#15663 - Capital Taxes - Tax Law

Problem Question Guide – CGT

Basic Rates

• Annual gains exemption of 11,100

• The rates applicable are:

  • 18%/28% for gains on residential property and carried interest

  • 10%/20% for all other gains

  • Although pre-April 2016, the rates are just 18% or 28%.

• The rate depends on the taxpayer’s income. If taxable income is above 32,000 then capital gains will be taxable at the higher rates of 20% or 28%. If taxable income is below 32,000 then the amount by which 32,000 exceeds taxable income is the amount of taxable gains subject to the lower rate of 10% or 18%, with any remaining gain taxed at 20%/28%.

• E.g. T has a taxable income after personal allowance of 29,6000 and also a capital gain of 21,100. The first 11,100 of this is exempt, leaving a taxable capital gain of 10,000. 2,400 of the gain (32000 minus 29,600) will be taxed at 10% and the remaining 7,600 at 20%.

Central concepts: Disposal of an asset resulting in gain, taking into account any exemptions and deducting allowable losses.

What is a chargeable asset?

A chargeable asset is defined in s 21(1) TCGA as ‘all forms of property’, specifically including any currency other than sterling, and ‘any form of property created by the person disposing of it, or otherwise coming to be owned without being acquired’

Rule: Rights of action not capable of being owned in a legal sense are not assets.

• E.g. in Kirby v Thorn EMI, the court held that a company’s right to trade and compete in the marketplace was not an asset and hence a sum received for entering into an agreement not to sell shares in subsidiaries was not a capital sum derived from an asset. On the other hand, the payment which were received for agreeing not to exploit the goodwill of the company was taxable.

  • The right to sell on the marketplace was not an asset (‘property’), but a right in a free society. ‘Property’ must be capable of being owned, in a normal legal sense.

  • Goodwill, on the other hand, ‘is not something possessed by everyone’. It has a value, even though by its nature this is not assignable. It can be protected by an action, and is discernibly distinct from the mere liberty of trade.

• Further example in O’Brien v Benson’s Hosiery: Held that a bundle of rights of an employer under a service agreement was an asset, so that a sum received by an employer to secure the release of the employee was derived from that asset and liable to CGT. It was sufficient that it could be ‘turned into account’; it was irrelevant that it was not assignable by the employer.

  • Lord Russell: ‘If the employer is able to exact from the employee a substantial sum as a term of releasing him from his obligation to serve, the rights of the employer appear to me to bear quite sufficient the mark of an asset of the employee, something which he can turn into account, notwithstanding that his ability to turn it to account is limited by the nature of the asset’.

• In Marren v Ingles, shares were sold for a cash sum plus the right to receive a further sum, to be computed by reference to future, unpredictable events. The right to receive a future sum was held to be an asset. ‘Asset’ includes incorporeal rights to money’s worth which was part of the consideration given for the shareholding.

What is a chargeable disposal?

This is not defined in legislation, but by s 21(2) it includes a part disposal, and by s 22, circumstances ‘where any capital sum is derived from assets notwithstanding that no asset is acquired by the person paying the capital sum’.

Tiley: disposals are the ‘transfer or alienation of the beneficial title to an asset from one person to another, involving a disposal by one and an acquisition by another’.

There is a disposal even if the person paying does not acquire an asset e.g. O’Brien, where the person is released from employment, T had not received an asset.

General rules

• The disposal of an asset otherwise at arm’s length (e.g. by a connected person) is to be treated as a disposal at open market value (s 17, 18(2) and 286 TCGA). Section 18(2) applies s 17 to disposals between connected persons, regardless of the motive of the parties or the price paid.

  • Connected persons: spouse, civil partner, sibling, ancestor or lineal descendant, as well as the spouse or civil partner of any one of those individuals and with those relations of the spouse or civil partner.

  • Aunts, uncles, nephews and nieces are not connected persons.

