CAPITAL GAINS TAX 2

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CAPITAL GAINS TAX 2
Theory and practice of taxation
B C33TB2 Lecture14

• COMPUTATION OF CHARGEABLE GAINS

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LAYOUT OF A CGT COMPUTATION

• DISPOSAL VALUE
  XXLess Incidental costs of disposal
  XX XXLess ALLOWABLE
  EXPENDITURE Acquisition cost of the
  asset XX Incidental costs of
  acquisition XX Enhancement
  expenditure XX Costs of
  defending the owners title to
  the asset
  XX Valuation fees
  XX
  XX Unindexed gain (unindexed loss)
  XX LessINDEXATION ALLOWANCE
  XX CHARGEABLE GAIN/ (LOSS) XX
• For individuals a Taper Relief may then apply
  (see subsequent lectures)

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NOTES1. DISPOSAL VALUE Normally proceeds
of saleBUTIFThe bargain is not at arms
lengthThe disposal is for a consideration which
cannot be valuedThe disposal is by way of
giftI.e. The asset is transferred at below
market value The proceeds of sale will be
deemed to be "open market value"This is most
likely to occur in a sale to a "connected" person
e. g. a relative or business partner.
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NB if a transaction with a connected person
results in a loss, this can only be set against
gains arising from transactions with the same
person in that or future years. Open market
value is the value which the asset might
reasonably be expected to fetch in a sale on the
open market. 2. INCIDENTAL COSTS OF DISPOSAL
may includeValuation feesEstate agency
feesAdvertising costsLegal costs
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3. ALLOWABLE EXPENDITURE - may include 3.1
ACQUISITION VALUE (If asset was acquired by way
of gift, its market value at the date of
acquisition is treated as its acquisition
cost.)3.2 INCIDENTAL COSTS OF ACQUISITION may
include legal fees etc3.3 ENHANCEMENT
EXPENDITURE- capital expenditure that increases
the disposal value of the asset. (Does not
include cost of repair and maintenance, insurance
or any expenditure deductible for Income Tax
purposes)Enhancement expenditure may qualify
for indexation allowance.
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INDEXATION ALLOWANCE

• Introduced with effect from March 1982 with the
  aim of ensuring that only "real" gains are taxed
  and exclude increase in value that only reflects
  impact of "general inflation".
• General inflation is measured by movements in
  Retail Price Index (RPI). Calculation rules were
  revised in 1985 and 1998.
• Individuals are entitled to indexation allowance
  up to April 1998 but not beyond.
• Companies are, however, entitled to indexation
  allowance up to date of disposal of the asset,
  even if this is beyond April 1998.

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INDEXATION ALLOWANCE EXAMPLE 1

• Jackie buys an asset in January 1996 and sells
  it in January 2007. Indexation allowance will be
  given from January 1996 to April 1998 ONLY.
• Indexation allowance is calculated for each item
  of allowable expenditure.
• Allowable expenditure x indexation factor
• RPI(D) - RPI(E) to 3 decimal places
  RPI(E)
• RPI Retail Price Index D month of disposal
  (or April 1998, if earlier) E month of
  expenditure (or March 1982, if later)

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INDEXATION ALLOWANCE EXAMPLE 2An asset was
acquired by an individual in August 1990 at a
cost of 15,000. Enhancement expenditure of
2,000 was incurred in January 1991. It was sold
in December 2006 for 28,000. Indexation
factors August 1990 128.1, Jan 1991 130.2,
April 1998 162.6 (Ignore Taper Relief)
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Sales proceeds
28,000Less Acquisition cost 15,000
Enhancement cost 2,000 17,000
Unindexed gain
11,000Less Indexation allowance
(i) on acquisition cost 162.6 - 128.1
.269 x 15,000 4,040
128.1 (ii) on enhancement
expenditure 162.6 - 130.3 .248 x 2,000
496 4,536
130.3 Chargeable gain before Taper Relief
6,464
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INDEXATION ALLOWANCE EXAMPLE 3

• Albert acquired an asset in September 1992 at a
  cost of 35,000. Enhancement expenditure of
  6,000 was incurred in May 1994. It was sold in
  December 2006 for 52,000.
• Calculate the chargeable gain before taper relief.

