The Capital Gains Tax - Report Example

Question: In relation to Capital Gains Tax (CGT), what amounts to the disposal of an asset? Introduction Prior to the introduction of the Capital Gains Tax (CGT), profits generated from the sale of capital assets were largely not subject to tax. Then Chancellor of the Exchequer, Mr. James Callaghan, acknowledged the failure of the prevailing tax system to tax capital gains and described it as “the greatest blot of [the] system.” (Lee 2009:467) After all, it did not seem right that an ordinary employee was regularly taxed for the salaries he received for his labor while a landowner who sold a property at a profit would be able to walk away with all the profits without having to pay taxes thereon. Thus, there was this gap in the taxation system as a whole and CGT was designed to fill it in. Capital Gains Tax (CGT) Defined Introduced in 1965, a Capital Gains Tax (CGT) is generally the amount paid by a taxpayer for selling capital goods (e.g., a parcel of land, a building, shares of company stocks, antiques, jewelries or an enterprise) at a profit. CGT is also levied on taxpayers who received prize money or compensation that is not covered by income tax, and those who gave away assets that are worth more than the corresponding acquisition costs. (The Times 2010) CGT is also defined as the tax that is “charged on any gain resulting when a chargeable person makes a chargeable disposal of a chargeable asset.” (Lee 2009:469) There are prevailing laws that dictate what constitutes a chargeable person, a chargeable disposal and a chargeable asset. There also are similar laws that specify exemptions, reliefs and allowable deductions in computing the final amount subject to CGT. These items are first considered in the computation of taxable capital gains before the tax charges are applied. (Lee 2009:469) Chargeable Persons Defined For CGT purposes, chargeable persons pertain to all who are subject to it by law. They include residents of the United Kingdom, trustees, proportional representations (PRs) and partners. In cases when a partnership as a whole has concluded a transaction that is to be charged with CGT, each of the partners would be charged according to his fair share in the total. In the case of corporations – the “artificial” beings in a country – that earned sums that would have been subject to CGT, corporation taxes are instead collected. These corporation taxes are based on corporate earnings that definitely include the chargeable gains. (Lee 2009:470) Needless to say, there is a whole set of rules governing corporation taxes – rules regarding CGT do not apply. Chargeable Disposal Defined Disposal involves changes in the ownership of an asset or the divestment by an owner of his interests in an asset. (Lee 2009:499) Disposal occurs when an asset is sold, given away, exchanged, lost or destroyed. (HM Revenue & Customs 2010) The meaning of the term “chargeable disposal” is extended to include the receipt of sums of money to compensate for the destruction or damage of an asset. These instances often involve insurance benefits that are availed of as a result of accidents or untoward incidents that an asset is insured against. (Lee 2009:471) All these instances of disposal of an asset constitute chargeable disposals that are subject to CGT. These occurrences are mandated to lead to the accurate computation of the taxable capital gains and to the collection of appropriate taxes thereon. Incidentally, CGT is charged only for profitable disposals of assets. Chargeable Assets Defined Assets generally refer to resources available to a person or entity. They include cash, receivables, property and equipment, and intangible items like goodwill. Except for a few, all kinds of properties are classified as assets that are subject to CGT. These properties extend to intangible ones such as shares of stocks, currency, goodwill, and even to non-assignable contracts and rights. (Lee 2009:470) Chargeable Gains Defined Chargeable gains are the net amounts on which CGTs are based. Chargeable gains are computed by deducting all allowable expenditures from the proceeds of the disposal of an asset. The bulk of the allowable expenditures would normally be made up of the original acquisition cost of the asset. (Lee 2009:471) Other allowable expenditures include cost of improvements, costs of disposal or costs of transfer or conveyance, and advertisement expenses incurred to find a buyer. Fees paid to the surveyor, appraiser, auctioneer, accountant, agent and legal adviser are as well deducted from the proceeds of the disposal before computing the capital gains. (Lee 2009:476-477) Some expenditure items are expressly not allowed as deductions. If the acquisition of the asset was financed by a bank, the interests incurred cannot be deducted from the sales proceeds thereof. This ruling leads owners purchasing assets in cash or using credit to be subject to the same tax terms. Without this rule, borrowers would then be at an advantage – the financing charges they incurred could actually lessen the CGT that they would have to pay. Similarly, insurance premiums that have been paid by the owner for the continued protection of assets from risks of loss or damage are disallowed as deductible expenditures. After all, availing of an insurance coverage for an asset is an option that the owner can take or not. The owner cannot be entitled to the advantage of having a reduced computed capital gain just because he never missed to have his assets covered by insurance. This would have constituted an unfair practice. Most importantly, expenses declared by the owner in the computation of his income tax cannot be doubly used as deductible expenses for CGT purposes. (Lee 2009:478) A taxpayer who is due to pay both income taxes and CGT would have to decide where to use the allowable expenses that he can deduct from either his gross income or his capital gains for the year. He can use each deduction item just once. Not all disposals of assets end up with chargeable gains and CGTs due to be paid. There are cases when assets are disposed of at costs that are less than their original acquisition prices. These cases, then, yield losses that the taxpayer can subsequently deduct from chargeable gains generated by his other assets. (Lee 2009:471) Losses, then, help decrease the total net taxes that a taxpayer would have to pay for a given year. Consideration for the Disposal Defined The consideration for the disposal is generally the amount at which an asset-owner is willing to sell his property or asset of interest. In concise terms, the consideration for the disposal of an asset is the proceeds of its sale at arm’s length (Lee 2009:471). The term “at arm’s length” designates two involved parties – the buyer and the seller – as independent of each other. The consideration for the disposal is not valued at the current