Table of Contents
Capital gains tax is a compulsory payment that HMRC places on individuals when they sell certain assets and profit from sales. For individuals, capital gains tax is distinct from income tax. As a business owner, you need to understand your tax obligations as you are legally required to pay the correct amount. This article will explain how capital gains tax is assessed for individuals, particularly those like you who own a business. It will also explain how HMRC assesses your company’s liability for capital gains and how it differs from the assessment of an individual person’s capital gains liability.
Capital vs Income
To understand how HMRC assesses your personal capital gains tax, you must understand the difference between capital gains and income gains.
The Apple Tree
Imagine you have an apple tree that regularly produces apples, which you sell. The apples are an income asset, and each time you sell one, you receive an income receipt. Likewise, the apple tree is your capital asset. If you were to sell the whole apple tree, the money you would receive would be a capital receipt.
The Pottery Business
Imagine you run a pottery business from your house. Each time you receive cash from the sale of the ceramics, this is an income receipt. The kilns and wheels are considered part of your business’ infrastructure as you need them to produce the products that give you an income receipt. If you sell them, you have a capital receipt.
If your business sells a service rather than goods — say, a recruitment business — the income is the money you receive for placing candidates with your clients. Your capital assets are the database, branding, and IT system you use to source candidates and connect them with your clients. If you sell these assets, you make a capital receipt.
For individuals, you can also think of capital assets as valuable property you buy and sell on occasion — a house, shares in a company, or fine art. Income, however, is your regular wage paid by an employer. Income also includes rental payments your tenant makes to you or any dividends you receive from a company that you own shares in.
Receipts vs Expenses
Similar to distinguishing between capital receipts and income receipts, there is a legal difference between capital expenses and income expenses. Any money your business spends producing products it sells is an income expense. In the case of a pottery business, this includes the clay, glaze, and energy expenses. A capital expense is the purchase of any capital asset, such as your kilns and wheels.
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Capital Gains Tax
HMRC has different rules for capital gains tax (CGT). Generally, you are only liable for CGT if you have made a gain — that is, a profit — on the sale of a capital asset. Not all capital assets attract CGT, including:
- your primary residence;
- vintage cars;
- property that generally does not last for more than 50 years, such as TVs, computers, and electronics;
- the sale of capital assets for less than £6,000; and
- cash.
The Sale Price
Most of the time, you want to get the best price for an asset. But sometimes, you may want to sell something for a discount or even give it away for free. In some cases, when you do this, the law may treat the transaction as if you had sold the property for its market value and charge you accordingly.
Basic Calculation of Gain
As long as your asset is not exempt from CGT, you must make a gain when you sell it. To determine whether or not you make a gain, HMRC looks at how much you paid for the asset when you bought it. At the most basic level, the gain is the difference between the price you paid and the price you sold it for.
The gain is the amount HMRC assesses for tax. Once you have the basic gain (price sold less the price you paid), there are additional allowances you can deduct. These are:
- initial expenditures, which in addition to the price you paid for the item, also include any fees incurred as part of the purchase, such as legal or brokerage fees;
- subsequent expenditure, which is any money you paid to enhance the value of the property; and
- incidental disposal expenditures, which are the fees you paid to sell the item (i.e. legal or brokerage fees).
The actual formula for calculating the amount HMRC will tax is as follows:
|
Sale Proceeds |
X |
|
Less: disposal expenditure |
(x) |
|
= Net Sale Proceeds |
X |
|
Less initial expenditure |
(x) |
|
Less subsequent expenditure |
(x) |
|
= Taxable Amount (i.e., your capital gain) |
X |
An Example
You bought a second home ten years ago for £100,000. It is now worth £200,000. You paid £10,000 in fees to purchase it, £20,000 to expand the kitchen, and £15,000 fees for selling it. Here is how HMRC calculates your capital gains:
|
Sale Proceeds |
£200,000 |
|
Less: disposal expenditure |
(£15,000) |
|
= Net Sale Proceeds |
£185,000 |
|
Less initial expenditure |
(£110,000) |
|
Less subsequent expenditure |
(£20,000) |
|
= Taxable Amount (i.e., your capital gain) |
£55,000 |
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CGT Rate
The CGT rate for individuals is either:
- 10% (the lower rate); or
- 20% (the higher rate).
Generally, if your total income and any capital gains you make in a tax year are less than £50,270 (the threshold between the basic income tax rate and the higher rate), then you will always pay 10% on the capital gains. Where the combined value of your taxable income plus capital gains puts you in the higher tax bracket, HMRC charges 20%.
Additionally, each person is entitled to £12,300 in tax-free capital gains allowance (this does not apply to companies). This means that as long as the sum of your annual income plus your capital gains (with the capital gains allowance factored in) does not exceed the upper rate income tax threshold, you will pay 10% on the capital gains.
In our above example, this means you would pay:
£55,000 – £12,300 = £42,700 x 10% = £4,270 in tax.
But, if your taxable income is £100,000 because this is more than £50,270, you would pay £8,540 in capital gains tax on the above purchase — or 20% of £42,700.
Key Takeaways
To assess your capital gains tax, you calculate the difference between the price you paid for a capital asset and the price you sold it for. From this figure, you can deduct other associated expenses and an allowance of £12,300. Subject to specific relief programs and your total annual income and capital gains, HMRC will charge you 10% or 20% on your individual capital gains.
If you need help with your capital gains tax assessment, our experienced commercial lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
If you sell a capital asset for more money than you paid for it, you have made a capital gain. There are other expenses and allowances towards this gain to reduce your capital gains tax liability, but this is the general principle.
What is a capital asset?
For individuals, you can think of a capital asset as any piece of valuable property that you occasionally buy or sell. Not all capital assets attract capital gains tax.
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