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INDEXATION ALLOWANCE EXAMPLE 3

• Albert Solution
  Sales proceeds
  52,000Less Acquisition cost 35,000
  Enhancement cost 6,000
  41,000 Unindexed gain
  11,000Less Indexation allowance
  (i) on acquisition cost 162.6 - 139.4
  0.166 x 35,000 5,810
  139.4 (ii) on enhancement
  expenditure 162.6 - 144.7 0.124 x 6,000
  744 6,554 144.7
  Chargeable gain before taper relief
  4,445

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RESTRICTION IN USE OF INDEXATION ALLOWANCE
Indexation allowance cannot be used to convert
an unindexed gain into an indexed loss. Or
be used to increase an unindexed loss.
Therefore if the index allowances are greater
than the unindexed gain the chargeable gain is
deemed to be NIL.E. g. (a) (b)
(c)Unindexed gain/(loss) 4,000 1,500
(200) Indexation Allowance
3,500 1,500 Nil (Say 3,500 for
a,b and c) Chargeable gain 500
Nil Nil
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LIFE AFTER INDEXATION ALLOWANCETAPER RELIEF

• For gains realised by individuals etc on or after
  6 April 1998 indexation allowance has been
  replaced by Taper relief.
• This reduces the amount of the Chargeable Gain
  according to the number of full years() that the
  asset has been held since acquisition or 6 April
  1998, if earlier.
• The relief is more generous for business than
  non-business assets.
• ()This will be increased by the addition of 1
  bonus year for non-business assets acquired
  before 17 March 1998

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TAPER RELIEF

• No of complete years of gain chargeable
• after 5.4.98
• for which asset held
• Business Non-business
• 0 100 100
• 1 50 100
• 2 (or more for businesses) 25 100
• 3 95
• 4 90
• 5 85
• 6 80
• 7 75
• 8 70
• 9 65
• 10 (or more) 60

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TAPER RELIEFEXAMPLE

• Julie buys a non-business asset on 1 February
  1998 and sells it on 1 August 2001.
• For taper relief Julie is treated as having held
  the asset for 4 complete years.
• (3 complete years after April 1998 plus one
  additional year)
• The taper is applied to net gains that are
  chargeable after deduction of any losses for the
  current year or brought forward.
• The Annual exemption is then deducted from the
  tapered gains.

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EXAMPLE - LOSSES AND TAPER RELIEF

• Grant sold a business asset in May 2006 which he
  had bought in January 2004 and realised a
  chargeable gain (before taper relief) of
  135,000.
• He also sold a sculpture in 2006-07 and made an
  allowable capital loss of 12,000.
• He had allowable losses brought forward of
  17,000.
• Losses are deducted before taper relief

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EXAMPLE - LOSSES AND TAPER RELIEF 2

• Gains 135,000
• Current year loss 12,000
• Current year net gain 123,000
• Brought forward loss 17,000
• Gains before taper relief 106,000
• Gain after taper relief (Jan 2004- May 2006
• 2 Years) 106,000 x 25 26,500
• Annual exemption 8,800
• Taxable gain 17,700

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EXAMPLE - LOSSES AND TAPER RELIEF

• Same example as before except gains have been
  altered to illustrate the last point (on this
  page)Grant sold a business asset in May2006
  which he had bought in January 2004and realised a
  chargeable gain (before taper relief) of
  35,000. (not 135,000 as before)
• He also sold a sculpture in 2006-07 and made an
  allowable capital loss of 12,000.
• He had allowable losses brought forward of
  17,000.
• Losses are deducted before taper relief BUT
• Brought forward losses are only deducted from
  current gains to the extent that these gains
  exceed the CGT annual exemption, thus

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EXAMPLE - LOSSES AND TAPER RELIEF 2

• Gains 35,000
• Current year loss 12,000
• Current year net gain 23,000
• Brought forward loss 23,000 - 8,800
  14,200
• Gains before taper relief 8,800
• Gain after taper relief (Jan 2004- May 2006
• 2 Years) 8,800 x 25 2,200
• Annual exemption 8,800 limit to
  2,200
• Taxable gain 0
• The balance of the losses 2,800 (17,000-14,200)
  is carried forward
• Note taper relief is wasted as brought forward
  losses reduce to the exemption level.

