Capital Gains Tax

It is important to understand how Capital Gains Tax (CGT) works when someone dies, and more importantly how this affects the computation of gains and losses by those who have inherited an asset as well as the personal representatives (such as executors and administrators) of an estate.

As a general rule, there is no CGT charge upon death. This is often referred to as a CGT uplift on death and effectively resets the clock on gains for CGT purposes. This can provide a significant opportunity to save tax. The CGT uplift is of most benefit to a surviving spouse or civil partner as the transfer will also be exempt from Inheritance Tax (IHT). IHT will be of course be due if the value of the estate after reliefs and exemptions breaches the relevant thresholds.

HMRC explains the CGT uplift in broad terms, whereby the assets which were owned by the deceased at the date of death are treated as though they had passed to the personal representatives or other person to whom they pass by law at the date of death, at their market value on that date. When the administration of the estate is complete, the assets are passed to those that inherited them as if they had paid the market value of the asset at the date of death.

Any CGT liability that was outstanding before the death of the deceased (due to the disposal of assets), will of course remain due to HMRC and must be settled by the deceased’s personal representatives.

One of the more surprising announcements in the recent Budget was the introduction of a new 2% Digital Services Tax (DST) from April 2020. This tax is intended to ensure that the major social media, search engine and online retailers are subject to a 2% tax on revenues generated from the participation of UK users in the use of their services. The DST is expected to raise £1.5 billion from 2020-21 to 2023-24 and to help combat criticism that a number of larger online companies pay little or no tax in the UK.  The DST would be payable by profitable companies with global revenues of at least £500 million per year.

The Chancellor stated that:

"Digital Platforms delivering search engines, social media, and online marketplaces have changed our lives, our society, and our economy mostly for the better. But they also pose a real challenge for the sustainability and fairness of our tax system. The rules have simply not kept pace with changing business models. And it’s clearly not sustainable, or fair, that digital platform businesses can generate substantial value in the UK without paying tax here in respect of that business."

The DST will be an allowable expense for UK Corporate Tax purposes under ordinary principles. However, as the DST will not be within the scope of the UK’s double tax treaties, it will not be creditable against UK Corporate Tax.

The Chancellor stressed that the government will continue to work with its partners in the EU, G20 and OECD towards reforming the international corporate tax framework for digital businesses. If an internationally recognised levy was introduced as a result, the UK may introduce this international levy in place of the 2% UK tax.

In the Budget, the Chancellor, Philip Hammond announced two changes to the way Entrepreneurs’ Relief (ER) will operate. ER applies to the sale of a business, shares in a trading company or an individual’s interest in a trading partnership. Where this relief is available Capital Gains Tax (CGT) of 10% is payable in place of the standard rate. CGT on the disposal of chargeable assets is usually chargeable at 20%. There are a number of qualifying conditions that must be met in order to qualify for ER.

The first change came into with immediate effect on 29 October 2018 with the introduction of two new tests to the definition of a personal company for ER. These tests require the claimant to have a 5% interest in both the distributable profits and the net assets of the company in order to qualify for ER. The new tests must be met, in addition to the existing tests, throughout the specified period in order for relief to be due.

The second change increases the minimum period during which certain conditions must be met to qualify for ER from one to two years. This measure will have effect for disposals on or after 6 April 2019, unless a business ceased operating before 29 October 2018. This measure will ensure that taxpayers looking to claim ER will be required to have a longer term interest in their business for an extended period of time.

These changes will affect a significant number of taxpayers looking to claim ER especially those involved with a business over a short-term period. However, there had been suggestions that ER could have been abolished completely, which would have had a far wider impact on investors.

As a general rule, there is no Capital Gains Tax (CGT) on a property which has been used wholly as a main family residence. This relief from CGT is commonly known as Private Residence Relief. Conversely, an investment property that has never been used as a main residence will not qualify.

Two changes to the way Private Residence Relief works were announced as part of the Budget measures. The Chancellor confirmed that two ancillary reliefs are to be amended, potentially reducing the amount of CGT relief available on the sale of a relevant property.

1. Currently, if a property has been occupied at any time as an individual’s private residence, the last 18 months of ownership are disregarded for CGT purposes. This relief applies even if the individual was not living in the property when it was sold. From April 2020, this final exempt period will be reduced from 18 months to 9 months. There will be no change to the 36 months exempt period available for those that are disabled or moving into care homes.
2. Home owners that let all or part of their house may not benefit from the full Private Residence Relief but can benefit from letting relief of up to £40,000 (£80,000 for a couple). From April 2020, lettings relief will be reformed. This change means that lettings relief will only be available to those property owners who are in shared occupancy with a tenant.

The Chancellor also announced a change to the CGT rules on the sale of a residential property. Going forward, if CGT is due, a payment on account will be required. The new rules will apply from April 2019 for non-UK residents and April 2020 for UK residents. This change will mainly affect individuals who are disposing of a second home or rental property. However, there will be exceptions including the limitations to Private Residence Relief mentioned above which result in CGT falling due, and for non-residents.

The Enterprise Investment Scheme (EIS) is designed to help smaller higher-risk trading companies to raise finance by offering a range of tax reliefs, including Income Tax and Capital Gains Tax (CGT) relief to investors who purchase new shares in those companies.

In a recent Upper Tribunal case, a taxpayer appealed against HMRC’s assertion that he was not entitled to a CGT exemption in respect of an investment under the EIS scheme. The facts of the case were slightly unusual. In January 2005, the taxpayer had invested £50,000 in shares in a company under the EIS. The taxpayer did not claim EIS Income Tax relief because his taxable income for 2004-05 was only £42. In June 2011, the taxpayer sold his shares for £333,200. In submitting his Self-Assessment tax return for 2011-12, the taxpayer did not include any gain in relation to the shares in the return because he understood that the gain was exempt from CGT under the EIS.

The taxpayer made a note on his return to explain why no CGT was payable. An HMRC enquiry followed, which decided that the taxpayer was only entitled to exemption from CGT if he had obtained EIS Income Tax relief on the acquisition of the shares and, as he had not done so, he was liable to CGT on the gain. The First-Tier Tribunal and the Upper Tribunal upon appeal, agreed that however unfairly the legislation had been worded, HRMC was correct that no CGT exemption was available where no claim for EIS Income Tax relief had been made.

The First-Tier Tribunal suggested that the taxpayer make a late claim for Income Tax relief to HMRC, which could solve the taxpayer’s issue. The taxpayer did do but the claim was rejected by HMRC. However, the Upper Tribunal in rejecting the taxpayers appeal issued a strongly worded request for HMRC to re-consider its decision in light of this exceptional case. Whilst the facts of this case are uncommon, it highlights that HMRC can be open to challenge by way of judicial review.