This year has seen some important changes to capital gains tax on investments, notably the cut in the tax rates. With this in mind, it is worth taking a quick look at the rules: what is new and its key principles.
CGT is a tax on gains and it applies on the disposal of assets. In the case of funds or shares, that is generally when the investment is sold. But giving away an asset is also treated as a disposal. Some gifts do not necessarily trigger a potential tax charge: for example, gifts between spouses or civil partners unless they are separated and did not live together at all in the tax year of the disposal. Basically, the donor’s original acquisition value is held over and used as the base cost for the donee’s final disposal. Gifts to charity are also exempt.
There is no CGT when someone dies but unlike the position with a held-over gain the deceased person’s assets are revalued at the date of death and these values are then taken as the base price for subsequent disposals. Dying can sometimes be very tax efficient.
After a company has gone bust, its shares are likely to become of nil or negligible value, and this is treated as a disposal for CGT. HM Revenue & Customs publishes a list of such publicly quoted investments on its website.
Some disposals are exempt including Isas, gilts, qualifying corporate bonds and, of course, main residences. There is a comprehensive list of exemptions on the HMRC website too. And where gains are not taxable, losses will not be allowable either.
CGT has to be paid on worldwide disposals of assets if the owner is UK resident and UK domiciled. There are special rules for those now relatively rare non-doms who claim the remittance basis of tax.
The rates of CGT have changed for the tax year 2016/17 and depend on whether the investor is a basic or higher/additional rate taxpayer, taking into account their income and their capital gains for the year.
Basic rate taxpayers pay a 10 per cent CGT rate, while higher rate taxpayers now pay 20 per cent tax on gains. Trustees or personal representatives of someone who has died pay 28 per cent on residential property and 20 per cent on other chargeable assets.
Another factor affecting the rates that apply is the type of assets being disposed of: higher rates apply to residential property and to “carried interest”. The people with “carried interest” are involved in investment management partnerships for private equity or other investment funds where they receive amounts that are chargeable to CGT and are linked to a fund’s performance. Gains on residential property or “carried interest” are subject to an extra 10 per cent rate.
There is also a special tax rate of only 10 per cent if the investor qualifies for entrepreneurs’ relief for business assets.
The lower rate of capital gains tax is good news for investors but, of course, the corollary is that carried forward losses are worth less than they were in the past.
Calculating a CGT liability
After deducting allowable losses, CGT is payable on total gains realised during a tax year. Losses realised in the same year are deducted against gains. Tax only has to be paid on overall gains above the tax-free annual exempt amount, which is currently £11,100 for individuals and £5,550 for most trusts. It has been the same level since 6 April 2015.
If the total taxable gain is above the annual exempt amount, an investor can deduct their unused losses from previous tax years. If these losses reduce the total gains to the £11,100 exempt amount, the remaining unused losses can be carried forward to a future tax year.
The first step in calculating a person’s CGT liability is to work out the amount of their taxable income. This is their income less their personal allowance and any other income tax reliefs to which they are entitled.
The next step is to calculate their total taxable gains: that is gains less losses. It is then necessary to deduct the tax-free annual exempt amount of £11,100 from their total taxable gains. Finally, this amount of net gains above the annual exempt amount has to be added to their taxable income.
For example, Fred has a taxable income (his income after deducting his personal allowance and any income tax reliefs) of £40,000 and his taxable gains are £15,100. His gains are not from residential property.
After deducting the annual exempt amount of £11,100 from his taxable gains, this leaves gains of £4,000 on which he will have to pay tax.
This £4,000 is added to his taxable income. The combined amount of £44,000 is more than £32,000 (the basic rate band for 2016/17). Fred will therefore have to pay CGT at the higher rate of 20 per cent, that is, £800.
If the taxable amount is within the basic income tax band, the individual will pay 10 per cent on their gains. They will have to pay 20 per cent on any amount above this.
Gains on residential property or carried interest will be subject to CGT of 20 per cent or 28 per cent. If there are gains from both residential property and other assets, the annual exempt amount can be set against any gains that would be charged at their highest rates, for example, where the investor would pay 28 per cent tax.
Danby Bloch is chairman at Helm Godfrey