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ALLOCATION OF LOSSES TO GAINS 1

• Where there are gains on more than one asset it
  will be necessary to allocate losses to each
  asset in order to calculate taper relief
• Allocation is made on the basis that produces the
  lowest tax charge.
• Losses should be deducted from the gains where
  the highest remains chargeable so preserving
  the assets where the lowest remains chargeable

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ALLOCATION OF LOSSES TO GAINS 2

• EXAMPLE
• Mike made these capital gains and losses in
  2006-07
• Loss 10,000
• Gains pre taper relief
• Asset 1 (non-business) 25,000
• Asset 2 (business) 18,000
• Asset 1 was bought in February 1999, sold January
  2007 - taper relief results in 75 of gross gain
  chargeable (7 years)
• Asset 2 bought November 2001, sold December 2006
  taper relief gives 25 of original gain
  chargeable (5 years, business asset)
• Optimum use of loss
• Set against non-business asset where higher
  amount is chargeable

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ALLOCATION OF LOSSES TO GAINS 3

• 
  Total Asset 1 Asset 2
  Percentage chargeable
  75 25Chargeable
  gains 43,000 25,000
  18,000Less losses
  10,000 10,000
  33,000
  15,000 18,000
  75
  25Chargeable after taper relief 15,750
  11,250 4,500Less Annual exemption
  8,800
  CGT assessment 6,950

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TAPER RELIEF SPECIAL SITUATIONS

• Transfer of assets between spouses and same sex
  couples where legally recognised (no gain/no
  loss) taper on subsequent disposal is based on
  combined period of ownership by spouses
• For other no gain/no loss transfers taper will
  operate on ownership period of new owner only
• Where gains have been relieved a provision which
  reduces the cost of an asset in the hands of a
  new owner (e.g. under gift relief) the taper will
  operate on holding period of the new owner.

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BUSINESS ASSETS DEFINITIONS

• AN ASSET
• used for the purposes of a trade carried on by an
  individual
• shares in a various companieseg in unquoted
  trading companies or held by employees in
  quoted trading companies or held by employees,
  without a material interest (10), in a non
  trading company

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ASSETS HELD ON 31 MARCH 1982

• CGT was introduced as from April 1965
• After the rapid inflation of the 1970's and early
  1980's it was decided to start from scratch.
• Assets held in March 1982 could be regarded as
  having been acquired at their market value at
  that date for CGT purposes. This is generally to
  the taxpayer's advantage.
• But in case the value of the asset had decreased
  from the original acquisition until March 1982,
  the legislation gives the taxpayer the choice of
  using the original cost or March 1982 valuation
  for CGT purposes.
• Indexation allowance is given only from March
  1982 but is applied to the higher of the original
  cost or March 1982 valuation.

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ASSETS HELD ON 31 MARCH 1982- EXAMPLE

• Liz acquired a holiday house in April 1975 for
  2,000 and sold it in June 2006 for 8,500.
• If its market value on 31 March 1982 (RPI 79.4)
  was 4,200.
• Original cost MV 31/3/82
• Sales proceeds 8,500 8,500
• Less Original cost 2,000
• MV 31/3/82 4,200
• Unindexed gain 6,500 4,300
• MV 31/3/82 is the preferred basis-

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ASSETS HELD ON 31 MARCH 1982- EXAMPLE 2

• Calculation continues as follows
• Unindexed gain 4,300
• LessIndexation allowance
• (March 1982 April 1998)
• 162.6-79.4 1.048 x 4,200
• 79.4
• 4,401 restricted to 4,300
• Chargeable gain 0

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ASSETS HELD ON 31 MARCH 1982- EXAMPLE 3

• If its market value on 31 March 1982 (RPI 79.4)
  was 1500 Original cost MV 31/3/82
• Sales proceeds 8,500 8,500
• Less Original cost 2,000
• MV 31/3/82 1,500
• Unindexed gain 6,500 7,000
• Original cost is the preferred basis-
• Calculation continues as follows
• Unindexed gain 6,500
• Less Indexation allowance 162.6-79.4
• 79.4
• 1.048 x 2000 2,096
• Indexed gain (subject to taper relief)
  4,404

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ASSETS HELD ON 31 MARCH 1982

• If both 31/3/82 and original cost methods give a
  gain then the chargeable gain is based on the
  smaller gain.
• If both 31/3/82 and original cost methods give a
  loss then the allowable loss is based on the
  smaller loss.
• If one basis gives a loss and one gives a gain
  then the transaction is deemed to give a Nil gain
  /Nil loss.
• Because of these rules at each disposal two
  calculation are needed
• To overcome this the taxpayer can make a
  "rebasing election" so that the pre 31/3/82 cost
  of ALL assets can be ignored with regards to all
  31/3/82 held assets.
• Must be made for all assets when first sale of
  pre 1982 assets takes place after 5/4/88.

