Out-Law Guide | 03 Aug 2011 | 11:40 am | 6 min. read
Capital gains tax (CGT) is a tax payable by individuals on gains they make on the disposal of assets. An asset is any form of property, whether situated in the UK or overseas, and includes shares.
The 'gain' on which CGT is charged
CGT is charged on the gain made from an asset. This gain is calculated by deducting the acquisition cost of that asset, together with any costs associated with the acquisition or disposal such as stamp duty or legal fees, from the proceeds of the sale. So, for example, if an individual bought some shares for £100 and sold them for £1,000, with no other incidental costs of acquisition or disposal, the gain would be £900.
There are special rules that apply to gifts or transactions between connected parties which can deem an asset to have been transferred for its market value for the purpose of CGT. In the case of some gifts of unquoted shares in a trading company or the holding company of a trading group, if conditions are satisfied, holdover relief may be available to defer the resulting gain until the recipient disposes of the shares.
Every individual has an annual tax free allowance. This means that there is no CGT to pay in any tax year if an individual does not exceed this annual exempt amount. To the extent that an individual exceeds their annual exempt amount, CGT is charged on the amount of the excess. The annual exempt amount for the 2018 - 2019 tax year is £11,700. Most trustees have an annual exempt amount of half the amount that applies for individuals.
Rate of CGT
The rate of CGT depends on the amount of an individual's total taxable income and gains from all sources.
From 6 April 2016, CGT is payable at a rate of 20% for higher and additional rate taxpayers and 10% for others, unless entrepreneurs' relief or investors' relief is available (which will reduce the rate to 10%). When working out whether the lower 10% tax rate is available, any capital gains are added to income. If the higher rate threshold for income tax is then exceeded, 20% CGT will be paid on the gains to the extent that the threshold is exceeded. This means that an individual who pays income tax at the basic rate could pay 20% CGT, if large gains were made in a particular tax year.
CGT is payable at the higher rates of 18% and 28% for residential property not qualifying for the private residence exemption and on 'carried interest'.
Entrepreneurs' relief reduces the amount of CGT to 10% on a disposal by an individual of a business, assets of a business or shares in a company if certain conditions are met.
There is a maximum lifetime limit of £10 million of gains that can be reduced by entrepreneurs' relief.
In order for the disposal of shares in a company to be eligible for entrepreneurs' relief, certain conditions must be met. Throughout the period of one year ending with the date of disposal of the shares:
These conditions, in particular the 5% ownership test, are not always easy to satisfy and so it is important to consider whether all the conditions are met for the required length of time.
Entrepreneurs' relief is not available automatically, and needs to be claimed on or before the first anniversary of the 31 January following the tax year in which the disposal is made.
Sometimes the commercial deal will be that an individual will hold less than 5% of the shares. The 5% ownership condition looks at percentage of ordinary share capital and voting rights - there is no requirement for the individual to hold at least 5% of the dividend rights or the rights to assets. It is therefore sometimes possible to structure a shareholding so that it meets the 5% test even though the individual has economically less than 5% of the share rights.
The conditions must be satisfied right up until the disposal of the shares. Particular care needs to be taken to ensure that the 5% shareholding is not lost before the disposal of the shares, by a dilution of the individual's shareholding, such as on the exercise by others of share options. New rules are to be included in the 2019 Finance Bill designed to enable an investor to effectively 'bank' entrepreneurs' relief on gains that have arisen up to the date when an investment by an external investor on or after 6 April 2019 causes the individual's shareholding to fall below 5%.
If when the individual sells his shares, some of the consideration is paid by way of an earn out, careful consideration needs to be given to structuring the transaction in order to maximise the amount of entrepreneurs' relief available.
Investors’ relief was introduced in 2016 and applies to individuals who invest in shares of unquoted trading companies, without being involved in the management or operation of the business.
Like entrepreneurs' relief, if conditions are satisfied, it reduces the amount of CGT to 10% and there is a separate lifetime limit of £10 million of gains that can qualify.
Detailed conditions must be satisfied. The main conditions are:
For the relief to be available, the investor must hold the shares continuously for a three-year period. For shares issued between 17 March and 5 April 2016, the holding period is extended to 6 April 2019.
Other ways to reduce the tax bill on the disposal of shares
There are various other options which might be available to individuals to reduce the tax bill arising on disposal of their shares:
Capital losses: Should an individual have available capital losses made on other investments in the tax year of disposal, or in previous tax years, these can normally be set off against any remaining capital gains after entrepreneurs' relief is applied.
Annual exemption: To the extent that an individual's annual exemption has not otherwise been used, this will be available to set against their gain after entrepreneurs' or investors' relief has been applied.
Transfer of shares to spouse: If an individual's spouse has not made any significant capital gains in the current tax year, it would be tax efficient to ensure that the spouse's annual exemption is used for the tax year in which the shares disposal takes place.
If a spouse gives an asset to another spouse, there is no tax to pay on the gift itself. The receiving spouse is treated as if he/she bought the asset for the price and at the time that the other spouse did. 'Spouse' for this purpose includes civil partners, but not unmarried partners living together. To qualify for this arrangement, the spouses/civil partners must be living together in the tax year.
The transfer to the spouse needs to be a genuine gift. On this basis, once the shares are given to an individual's spouse, that individual will have no right to have the shares or the proceeds of the sale back.
Reinvestment in small companies: Should an individual have any plans to reinvest their sale proceeds in small private companies, this could defer the time at which the tax is payable. For more details see the section on EIS reinvestment relief in this guide to EIS. For investments in very small companies Seed Enterprise Investment Relief (SEIS) may provide a 50% exemption for gains reinvested in SEIS shares.