Capital gains tax

Exclusions
The following areas are excluded from the syllabus:

• assets held on 31 March 1982
• wasting assets (other than chattels)
• leases
• transfers between husband and wife, or between connected people
• incorporation relief
• the calculation of indexation allowance for individuals.

It should be noted that where an asset was purchased by an individual before 6 April 1998, the indexed cost as at 6 April 1998 will always be given by the examiner. The indexation allowance calculation up to the date of disposal is still required knowledge for companies.

The syllabus
The Paper 9 syllabus includes the following specific areas:

• basic calculations for individuals and companies
• part disposals
• chattels
• compensation and insurance proceeds
• shares and securities
• reliefs
• administration and payment of tax.

Each of these areas is discussed in detail below. The rules for individuals and companies are totally different, and students are expected to understand both sets of rules.

Question 2 of the Paper 9 exam will always be on corporation tax and may require a calculation of a gain as a result of an asset disposal by a company. Question 3 will always be on CGT for individuals.

Basic calculation
The basic calculation of a gain is simple, but the procedure depends on whether the sale is by an individual or by a company, and when the asset was purchased. The syllabus specifically excludes assets purchased before April 1982. Only assets purchased after that date will therefore be examinable. However, there is still the problem, for individuals, of those assets purchased before 6 April 1998 - this is described below.

Disposals by a company
The basic calculation is:

'Proceeds' is the actual amount received on sale, but this can be reduced by expenses of selling. The current market value may be used where the sale is, for instance, undervalue or made as a gift.

The 'cost' is the gross amount paid for the asset (including any expenses of purchase), or the market value if received, for example, as a gift. Either can be increased by any additional capital enhancement expenditure.

Indexation allowance reflects an allowance for the effects of inflation and is measured by reference to the movement in retail price indices. The indexation factor representing the movement between the months of purchase and sale will always be provided in the exam, which is then to be applied to each cost as applicable. The indexation allowance cannot increase a loss or convert a gain into a loss. In the latter case, if the indexation allowance is greater than the gain then the result is nil (neither a gain nor a loss).

Example 1
ABC Ltd purchased a factory on 2 October 1987 for £100,000, incurring expenses of £5,000. The company spent £20,000 on an extension to the factory in November 2000. The factory was sold for £220,000 on 31 October 2004, with expenses of sale amounting to £8,000.

Indexation factors:

• October 1987 to October 2004: 0.792
• November 2000 to October 2004: 0.077

The gain is:

Disposals by an individual
The basic calculation is effectively the same as for a company, but with two major differences. Firstly, indexation allowance ceased to be available on 5 April 1998, and secondly, taper relief was introduced with effect from the same date to give relief from gains based on periods of ownership. In addition to these major differences, an individual is entitled to an annual exemption of £8,200 (for 2004-2005) against total gains.

Where an asset is purchased prior to 6 April 1998, and is disposed of on or after that date, then the cost is indexed to April 1998 and no further. The indexed cost of the asset as at 6 April 1998 will be provided in the exam, and the calculation of indexation allowance for individuals is therefore not required knowledge.

To compensate for the loss of indexation allowance, chargeable gains occurring after 5 April 1998 can be reduced by taper relief. This is given by reference to the number of complete years of ownership from 6 April 1998 onwards, or the date of purchase, if later.

The amount of relief differs depending on whether the asset concerned is a business or non-business asset. Note that a non-business asset will qualify for an additional year of ownership (a bonus year) if it was purchased prior to 17 March 1998. For taper relief purposes, the date of any enhancement expenditure after 5 April 1998 is irrelevant, and the total gain is tapered in accordance with the total period of ownership from the original purchase date (or 6 April 1998 if later).

The definition of a business asset is required knowledge. However, the examiner will usually, but not always, state whether the asset sold is a business or non-business asset. A table showing the percentage of gain chargeable can be found in all the recommended textbooks and will always be given in the exam.

Example 2
Greg purchased a house in 1987 for £80,000 and extended it in June 1999 at a cost of £18,000. He sold the property in August 2004 for £246,000. It had
never been his main residence and the indexed cost as at 6 April 1998 was £129,000.

The gain is:

Capital losses
Capital losses can only be used in the same or future years. For companies, the situation is simple - losses must be set off, in full, against gains in the same accounting period. If net losses remain, these must be carried forward to future periods and only used against the first available capital gains. They can never be used against other income in any year, or carried back against capital gains in previous years.

