Capital Gains Tax (CGT) is a tax by the UK government on the selling assets which include property, investments and shares of a listed company. This tax is split into two marginal rates of 18% and 28% depending on one’s annual income. This tax is paid on most investments in companies including units in a unit trust, certain bonds and shares that are not in an ISA or PEP. For high net worth individuals this can be a significant tax penalty, wiping out a significant portion of the profits you make on investment. However there are a number of ways to either reduce this tax or defer and reduce it by 100%.
The amount of CGT payable is based on the profit you make on an investment. The profit calculated by subtracting the sale price from the purchase price and then deducting the associated costs to establishing what is termed as the “Gain”. Once you have calculated the amount of gain, you then deduct your tax free allowance known as the “Annual Exempt Amount” and are left with the “Taxable Gain”. You will then be liable for CGT on the entire Taxable Gain.
TheAnnual Exempt Amount is a paltry £11,000, which for serious investors is not much at all.
If you pay Higher Rate Income Tax in the year of the Gain, then youwill be taxed at 28% on the entire amount. If you do not pay Higher Rate Income Tax, then some of the Taxable Gain may be taxed at the lower rate of 14%. To work out how much of a Gains is taxed at 14%, you deduct the amount of taxable income you have from the Basic Rate Income Tax Band (which is £31,786 for the 2015/6 tax year).
Being able to reduce, mitigate or entirely defer this tax becomes essential to investors. Learn more ways to defer or reduce this tax below.
Reducing your CGT
If you are selling a qualifying business which you own more than 5% of the voting shares in, then you may be entitled to Entrepreneurs Relief which would reduce your CGT rate to 10%, much less than the potential 28% tax. Even if you sell assets that were loaned to the company, these can be claimed under this reduced rate. You can sell assets from the personal business that has been sold for up to 3 years after the sale and still claim this lower tax rate.
Gift Hold-over Relief
The gift hold-over relief allows you to give away or sell assets, shares or a trading company (in which you own at least 5% and the company is unlisted) for less than they are worth, providing a full capital gains deferral to the person receiving the gift. The person receiving the gift will be liable to the CGT when they sell the shares, assets or business. However, if you sell an asset below its market value and still make a capital gain, you would still be liable for that gains tax. For example: you sell a shop worth £100,000 to your sister at £50,000 but your cost for the shop was £30,000, you would still be liable for a £20,000 CGT.
When you transfer your ownership in a business into a corporation in return for shares, you may qualify for an Incorporation Capital Gains relief. To qualify you need to be involved as the principle owner or partner in a trading business and transfer all the assets and business (excluding cash) to the new corporation. In this situation you would be able to defer your CGT until you sell the shares at a later date. However, any cash received in the deal would be subject to CGT.
Unfortunately most of these small measures simply delay CGT payment or reduce CGT by a nominal amount. These measure usually do not provide any relief for investors either. For investors looking to maximise CGT relief, they should consider Enterprise Investment Schemes (EIS) or a Seed Enterprise Investment Schemes (SEIS).
Seed Enterprise Investment Scheme (“SEIS”)
The SEIS was designed to help start up trading companies get the funding they need and provide incentives to investors for taking the extra risks associated with these investments. The shares for this scheme must be ordinary, full-risk associated shares and paid in full with cash to qualify for the CGT deferrals. You also must not own more than 30% of the company and have no employment connection with the company. The first of the reliefs available for the SEIS is the Reinvestment Relief. You were entitled to claim 100% relief on any Taxable Gains of up to £100,000 for the year 2012-2013 if you reinvest the Gain and SEIS qualifying shares. This relief reduced to 50% for the 2013-2014 tax year and beyond. The asset does not have to be disposed of before the investment into an SEIS, but both need to occur within the same tax year to qualify. A Tax Year runs from the 6th April to the following 5th April.
The second CGT relief is available upon disposal of the SEIS shares. Any profits from the SEIS shares that were held for at least 3 years are not subject to CGT thus allowing a 100% relief on up to £100,000 of capital gains providing you also claim income tax relief when you invest I the shares.
Enterprise Investment Schemes (“EIS”) CGT deferral and relief
EIS is similar to SIES, however, the investments tend to be less risky than SIES and therefore the Tax Benefits are less generous. If you have a Taxable Gain and you invest in EIS qualifying shares, you are able to defer the CGT liability and in some instances the avoid CGT completely. There is no limit to the size of the Gain you can defer.
When deferring a gain, you are able to choose how much of the gain you defer to each investment you make. When you eventually sell the EIS shares, you will crystal the original gain. This is treated as though the deferred gain is realised in the tax year in which you sell the EIS shares and the tax is based on the rate of tax at that time, benefiting from a further Annual Exempt Amount.
Just like SEIS, you must invest in full-risk shares without any preferential treatment for recouping losses on assets or at wind up and must be paid for in full at time of purchase with cash. To qualify for the relief, you need to be a resident and ordinary resident in the UK for tax purposes both at the time when the gain was incurred and when the shares are issued. You do not qualify for the relief if you are also resident in another country under a double tax treaty.
With an EIS, you can also benefit from CGT relief when you sell the shares providing you claim income tax relief. The relief allows you to enjoy tax free profits on the any gains you make from the investment in the EIS. If you have claimed CGT Deferral, you will still crystallise the original gain that you deferred into the EIS when you finally exit the investment.
In order to ensure your investment is properly recorded and eligible for these deferments and CGT reliefs, a quality EIS or SEIS Fund Company will be your best choice.
Twelve CGT Takeaways
- Capital Gains tax is as much as 28%.
- Capital Gains is payable on shares, personal possessions, property that is not your main residence and business assets upon their sale.
- £31,786 is the personal income level over which you will pay 28% CGT.
- Personal CGT Exemption is only £11,000.
- Entrepreneurs still pay 10% CGT on sold businesses or assets.
- The SEIS CGT relief was extended for the 2013-2014 tax year to 50%.
- You must not own more than 30% of a company in an EIS or SEIS to qualify for CGT relief, or reinvestment relief. You can own more than 30% of the company and claim CGT deferrals.
- You cannot be employed by the company invested in to receive relief.
- If you received Income Tax relief on the cost of shares in an EIS and held the investment for the minimum 3 year period, you will pay ZERO CGT on profits.
- Any investment in an EIS or SEIS must not be funded more than £5 million in a year or none of the investors will qualify for CGT relief.
- Business Angels can be a director of an EIS company and still claim EIS relief on their investment providing they do not receive a salary for their investment.
- There are very few other ways of reducing a Capital Gain other than investing in EIS or SEIS qualifying shares.
Please note that this is guidance only. Kuber Ventures is not a tax advisor and you are encouraged to seek your own Tax and CGT advice.