• Death is not a disposal for the purposes of CGT. Instead, the assets are deemed to be acquired by the personal representative on whom they devolve ‘for a consideration equal to their market value at the date of death’ (s 62(1)(a)) i.e. a free uplift. No CGT, but IHT may nevertheless be due. The free uplift applies regardless of whether IHT is due. Therefore, when the personal representative sells the asset, CGT is charged on sale, taking the market value at the time of death.

• Gifts to charities and inter-spouse transfers are also treated as not giving rise to a chargeable gain.

• *Note also, holdover relief:

  • This is available for gifts when there is a disposal otherwise than under a bargain at arm’s length. The gain that would otherwise be chargeable to tax is held over so that the gain crystallised by the donor, D, is reduced to nil. The donee, E’s, acquisition cost is also reduced.

  • When holding-over, the chargeable gain made by disposal 1 from D to E is reduced to nil. E sells the assets at a capital gain in disposal 2; the proceeds of disposal 2 are reduced by the gain held over in disposal 1.

On compensation claims

Generally, compensation or damages received as a result of court action or by negotiated settlement of the action, is a disposal of the right of an action and is subject to CGT. The base cost of the right will be nil and hence the whole amount is subject to CGT.

Note ESC D33 (Which is not yet codified): It relates the damages to the underlying asset where the right of action relates to the damage to the asset (base cost of the asset is used to compute chargeable gain).

• Only the first 500,000 of chargeable gains not linked to an asset will be exempt from tax. Therefore taxpayers receiving compensation more than 500,000 are generally not exempt from tax.

• ESC D33 states that where the right of action arises by reason of the total or partial loss or destruction of property which is an asset for CGT purposes, any such gain or loss on the disposal of the right of action may by concession be computed as if the compensation derived from that asset, and not from the right of action.

• Damages must be resultant from an underlying asset that is an asset for CGT purposes. If a relief or exemption was or would have been available under the disposal of the underlying asset, it will be available on the disposal of the right of action.

Pennine Raceway Ltd v Kirlees Metropolitan

• The court held that the compensation received from a council following the revocation of a planning permission was derived from the company’s license (asset) rather than the right to sue the council.

• As the capital sum was derived from the company’s license rather than the rights it held, part of the allowable costs of the license fell to be deducted in computing the gain.

• In this case, T was entitled to a capital sum by way of compensation for depreciation of an asset (i.e. the license) when the planning permission as revoked because the asset had sustained loss or damage which was directly attributable to the revocation of permission. The capital sum was derived from the asset.

Zim Properties v Procter (pre-ESC D33 and Pennine)

• Warner J held that a right of action for damages relating to the conveyance of property was an asset separate from the property conveyed. He found that the property remained unaffected by the actions of the solicitors so that it was not the source of the damages. Instead, the right to sue the solicitors was the source of the damage; the right to sue was an asset for CGT purposes. By receiving damages, the company had disposed of that asset. This established that the right to take court action for compensation is an asset in its own right for CGT purposes.

• Facts: T contracted to sell the property, but the purchaser repudiated the contract alleging that T’s solicitors had failed to demonstrate good title to the property. T sued its solicitors for negligence and the action was settled. T claimed that the settlement payment was for the depreciation of the value of the property caused by the solicitor’s negligence.

Part disposals

• The A/(A+B) formula applies

• The portion of the acquisition cost attributable to the part disposal is A/(A+B) where A is the consideration for the disposal and B is the market value of the remainder

• Cf. s 42 TCGA.

What are the exemptions?

Main residence exemption (s 222-226)

• Generally, a gain is wholly or partly exempt if it is attributable to the disposal of, or an interest in, a dwelling house which has been the owner’s only or main residence.

• ‘Residence’

  • Morgan (David) v HMRC: T intended to purchase and move into a property with his girlfriend. The relationship ended and he proceeded to live in the property to get the house ready to let, before moving out. He let the property for five years, and then sold it for capital gain. The court held that the property qualified as his residence.

  • Note especially, the overwhelming importance of intention as to permanence at the time of moving in: Gort J stated that ‘IM need only show that at the time when he moved into property, it was his intention to make it his permanent residence, even if he changed his mind about...