For individuals, the situation is a little more complicated. Losses must be used as far as possible against capital gains in the same tax year (6 April-5 April). If any losses remain, they can be carried forward against capital gains in future tax years, but need only be used to reduce the gains down to the annual exemption (£8,200 for 2004-2005). It must be emphasised that in the year of the loss, the full loss is to be used against untapered gains before reference to the annual exemption.

Both current year capital losses and brought forward capital losses (where necessary) must be used in priority to taper relief. However, losses can be allocated to those gains with the highest chargeable percentage of gain first - in general to
non-business assets before business assets.

Example 3
John sells three assets in 2004-2005. A gain of £14,000 is made on a business asset (taper percentage 25%), a gain of £19,000 is made on a non-business asset (taper percentage 80%) and a loss of £6,000 on the third asset. A capital loss of £4,000 is brought forward as at 6 April 2004.

The best use of the losses is:

Part disposals
Where a taxpayer makes a disposal of part of a set of items, or a share of (for example) a painting, then the cost of the part sold is to be calculated by reference to the part disposal formula. This formula is not given in the examination and must therefore be remembered:

Gross proceeds x Cost
Gross proceeds + MV of the remainder

The remaining proportion of the cost is the deemed cost of the part retained, and will be used in any future disposal of the part retained.

Example 4
Jeremy purchased a valuable piece of art for £240,000 in August 1998. In November 2004, he was short of cash and decided to sell a 25% stake in the painting for £90,000. He incurred auction fees of 10% on the sale. The remaining 75% has a market value of £380,000 (November 2004). The gain was:

The cost of the part retained is £194,093 (£240,000 - £45,957)

Chattels
Chattels with a useful life of less than 50 years (wasting assets) are exempt capital gains unless they are plant and machinery used in a trade. The calculation of the gain/loss for other chattels depends on the actual cost and disposal value.

• Cost and disposal value both less than £6,000: asset exempt capital gains.
• Cost more than £6,000 but disposal value less than £6,000: gross proceeds deemed to be £6,000.
• Cost less than £6,000 but disposal value 'marginally' above £6,000: 5/3rds rule applies.

Wasting chattels (plant and machinery) follow the same rules as above. However there can never be a capital loss on the sale of plant and machinery because capital allowances will cover any actual loss. Plant sold at a loss therefore will always have a nil result.

Example 5
Bill sells the following assets in October 2004:

1. an antique desk for £5,800 - he originally purchased it for £4,000 in August 1999
2. a Ming vase for £7,800 - it was originally purchased for £4,500 in May 2003
3. a painting for £5,000 - which had cost £7,600 in June 2001.

The gains are as below:

1. Exempt - both cost and proceeds are below £6,000
2. Proceeds 7,800 Cost (4,500)
   3,300
   OR (£7,800 - £6,000) x 5/3 = 3,000
   Lower gain taken - £3,000
   (No taper relief - asset held for <3 years)
3. Deemed proceeds 6,000
   Cost (7,600) Restricted loss 1,600
   COMPENSATION AND INSURANCE PROCEEDS
   When an asset is destroyed, any compensation received is usually used as the proceeds figure in a normal capital gain calculation. If, however, the proceeds of a non-wasting asset are reinvested in another asset within 12 months, any gain resulting from the previous destruction can be deferred and deducted from the cost of the replacement. If all the proceeds are not reinvested then a gain equal to the proceeds retained will be taxed immediately, and only the remaining gain can be deferred.

Example 6
Peter purchased an asset for £30,000 in May 2000. It was subsequently destroyed in August 2004. The insurance company paid £35,000 and a replacement asset was purchased in March 2005 for £33,500.

Tapered gain: £1,500 x 90% = £1,350
Base cost of new asset:
£33,500 - £3,500 = £30,000

Shares and securities
The rules for companies and individuals are totally different. The following areas need to be understood:

• matching rules
• the construction of the FA1985 pool
• bonus and rights issues
• awareness of disposal of rights
• calculation of gains.

Note: The FA1985 pool ceased on 6 April 1998 for individuals. Where this pool forms part of the question for an individual, the value of the pool as at 6 April 1998 will always be given.

The matching rules outline the order in which shareholdings are deemed to be sold for capital gains purposes. For an individual the order is: same day, next 30 days (on a FIFO basis), shares purchased after 5 April 1998 (on a LIFO basis) and then the FA1985 pool. For a company the order is: same day, previous 9 days (on a FIFO basis) and then the FA1985 pool. On a disposal of shares, gains for each 'holding' must be computed separately.