market price that an item would fetch if the exchange is done between persons who are deemed to not have the prescribed independence of each other. Such “connected persons” include a person and his spouse and relatives, companies under common control or ownership, partners bound by a partnership agreement, and persons involved in trustee-settlor contracts. (Lee 2009:473) Determination of the Market Value Market value is the price upheld in the open markets; it is the prevailing price for specific assets at specific times or dates. The market price per unit item is not influenced by the number of items that would be purchased as one transaction – it stands as the market price per unit whether an exchange involves just one or many. (Lee 2009:473) The market value of assets is determined by designated authorities. Market values of properties are set by industry bodies according to the location and type thereof. Market and economic forces also influence the prevailing market values of real estate. The stock market exchanges across the globe provide the market value of shares of all listed companies at a given time or on a given day. The same is true with stock options and futures. Exemptions Exemptions to CGT include gains below £10,000, sales proceeds of belongings worth less than £6,000 and donations of assets to selected charitable institutions. (The Times 2010) There also are certain assets that are not subject to CGT, particularly those that have limited useful lives. The gain on the disposal of these assets is exempt from CGT. (Lee 2009:470) The consideration for the disposal of an asset is not always its market or current value at the time of disposal. When the exchange of assets occur between married couples and civil partners, the consideration for the disposal is set at an amount that will mean that no gain and no loss will come out of the transaction. (Lee 2009:472) Part Disposals Assets are not always disposed of wholly or fully. Assets can be subject to “part disposal,” which means that a fraction of the asset remains to be owned by the original owner. When only a part of an asset or a stake in it is to be transferred to a new owner, the CGT arising from the transaction would have to be based on the original cost of the part sold. (Lee 2009:484) The capital gains and the allowable deductions are, therefore, computed pro-rate – based on the fraction of the asset disposed of as a part of the whole. Wasting Assets Wasting assets are those that are projected to be useful for not more than 50 years and are generally exempt from CGT. Wasting assets include tangible properties, stock options, “purchased life interests in settled property where the predictable life expectation of the tenant is 50 years or less.” (Lee 2009:485) When wasting assets are disposed of, the capital gains or losses resulting from such disposal are computed using allowable expenditures that are adjusted according to the expected useful life of the assets. This way, claims for losses or any compensation for it are minimized. (Lee 2009:485) Losses Losses occur when the proceeds of the disposal of an asset is not sufficient to cover all the allowable expenditure items. These transactions yield losses that the owner would have to offset against capital gains earned in the same year. If such capital gains turn out to be less than the losses, then the excess losses can be deducted capital gains in future years. (Lee 2009:488) Some losses are disallowed by law as deductions from capital gains due from taxpayers in a given year. One case that illustrates this is that of Jason Drummond whose claim of allowable loss amounting to £1,962,233 was disallowed; the amount represented losses related to insurance policies that he purchased. Such loss was to be considered as an income tax item for the year it was incurred, and not as a deduction from accumulated capital gains – this arose from the terms of the insurance policy. (Taxbar 2010) Another case of declared losses being questioned as deductions for purposes of CGT computation is that of Philip John Underwood, who claimed that losses were incurred in the disposal in April 1993 of certain lands he owned. In the end, it turned out that no losses were incurred because no disposal of properties occurred. (Taxbar 2010) CGT Rates CGT used to be calculated at a constant rate of thirty percent (30%) until 1988 when the application of income tax rates to capital gains began to be implemented. Then CGT has been fixed at eighteen percent (18%) since the year 2008. (Lee 2009:494) Payment of CGT CGT is declared by taxpayers in the year the asset disposal takes place then the payment for the computed taxes is made on the 31st of January of the next year. Interest charges are incurred by taxpayers who fail to meet this due date. (Lee 2009:498) CGT is normally paid at one time except for the two cases that allow installment payments. The first case is when the sales proceeds are to be received by the original owner of the asset in installments and when the installment period runs longer than 18 months. CGT can then be paid by installments over a period not exceeding eight years. (Lee 2009:498) The second case is when land, controlling interest in a company or “a minority holding in an unquoted company” is given as a gift. The issuer or giver of such gifts would be allowed to pay the CGT due in ten annual installments. (Lee 2009:498) When the net taxable capital gains of a taxpayer turns out to be less than his annual exempt amount, he does not have to pay CGT. (HM Revenue & Customs 2010) Summary Given that CGT is computed when a chargeable person, a chargeable disposal and a chargeable asset all happen to be present in a given scenario, it is of utmost importance that the meaning of the mentioned terms be made clear to concerned taxpayers. The disposal of an asset does not always have to be voluntary, since even the unexpected destruction of a property – whether caused by man-made disasters or by fortuitous events – is to be considered a disposal thereof. Disposal involves loss of control or ownership over an asset, whether or not the owner approves of it. The disposal of an asset leads to CGT’s falling due, unless such disposal resulted to losses for the owner. Given that the most common form of disposal is sales, then there relatively are more profitable disposals than there are deficit-yielding ones. List of References Lee, N. (2009) Revenue Law – Principles and Practice. United Kingdom: Tottel Publishing Ltd. Times Online (2010) Capital Gains Tax Explained [online] available from [accessed 29 May 2010] HM Revenue & Customs (2009) Capital Gains Summary Notes [online] available from [accessed 30 May 2010] Taxbar (2010) The Special Commissioners Report [online] available from [accessed 11 June 2010] Taxbar (2010) The Special Commissioners Report [online] available from [accessed 11 June 2010] Read More