losses against gains to reduce the liability. If you have locked in gains in a tax year that exceed your annual allowance, crystallising any losses you may have incurred up to a similar amount before the end of the tax year could reduce or eliminate your CGT bill.
- A third technique is ‘Bed and Breakfasting’ which involves selling assets and buying them back to lock in the capital gain. The price you buy back at becomes your new cost price. It used to be possible to do this transaction overnight, selling one day and buying the next, hence the B&B terminology. However, since the 1998 Budget, the repurchase cannot take place within 30 days if the purpose is to use your tax exempt allowance. The risk now is that you are out of the market during this period and the price you repurchase at may be higher, or lower, than the sale price. There will also be transaction costs.
- A way around the 30 day rule is to sell while your spouse or civil partner makes an identical purchase on the same day, a tactic called ‘Bed and Spouse’. This may also have the added advantage of transferring income generating assets to a spouse with a lower marginal tax rate.
- Another option (approved by HMRC) is to repurchase the investments within an ISA or SIPP as the 30 day rule does not then apply. This route is known as a “Bed & ISA” or “Bed & SIPP” transaction. So if you have a taxable portfolio with large unrealised capital gains, you could consider using your annual CGT allowance to realise some of these, then buy the shares back inside the tax wrapper immediately.
- Transfers between spouses and civil partnership couples take place at 'no gain, no loss', providing a useful technique for minimising a family's CGT liability. This can be useful if, for example, a man has gains but his wife is holding an asset that has lost value. If she transfers the asset to her husband and he sells it, the loss becomes his so he can use it to reduce his net gain and therefore his CGT liability.
- Another possible way of reducing CGT is ‘multiple ownership’ of assets. For example, if 4 friends bought 4 investment properties each would have an annual exemption to use on the sale of the properties if they were sold in different tax years. On the other hand if they each owned an entire property there would be only one exempt amount each, assuming it is unlikely they could sell a fraction of a house!
- Finally, remember that pension contributions extend the upper limit of an individual’s income tax band by the amount of the gross contribution. So contributions which bring you back into the basic rate income tax band may also reduce the tax on a capital gain (or at least part of it) from 28% to 18%. For example, if you had a salary of £50,000 and paid £10,000 into a SIPP this would reduce your taxable income to £40,000 leaving £2,385 of income remaining in the basic rate tax band. So if you had a taxable capital gain of £2,500 most of it would be taxed at 18%. Without the pension contribution the CGT rate of 28% would apply.
Your gain is usually the difference between what you paid for your asset and what you sold it for. The capital gain after the tax free allowance is then added to other income earned to determine the rate of CGT payable, as shown in the table above. A simple example is given below:
We can see that this individual has a total income of £48,900 (made up of their £30,000 salary and the £18,900 capital gain). As the starting rate for higher rate tax is £42,385 some of their capital gain will fall into the 18% band and the balance into the 28% band as follows:
|Starting rate for Higher rate tax
|Taxable Capital gain
|Capital Gain taxed at 18%
||£12,385 (£42,385 - £30,000)
|Capital Gain taxed at 28%
||£6,515 (£18,900 - £12,385)
|CGT charge on £12,383
|CGT charge on £6,515
|Total CGT payable
||£4,053.50 (£2,229.30 + £1,842.20)
Some expenses can be deducted before calculating a gain, for example transaction costs. If disposing of shares or funds bought at a series of different dates it will be necessary to calculate the average purchase cost. Also, there are some situations where market value is used instead of purchase or sale price:
- Gifts-value at date of gift
- Assets sold at a favourable price to assist the buyer
- Inherited assets- date of death
- Assets owned before 31 March 1982
* Trusts and reliefs for entrepreneurs are beyond the remit of this article which contains generic information aimed at the individual. For advice on these subjects you should consult a tax expert.
: We do not give investment advice so you will need to decide if an investment is suitable for you. If you require further information with regards your own personal circumstances in relation to capital gains tax, you may wish to contact a specialist. The information provided in this article is of a generic nature only and some of the strategies can be complex requiring specialist advice.