Bonus and rights issues are treated in a similar fashion to each other with the main difference being that rights issue shares involve the taxpayer buying the shares and are in effect therefore treated as a simple purchase. Bonus issues merely add extra shares to a holding with no financial implication. The most important rule with both of these issues is that the share issue must be allocated to the existing holding that gives the entitlement to these new shares. For taper relief purposes, the holding period on disposal is measured from the date of purchase of the original holding - not from the date of the rights or bonus issue.

Awareness of disposal of rights requires candidates to understand what a 'right to purchase' is, and to know the options open to the taxpayer. These are: to ignore it - therefore no capital gains action; to purchase the offered shares - therefore action as in the previous paragraph; or finally to sell the right - which results in a part disposal or a disposal of a small capital distribution. A calculation of the gain as a result of a disposal of rights will not be required knowledge.

Example 7
Sylvia had the following transactions in the shares of ABC Ltd:

• 14 October 1987 - 2,000 shares for £4,400
• 19 June 1999 - 1,000 shares for £3,500
• 21 May 2000 - 1,500 shares for £4,500
• 16 September 2001 - A one-for-two bonus issue
• 2 November 2004 - 800 shares for £2,000

She sold 4,800 shares on 31 October 2004 for £2.80 per share. The indexed value of the FA1985 pool as at 6 April 1998 was £5,600. Calculate the total chargeable gains. Sylvia has no capital losses or other capital gains in 2004-2005.

Reliefs
There are three main reliefs in the Paper 9 syllabus - gift relief and principal private residence (PPR) relief for individuals only, and rollover relief for both individuals and companies. For all three reliefs, the full conditions of entitlement must be understood. In the case of rollover relief, the special treatment of depreciating assets (holdover relief) is also required knowledge. Calculations of gains for gift relief and rollover relief will be set but no calculations will be set for PPR. PPR questions will only require knowledge of the rules and the deemed periods of occupation, including letting relief.

Gifts with part payment and restricted rollover relief claims due to not all proceeds being reinvested are both examinable. The interaction of taper relief with these reliefs is also required knowledge, ie only the chargeable gain is tapered not the gains deferred by rollover or holdover relief.

Administration and payment
Details of how and when gains have to be reported to the Inland Revenue is required knowledge. Individuals report gains using the self-assessment form for a particular tax year and companies use the corporation tax self-assessment form (CT600) for a particular accounting period. The self-assessment form for individuals has to reach the Inland Revenue by 31 January following the appropriate tax year end and the CT600 must reach the Inland Revenue within 12 months of the end of the relevant accounting period.

Individuals pay capital gains tax on their net chargeable gains after the annual exemption for the tax year whereas companies include their net chargeable gains in their corporation tax calculations and pay tax at their appropriate marginal rate.

Tax is usually due on the 31 January following the tax year for individuals (no payments on account) or 9 months and 1 day after the accounting period end for companies. If the company is large however, then the tax on the gains will be included within the quarterly payment system.

The calculation of tax for individuals depends on the taxpayer's income assessed under income tax rules and the income tax thresholds for any particular tax year. Income tax must be calculated first and then net chargeable gains are taxed using up any remaining bands of tax, using 10%, 20% or 40% only. Capital gains are never taxed at 22% or 32.5%.

Example 8
Geraldine has net chargeable gains (after taper relief) for the tax year 2004-2005 amounting to £14,000. Her total taxable income (after her personal allowance) for income tax purposes amounted to £28,500 for the same year. Calculate the capital gains tax payable and state the due date of payment.

Step 1: Check amounts assessed to income tax first
1st £2,020 @ 10%
Next £26,480 (£28,500 - £2,020) @ 22% or 20%

Step 2: Calculate amount of gains chargeable
Net gains 14,000
Less annual exemption (8,200)
£5,800

Step 3: Tax the amount of the gain falling in the remaining basic band at 20%

Step 4: Tax any remaining gain at 40%
1st £2,900
(£31,400 - £28,500) x 20% 580
Next £2,900
(£5,800 - £2,900) x 40% 1,160
Total CGT payable £1,740

Step 5: Payment date - 31 January 2006

Conclusion
It is hoped that candidates will be better prepared for the examination as a result of reading this article. It should be read in conjunction with the published Syllabus and Study Guide which can be accessed on the ACCA website. Good luck in your studies.

Keith Molson is examiner for Paper 9 (GBR)