A Guide to Capital Gains Tax

As the end of the 2023/24 tax year approaches, it’s crucial to be mindful of changes to Capital Gains Tax (CGT) exemptions. Previously set at £6,000, the tax-free allowance for capital gains is now decreasing significantly to £3,000 for the upcoming 2024/25 tax year.

CGT is a vital aspect of financial planning and wealth management in the UK. For professional advisers, understanding the intricacies of CGT is essential for providing comprehensive guidance to clients. In this guide, we’ll delve into the fundamentals of CGT, explore key considerations for minimising tax liabilities, and provide actionable insights to help navigate the complexities of CGT in the UK.

Understanding Capital Gains Tax:

CGT is a tax on the profit made from selling or disposing of assets that have increased in value. These assets can include property (excluding main residences), stocks, bonds, precious metals, and certain personal possessions. The tax is levied on the gain realised, not the total sale proceeds.

The tax rates on capital gains vary depending on the individual’s total taxable income and the type of asset sold. As of the 2023/24 tax year, the standard rates are 10% for basic rate taxpayers and 20% for higher and additional rate taxpayers. However, different rates may apply to gains on residential property and carried interest.

The capital gain is calculated by subtracting the cost of acquiring the asset (purchase price) from the proceeds received from its sale. Allowable deductions, such as transaction costs and enhancement expenditures, can be deducted from the gain to arrive at the taxable capital gain.

Working out Capital Gain

Let’s say Ms Sharma, a UK resident and higher-rate taxpayer, purchased an investment property ten years ago for £200,000. Now, she’s decided to sell the property for £400,000, realising a substantial capital gain of £200,000 (Capital Gain = Proceeds – Cost of Acquisition). However, Ms Sharma has incurred costs of buying, renovating and selling the property, which are allowable deductions: £3,000 solicitor’s fees, £5,000 estate agent’s fees, £10,000 Stamp Duty Land Tax, and £15,000 in home improvements (£33,000 total deductions). Therefore, Ms Sharma’s adjusted capital gain is £200,000 – £33,000 = £167,000 (Adjusted Capital Gain = Cost of Acquisition – Allowable Deductions).

Working out CGT liability

As Ms Sharma is subject to the higher-rate of 20% for residential property gains, her CGT liability is calculated as follows:

CGT = Adjusted Capital Gain x Tax Rate

£167,000 x 0.20 = £33,400

Thus, when selling her investment property for £400,000, Ms Sharma will have to pay £33,400 in CGT.

Allowances:

In the UK, individuals are entitled to an annual tax-free allowance, known as the Annual Exempt Amount (AEA), which exempts a certain amount of capital gains from tax each tax year. For the 2023/24 tax year, the Annual Exempt Amount is £12,300 for individuals and £6,150 for trustees.

So, following the previous example of Ms Sharma’s investment property sale, the Annual Exempt Amount will reduce her CGT liability. For the 2023/24 tax year, the AEA for individuals is £6,000. Therefore, Ms Sharma can offset this amount against her capital gains before applying the applicable tax rates.

Let’s revisit Ms Sharma’s case:

Adjusted Capital Gain (after allowable deductions): £167,000

If we deduce the AEA from Ms Sharma’s adjusted capital gain:

£167,000 – £6,000 = £161,000

This means that Ms Sharma’s taxable capital gain after applying the Annual Exempt Amount is £161,000.

Now, let’s calculate the Capital Gains Tax liability on this reduced taxable gain: £161,000 x 0.20 = £32,200 (CGT = Tax Rate x Taxable Gain).

Therefore, with the Annual Exempt Amount taken into account, Ms Sharma’s Capital Gains Tax liability would be £32,200.

Mitigating Capital Gains Tax Liabilities:

There are several strategies you can employ to help clients mitigate CGT liabilities:

Utilising tax-efficient investment wrappers

• Individual Savings Accounts (ISAs):
  ISAs are tax-efficient investment accounts, allowing individuals to invest money in a wide range of assets, including cash, stocks and shares, bonds, and innovative finance products. Any capital gains or income generated within an ISA wrapper are exempt from CGT and income tax, making ISAs a powerful tool for mitigating CGT liabilities. Individuals can contribute up to the annual ISA allowance (£20,000 for the 2023/24 tax year) across one or more ISA accounts. Investments held within an ISA can be bought, sold, or switched without incurring CGT. This flexibility allows investors to manage their portfolios actively without triggering tax liabilities.
• Self-Invested Personal Pensions (SIPPs):
  SIPPs are tax-efficient pension wrappers that allow individuals to save for retirement by investing in a wide range of assets, including stocks, bonds, property, and collective investment schemes. Contributions to SIPPs benefit from tax relief at the individual’s marginal income tax rate, up to the annual allowance (£40,000 for the 2023/24 tax year). Investments held within a SIPP grow free from CGT, and individuals can access their pension savings tax-efficiently in retirement.

