Capital Gains Tax – A Review of Reliefs

Following the changes in legislation to the inheritance tax (IHT) thresholds and the restriction on both agricultural and business property reliefs (APR & BPR) to £2.5 million at 100% per person and 50% thereafter, greater consideration is now being given to gifting assets during lifetime rather than on death. However, where such gifts are made, this is deemed an event for capital gains tax (CGT) purposes with potential liabilities arising. 

Gifts of cash can be made without any CGT consequences, however gifts of other assets such as property or shares will give rise to a capital gain if the value at the date of gift is greater than the acquisition cost. Where transfers take place between connected parties, these are deemed to be at market value regardless of any actual amount paid. This potential liability can therefore make the option of gifting during lifetime far less attractive – and potentially prohibitive. 

When gifts of trading assets or agricultural property are made, the gain can be deferred and effectively passed to the recipient using ‘holdover relief’. This means the donor does not suffer any CGT on the gift, however the donee takes on their original base cost. If they then subsequently sell the asset, they will have a greater level of CGT payable – but should also have the cash to pay the tax! 

In order to claim holdover relief, the asset must have been used within the owners sole trade, partnership or personal company (i.e. they hold at least 5% of the shares). If shares are being gifted, the company must be a mainly trading company (rather than investment), not be listed on the stock exchange and be the donor’s personal company. The trustees of a trust or beneficiary of a life interest trust can also claim holdover relief. Gifts of agricultural land also qualify. 

Relief is not available for gifts made to non UK residents, a settlor interested trust or gifts of shares to a company. Where assets have been used for business purposes for only part of the ownership period, or only part of the asset is used as such, the relief is restricted accordingly

Holdover relief can also be used when transferring assets into a discretionary trust. Whilst gifts made directly to individuals can only benefit from the relief if they are trading assets or agricultural land, gifts made into a trust qualify regardless of whether they are business assets or not. Trusts can therefore be used to pass assets such as letting properties to the next generation without triggering a CGT liability on transfer, though there are other tax implications that must be considered.

Where holdover relief can be used for gifted assets, a further relief – rollover relief, can potentially be used where trading assets are sold at a gain. The relief applies where replacement trading assets are purchased using the proceeds and can be used by both individuals and companies.

Similarly to holdover relief, rollover relief defers the gain arising by reducing the cost of the new asset by the level of the gain. For example:

The gain effectively becomes chargeable if the replacement asset is subsequently sold. Whilst the replacement asset must be brought into business use immediately upon acquisition, it does not have to be the same type of asset – for example farmland could be sold and a shop purchased.

The gain available for rollover is calculated on a time apportioned basis if the asset being disposed of has not always been used for business purposes.

In order to qualify for the relief, the replacement asset must be purchased within 12 months before, or 3 years after the sale of the old asset. It is a popular misconception that the relief relates to the gain on the sale of the old asset whereas in fact it is based on the proceeds received. For example:

If the net proceeds are reinvested in full, the gain can be fully deferred. If however only part of the proceeds are reinvested, the tax payable is calculated based on the proceeds not reinvested. As such, if the gain is lower than the proceeds not reinvested, rollover relief is generally not beneficial.

Where an individual holds an asset that is used within their personal trading company, or within a partnership in which they are a partner, the relief can be claimed. The types of assets that can be acquired using rollover relief are as follows:

• Land and/or buildings used within a trade
• Fixed plant or machinery that does not form part of a building
• Depreciating assets – these are assets with a life expectancy of 60 years or less at the date of purchase

Where depreciating assets are acquired, the cost of the new asset is not reduced by the deferred gain. The relief applies for 10 years or until the asset is sold or removed from business use and after that point, the gain comes back into charge and the tax becomes payable. If a non depreciating asset is purchased before the gain becomes chargeable, the deferred gain can be rolled into this further replacement.

For both holdover and rollover relief, where a gain is deferred and later comes back into charge, CGT is payable at the rate in force at that date – not the rate at the time the assets were initially gifted or sold. Therefore if a gain arises when the rate of CGT is low, it may be preferable to pay the tax rather than defer and risk paying more at a later date. For assets that are unlikely to be sold in the future, the reliefs can be very beneficial.

Another valuable relief is PRR, available on the sale or gift of a dwelling that has at some point been used as the vendor’s main residence. The entire gain can be relieved where the property has always been occupied as such, or partial relief can be available where there have been periods of non-occupation. This can mean that provided the donor survives 7 years after the date of gift, and retains no benefit in the property, a potentially valuable asset can be removed from the estate tax efficiently.

BADR is available where assets are sold that coincide with the cessation of the trading business, or where the business itself is disposed of. The sale of shares in a company also qualify providing the company is a trading company and the seller holds at least 5% of the shares prior to sale. The assets must have been held by the vendor for a period of at least 2 years.

The effect of the relief is to reduce the rate of tax from 24% to 18% on gains of up to a lifetime limit of £1 million per person.

With the changes to the IHT reliefs prompting many to consider their options, taking advantage of the CGT reliefs to avoid being taxed on gains is becoming an increasingly important part of estate planning.