If you sell a valuable asset at a profit, such as a buy-to-let property or even your business, this will trigger a potential liability to pay capital gains tax (CGT).
Below we answer some frequently asked questions about capital gains tax to help you understand more about how CGT works and whether this affects you.
What is capital gains tax?
Capital gains tax is the tax you pay on any profits, or gains, arising from the sale or disposal of an asset.
If you specifically purchase an item purely with the intention of making a profit from its’ sale, this will be treated as trade for which you will be liable to pay income tax rather than capital gains tax.
The distinction here can be important because of the allowances or rates upon which you pay each different type of tax. In most cases, paying capital gains tax can be far less costly than paying income tax.
Who pays capital gains tax?
CGT is payable by individuals, sole traders, partnerships, as well as trusts, although the gains made from most trust property are treated slightly differently.
If you are a company, you will not pay any capital gains tax, you will instead pay corporation tax.
Does my residence status matter?
If you are a UK tax resident, you will be liable to pay capital gains tax on all worldwide gains, not just those arising in the UK. However, special rules apply for UK residents who are not domiciled in the UK, otherwise referred at as non-doms.
A non-dom, having elected to use the remittance basis of taxation, will only pay capital gains tax on any chargeable gains brought, or remitted, to the UK.
If you are a non-UK resident, you will only pay gains arising from the sale or disposal of residential property in the UK, although these rules may soon extend to commercial real estate.
Further, for those who return to the UK after a period of temporary non-residence of less than five years, you may still be liable to capital gains tax for that period of absence.
When does a liability to CGT arise?
Any potential liability to capital gains tax will arise when you sell or otherwise dispose of a chargeable asset.
You usually dispose of an asset when you stop owning it. This can include giving it away, transferring it or exchanging it for something else.
For CGT purposes, a disposal also includes a part-disposal, for example, you may have disposed of a part share in a house you inherited, or you may have sold half your collection of jewellery.
Does a liability arise when someone dies?
Typically, when you inherit an asset, inheritance tax is paid by the estate of the person who has died. You will only be liable to any capital gains tax in the event that you subsequently dispose of the asset(s) left to you.
Broadly speaking, the taxable gain will be calculated on the basis of the difference between the market value of the asset at the date it was inherited, and the disposal proceeds, deducting any CGT tax-free allowance for that tax year.
What is a chargeable asset?
A chargeable asset includes the following:
- property that is not your main residence, for example, a holiday home or buy-to-let property
- personal possessions worth more than £6,000, for example, jewellery, antiques and artwork
- stocks and shares, other than those you hold in tax-free investments savings accounts such as an ISA or PEP
- business assets and premises
- copyright or registered trademarks
- goodwill, ie; the good name or reputation of your business.
Certain assets are exempt from tax, such as private cars. These are classed as wasting assets, with a predictable life of 50 years or less. Other items, including those with a limited lifespan, are also exempt.
How do I calculate any chargeable gain?
You are only liable to capital gains tax on the increase in value, or gain, that you make on a chargeable asset, not the overall amount of money you receive having sold or otherwise disposed of that asset.
To calculate any chargeable gain, typically you would deduct the purchase price from the selling price. However, if the asset was a gift, you will need to work out its market value at the time it was given to you.
Equally, if you give away or transfer an asset, the market value can be used to determine the disposal proceeds, and therefore the extent of any actual gain.
At what rate do I pay capital gains tax?
The rate at which you pay capital gains tax will depend on the type of asset sold or disposed of, and the level of your income during the year in which the sale or disposal is made.
There are different rates for basic rate and higher rate taxpayers. Different rates also apply depending on whether the asset comprises residential property or other chargeable assets.
For 2020/21 capital gains tax on residential property is payable at either the standard rate of 18% or the higher rate of 28%. The rate for other chargeable assets is 10% and 20% respectively.
How do I calculate my CGT liability?
All gains made on chargeable assets during any given tax year will need to be added together to give your overall net gains for that year, having deducted your tax-free allowance, as well as any allowable costs.
You will need to add these net gains to your total taxable income to determine the appropriate rate of tax, the standard or higher rate.
If your taxable income and chargeable gains added together are less than current basic rate income threshold, you will pay tax at the standard CGT rate.
Where the two figures combined are above the basic rate threshold, you pay the standard rate on any gains up to the threshold, and the higher rate on the rest.
Am I entitled to a tax-free allowance?
You are only liable to pay capital gains tax if your overall gains for the year are in excess of your tax-free allowance. This is known as your ‘Annual Exempt Amount’ (AEA).
The AEA is currently set at £12,300.
The allowance for executors or personal representatives of a deceased’s estate is also set at £12,300, and similarly for trustees of disabled people. The allowance for other trustees is £6,150.
The net effect of this capital gains tax allowance is that you will not be liable to pay tax on any profit if all your gains in one year fall below this threshold.
Note that you can use your tax-free allowance against the gains that would be charged at the highest rates, for example, where you would be liable to pay 28% on residential property.
How do I declare any chargeable gain?
You will need to declare all chargeable gains by way of a self-assessment tax return, to be submitted to HMRC.
However, you only need to include in your tax return any gain on the disposal of an asset where the disposal proceeds were more than £6,000 and the asset is not exempt from capital gains tax.
Capital Gains Tax – key takeaway
The rules relating to capital gains tax can be complex. Although these FAQs provide answers to some of the most basic questions about CGT, professional advice should always be sought from a tax specialist.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute tax, financial or legal advice, nor is it a complete or authoritative statement of the rules and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert tax, financial, legal or other advice should be sought.