When computing a capital gain on the disposal of an asset, the taxpayer must deduct the expenditure on the asset from the sale proceeds to arrive at the capital gain or loss on the asset. The expenditure on the asset consists of various elements including the original cost of the asset, enhancement expenditure and the expenses connected to the sale.
The disposal value will generally be the amount for which the asset is sold. Where the sale is not at arm’s length, for example a sale to a connected person or a gift for no consideration, the market value will be substituted for the sale proceeds. This is simply the amount for which the asset could be sold if it were offered for sale on the open market on the date of disposal or gift, though in practice this value may be difficult to establish. Where an asset is transferred between spouses or civil partners who live together, there is a deemed disposal value that ensures that no gain or loss arises on the disposal.
A deduction from the sale proceeds is allowed for the incidental costs of the disposal, including legal fees, costs of advertising the asset for sale, auctioneer’s fees and legal fees incurred in connection with the sale.
Deductible expenditure
The original cost of acquisition of the asset is deductible in arriving at the capital gain. Where the asset was acquired as a gift, the market value at the date of the gift is used instead of the acquisition cost. The incidental costs of acquisition, for example the legal fees paid, are also deductible.
Any expenditure made on improving the asset is allowed as a deduction provided that the improvement represented by this expenditure is still reflected in the state of the asset at the time it is sold. The expenditure must represent improvement of the asset rather than only repairs and maintenance, which are not allowable as a deduction in computing the capital gain.
Another category of expenditure that is allowed as a deduction is any expenses incurred in defending the owner’s title to the asset. This would normally be legal fees incurred in defending the owner’s position in court or otherwise settling the dispute.
The valuation fees that may become necessary as part of computing the value of the asset for capital gains tax purposes are also an allowable deduction. The task of valuing the asset could become necessary for one of the reasons stated above where the market value of the asset is used in the capital gains tax computation rather than the cost of the asset.
Capital gains on part disposals
Where only part of an asset is sold, the deductible costs must be apportioned between the part of the asset being sold and the part of the asset that is retained. This would be done by dividing the sale proceeds (or market value) of the part of the asset being sold by the total of the sale proceeds and the market value of the part of the asset retained, and applying this fraction to the deductible costs.
A simplified calculation applies in the case of small part disposals of land. This applies where the land is freehold or is held on a lease with more than fifty years left on the lease. Where the disposal is caused by a compulsory purchase order, the disposal must be less than 5% of the value of the land for this provision to apply, and in other cases the disposal proceeds must not exceed 20% of the value of the whole of the land and the total proceeds from all disposals of land by the taxpayer in the tax year of assessment should be £20,000 or less.
The taxpayer is entitled to claim that the disposal proceeds of the piece of land are subtracted from the original cost of the land for capital gains tax purposes, with the result that there is no charge to capital gains tax on the part disposal. This means that on the subsequent disposal of the rest of the land the capital gain will be increased.
Negligible value claims
Where the value of an asset has been reduced to zero or a negligible amount, the taxpayer can make a claim for the asset to be treated as disposed of at its current value and re-acquired at the same date, thereby giving rise to a capital loss at that date. If the asset later increases in value again, there would be negligible cost to offset against the sale proceeds in the capital gains computation so the capital gain on a later disposal would be increased.
Capital gains computation
When the capital gains and losses in a tax year (to 5 April) have been established, the capital losses are offset against the capital gains to arrive at the net capital gains for the tax year. Any unused capital losses brought forward from previous tax years are then offset against the capital gains. Each taxpayer has an annual capital gains exemption of £10,100 and only the net capital gains exceeding this amount are subject to tax. Where the total income and capital gains of the taxpayer fall into the standard rate income tax band for the year, capital gains tax is payable on the gains at 18%. Where the total income and capital gains fall wholly or partly within the higher rate for income tax, the capital gains tax is payable at 28%.
The taxpayer should consider if any further capital gains tax reliefs are applicable, such as the entrepreneurs’ relief on the disposal of the whole or a significant part of a business. Alternatively it may be possible to defer the capital gain, for example by purchasing shares qualifying for the Enterprise Investment Scheme.
Sources:
HM Revenue and Customs www.hmrc.gov.uk
“Taxation” by Alan Melville, fifteenth edition 2010, FT Prentice Hall