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PART DISPOSALS If only part of an asset is
disposed ofOnly part of the acquisition cost is
deemed allowable expenditure. Allowable part
of expenditure given by fraction. A .
A B Where A is the value of the
part disposed of B is the value
of the part remaining. Both at
the day of disposalThis fraction applies to any
expenditure relating to the whole asset
Expenditure which relates only to the part
disposed of should be allowed in full.
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PART DISPOSALS - EXAMPLE"Z" buys a piece of
land for 26,000 in October 1985. He divides the
land into two plots, a larger and smaller one.
He undertakes drainage improvements on the
smaller plot in June 1991 at a cost of 3,000.
He sells the smaller plot for 16,000 in August
2006. The incidental costs of disposal were
500. The value of the remaining larger plot of
land in August 2006 was estimated at 40,000.RPI
at October 1985 was 95.59 at June 1991 134.1
at April 1998 162.6
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SOLUTION Sales
proceeds 16,000 Less Incidental costs of
disposal 500 15,500 Less Part
acquisition cost 16,000 x
26,000 7,42816,000 40,000
Enhancement expenditure 3,000 10,428
Unindexed gain 5,072
Less Indexation allowance (i) on
acquisition cost 162.6 - 95.59
.701 x 7,428 5,207
95.59 (ii) on enhancement expenditure
162.6 - 134.1 .213 x 3,000
639 134.1
5,846
Restricted to 5,072 Chargeable gain
0
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SMALL PART DISPOSAL OF LAND Land held as
freehold or leasehold with more than 50 years to
runIf the following conditions are met, no
chargeable gain is calculated on the sale of a
part of a larger parcel of land and the sales
proceeds are deducted from the original cost of
the full parcel of land. . If sold under
compulsory purchase and the sales proceeds are
not more than 5 of value of total parcel of land
immediately before the part disposal or 3,000 if
less. If sold other than under compulsory
purchase , the sales proceeds are not more than
20 of value of total parcel of land and total
sales proceeds from land in the year not more
than 20,000. The deduction of the sales
proceeds are indexed from the date of sales to
the date of sale of the remaining part of the
land.
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EXAMPLE Land bought as an investment for
40,000 in July 1989 (RPI 115.1) Part disposal
made in June 1993 (RPI 141.0) for 11,000. The
market value of the remainder of the land in June
1993 was 50,000. The remaining land was
sold in June 2001 for 60,000. Qualifies as
a small part disposal(11,000 50,000)
61,000 x 20 12,200 Greater than 11,000
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Sales proceeds
60,000 Less Reduced cost of acquisition
(40,000 - 11,000)
29,000 Unindexed gain
31,000Less Indexation
allowance (i) on full original
cost 162.6 - 115.5 0.407 X
40,000 16,280 115.5 (ii) on
proceeds of small part disposal
162.6 - 141.00 0.153 X 11,000 1,683
14,597 141.0 Indexed gain
16,403Taper relief 31 years - non-business
asset.
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ASSETS ACQUIRED BEFORE 6 APRIL 1965 A
taxpayer had a choice of methods of calculating a
gain for assets held when CGT was first
introduced. "Time apportionment" method
-Calculate the total gain from acquisition to
disposal and apportion it between the period
prior to April 1965 (not taxable) and post April
1965 (taxable). 6 April 1965 market value method
- Gain calculated by comparing the sales proceeds
with the April 65 MV e. g. Time
apportionment. Chargeable gain is (Selling
price-original cost)
x Post 6/4/65 period of ownership

Total period of ownership
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ASSETS ACQUIRED BEFORE 6 APRIL 1965

• Gains on sales made after March 1982
• 1 Calculate gain on time apportionment method.
  Indexation based on higher of original cost and
  MV at March 19822 Calculate gain based on MV at
  April 1965. Indexation based on higher of MVs at
  April 1965 and March 19823 Lower of gains from 1
  and 2 is then compared to gain based on rebasing
  rules using MV at March 1982. Indexation based
  on a) greater of original cost and MV at
  March 1982 if time apportionment, or b)
  greater of MVs at April 1965 and March 1982 if
  1965 MV method

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LOSSES ON DISPOSAL OF PRE 6/4/1965 ASSETS
Compare "time apportionment" method with
"6/4/65" valuation method. Then compare with
31/3/82 valuation method. If "time
apportionment" gives a higher loss than "6/4/65",
or "time apportionment" gives a loss and "6/4/65"
gives a gain the time apportionment prevails
and it is then compared with "31/3/82" method
If "time apportionment" gives a gain and
"6/4/65" gives a loss the situation is No gain /
No loss and no comparison with "31/3/82" method
is made. If "time apportionment" gives a loss
and "6/4/65" gives a greater loss neither is
adopted and the loss based on original cost
without time apportionment is compared with
"31/3/82" method