Making use of tax reliefs and exemptions

• Business Asset Disposal Relief
  By qualifying for Business Asset Disposal Relief, individuals can benefit from a reduced rate of CGT of 10% on qualifying gains, up to a lifetime limit of £1 million (for disposals made on or after 11 March 2020). This relief can significantly reduce the CGT liabilities for business owners, entrepreneurs, and investors who meet the eligibility criteria.
• Investors’ Relief
  Investors’ Relief is a tax relief available to individuals making qualifying investments in unlisted trading companies or qualifying trades. Like Business Relief, Investors’ Relief allows eligible individuals to benefit from a reduced rate of CGT at 10% on qualifying gains, subject to a lifetime limit of £10 million (for disposals made on or after 6 April 2019). This relief incentivises investment in growing businesses and can help reduce CGT liabilities for investors.
• Private Residence Relief
  Private Residence Relief (PRR) applies to individuals selling their main residence or certain types of property that have been used as their main residence. PRR can exempt or reduce CGT liabilities on the sale of a primary residence. Individuals may be entitled to full or partial relief depending on factors such as the length of time they have lived in the property, whether it has been let out, and any additional reliefs or exemptions available (e.g., Letting Relief or the Final Period Exemption). By claiming PRR, individuals can effectively mitigate CGT liabilities on the sale of their home.

Employing gifting and inheritance planning strategies

• Gifting Assets
  By gifting assets to family members who are in a lower tax bracket or have unused CGT allowances, individuals can effectively transfer ownership of assets and potentially reduce future CGT liabilities. Each individual has an annual gift allowance (£3,000 for the 2023/24 tax year), which allows them to gift assets up to this amount without incurring CGT. In addition to the annual gift allowance, individuals can make small gifts of up to £250 to any number of people each tax year without triggering CGT. Gifts between spouses or civil partners are generally exempt from CGT, regardless of the value of the gift.
• Inheritance Planning and Trusts
  Establishing trusts can be a tax-efficient way to transfer assets while retaining some control over how they are used and distributed. Certain types of trusts, such as Discretionary Trusts and Bare Trusts, can offer CGT advantages by allowing trustees to distribute assets to beneficiaries in a tax-efficient manner. Transferring assets into a trust structure can trigger CGT at the time of transfer, but certain reliefs and exemptions may be available to mitigate the tax impact, such as Hold-Over Relief or Gift Hold-Over Relief.

Timing asset disposals to make use of annual exemptions and lower tax rates in certain tax years

• Annual Exemptions:
  By timing asset disposals strategically, individuals can aim to realise capital gains up to the value of the AEA in each tax year (£6,000 for individuals in 2023/2024; £3,000 in 2024/2025), effectively reducing or eliminating their CGT liabilities on those gains. Due to the reduction in AEA in the upcoming 2024/2025 tax year, clients could benefit from the larger exemption amount before the end of the 2023/2024 tax.
• Lower Tax Rates in Certain Tax Years:
  CGT rates vary depending on an individual’s total taxable income and the type of asset sold. Basic rate taxpayers are subject to CGT at a rate of 10%, while higher and additional rate taxpayers are subject to CGT at a rate of 20%. In certain tax years, individuals may find themselves in a lower tax bracket due to changes in income or other factors. By strategically timing asset disposals to coincide with these tax years, individuals can benefit from lower CGT rates and reduce their overall tax liabilities.
• Spreading Disposals Across Tax Years:
  Rather than selling all assets in a single tax year, individuals can spread asset disposals across multiple tax years to make use of multiple AEA allowances and potentially benefit from lower CGT rates. By carefully planning the timing of asset disposals, individuals can optimise their CGT position and minimise their overall tax liabilities over time.

Conclusion

Capital Gains Tax is a complex yet significant aspect of financial planning for individuals and businesses in the UK. Professional advisers and estate planners play a crucial role in helping clients navigate the complexities of CGT and optimise their tax positions.

At CTT Group, we provide our members with support and guidance on a range of financial and estate planning matters, including Capital Gains Tax – in fact our previous webinars on CGT are available for members to revisit. Contact us today to learn more about how we can assist you and your clients in optimising tax efficiency and achieving financial goals.