Capital Gains Tax Planning – How to avoid CGT

What is Capital Gains Tax?

Capital Gains Tax (CGT) is a tax on profit or gain made when selling, gifting, transferring, exchanging, destroying or disposing of any asset for compensation. The gain, or the profit made (which is the selling price minus cost price) attracts capital gains tax.

As a general rule of thumb, transactions that do not attract income tax attract capital gains tax. For instance, a property dealer would pay income tax on gains resultant from the sale of property whereas another individual indulging in a one-off property transaction may pay capital gains tax rather than income tax for the transaction.

In the UK, present capital gains tax rates are 18 per cent or 28 per cent depending on the income levels. The tax applies when the amount of capital gains is in excess of the annual exempt amount, which stands at £10,100 for 2010-11 and £10,600 for 2011-12. The annual exempt amount for most trusts is half the amount for individuals. Trusts with mentally disabled beneficiaries or certain other disabled beneficiaries enjoy the same annual exempt amount as individuals.

Why opt for capital gains tax planning?

The importance of tax planning can never be understated, more so for CGT planning. With careful planning and foresight, it becomes possible to reduce significantly, or even eliminate altogether this tax liability. A proper understanding of all the rules, regulations and stipulations allows one to plan investments and finances in a way that minimises capital gains tax outflow.

What are the assets that attract CGT?

Most assets, regardless of whether situated in the UK or overseas become liable for capital gains tax when disposed of. The law however allows some exemptions, such as

  • Personal possessions such as jewellery or paintings disposed for £6,000 or less
  • One car
  • The principal or main residence
  • Stocks and shares held in tax-free investment savings accounts
  • UK Government or gilt-edged securities such as National Savings Certificates, Premium Bonds and loan stock issued by the Treasury
  • Betting, lottery or pools winnings
  • Personal injury compensation

Most assets other than these are liable to tax when disposed of.

Do overseas assets qualify for CGT?

UK residents are liable to pay capital gains tax for gains resultant from disposal of overseas assets. Non-domiciled residents may however claim remittance basis of capital gains tax, wherein the foreign gains become liable for capital gains tax only when bringing the gain into the UK.

Do gifts attract CGT?

All gifts except ones made to a spouse, civil partner or charity attract capital gains tax. Gifts to a child, or transfer of assets in the basis of divorce or dissolving of a civil partnership also attract tax.

Capital gains tax on property

Gains from the sale of property such as a second home, rental property, business premises or agricultural land become liable for capital gains tax.

The main home also attracts CGT, but the law provides for private residence relief that virtually exempts profits from the sale of the principal dwelling house.

What is Private Residence Relief?

Private residence relief is the provision in law that exempts capital gains tax for a person’s primary or main residence, subject to the condition that the asset was in use only as a home. The gains resultant from disposal of a part of the house or the garden of the house, while retaining the remaining portion also qualifies for such a relief.

The relief is the full amount of CGT, subject to fulfilling certain conditions:

  • The garden or grounds, including the site of the house is less than 5,000 square meters
  • The house is not let out in part of whole, or no more than one lodger resides at a time
  • The intention of the transaction is not to make a quick profit
  • No portion of the house is in use exclusively for any business purposes. If any portion is in use for business purpose, such portion becomes ineligible for the relief, on a proportionate basis
  • If the house owner does not reside in the house, it should be for a genuine reason such as distance from work or that job requirements prevent the residence. Absence of more than four years, however, makes the relief void regardless of the reason. However, the law excludes the last 36 months before the disposal for this purpose, meaning that during this time, the homeowner may choose not to reside there for any reason.

What is Letting Relief?

Letting relief is exemption from capital gains tax when renting the property. The maximum amount of letting relief due is £40,000, or the private residence relief due, or the gain made on the let out part of the property, whichever is lower.

To illustrate, assume a person uses 70 percent of the house as his residence, lets out the remaining 30 percent and makes a total gain of £60,000 by selling the property. The property attracts private residence relief of £42,000 (70 per cent of the £60,000 gain) and a maximum letting relief of £18,000 (30 per cent of the £60,000 gain). This means that there is no tax to pay.

Does inheriting a property make one liable to pay CGT?

Inheriting assets by itself does not attract capital gains tax, but when disposing of the inherited asset, the profits from the time of originally acquiring the asset rather than the value at the time of inheritance attracts capital gains tax.

Do profits from shares, unit trusts and other investments attract capital gains tax?

Disposal of stocks and shares in a company, units in a unit trust, debentures, bonds excluding premium bonds and investments in companies or in the government are liable to CGT. There is however, no capital tax payable when replacing one set of shares by another set of shares following company reorganisation or take-over.

Gifting of shares to a spouse or civil partner do not attract capital gains tax, provided the gift is not trading goods bought for resale, and the partners have lived together. However, when the spouse or civil partner sells or disposes of the shares, it attracts CGT at the original purchase price and not at the value at the time of receiving the gift.

Shares acquired through share incentive plans, “Save as you earn” schemes and company share option plans may be exempt, or may enjoy a discount.

What is Negligible Value Claim?

At times, shares on hand become worthless owing to company liquidation or some other factors. In such cases, it becomes possible to make a “negligible value claim” for capital loss, and set off such loss against other capital gains.

Negligible value claim assumes selling the shares on the date of application, and then buying it back in either of the two previous tax years

What is Gift Holdover Relief?

Gift holdover relief allows postponing the capital gains tax.

When gifting business assets, or unlisted shares of trading company where the taxpayer holds a minimum of five percent of voting rights, the taxpayer can claim gift holdover relief. With this relief, the tax is not due, or is “held over” until the person who receives the shares disposes of them. The held over gain is based on the market value of the shares on the day the taxpayer no longer owns it.

What is the Enterprise Investment Scheme?

Enterprise Investment Scheme is a tax incentive on investing in small, unlisted companies. The scheme allows deferral of capital gains tax when reinvesting a gain on an asset in shares enterprise investment scheme shares. The investment in such shares has to take place between one year before and three years after disposing the original assets.

What is Roll-Over Relief?

Employees may claim roll-over relief for CGT when the employer operates a share incentive plan and the employee disposes of shares in an unlisted company to the trustee of such share incentive plan.

Business roll-over relief applies when when the proceeds of disposal of an asset finds use to buy another asset that attracts capital gains tax. In such cases, the tax applies only when disposing of the newly acquired asset.

What is capital gains tax on antiques, jewellery and other personal possessions?

Disposing of chattels or personal possessions worth more than £6,000 attracts CGT

Possessions that attract tax include artwork such as a painting, antiques, jewellery and more. Items with an expected useful life of less than 50 years and not used in a trade or job, such as a caravan or motorboat are exempt.

What is capital gains tax on Business assets?

Many business assets such as the premises, fixtures and fittings, shares, and even intangible assets such as registered trademark and goodwill are liable to CGT. However, the business may avail of business asset-roll over relief, entrepreneur’s relief, or incorporation relief.

Business Asset Roll-Over relief is exemption from paying capital gains tax when selling a business asset and re-investing the proceeds in a new business asset, between one year before and three years after the date of disposal of the old asset.

Entrepreneurs’ Relief is exemption from CGT when selling shares in a trading company or the holding company of a trading group, when the taxpayer has worked for the company or owns at least 5 per cent of the ordinary shares in the company with voting rights. The tax rates for gains that qualify for entrepreneurs relief are 10 percent rather than the normal 18 or 28 percent.

Incorporation relief is exemption from paying income tax when a sole trader or partner transfers the business to a company