Capital Gains Tax explained
Our guide to help you understand and calculate Capital Gains Tax
If you think your start-up is going to be worth a fortune in four or five years’ time, you will no doubt already have thought about your exit strategy. If this is the case, or if you’re planning to sell or exit your business or sell any assets that have gained value, then you need to be aware of Capital Gains Tax.
What is Capital Gains Tax?
Capital Gains Tax is tax on any profits or gains you make when you sell or ‘get rid’ of an asset. Assets not only apply to the sale or exit of business but you may also have to pay Capital Gains Tax when you sell assets such as offices, furniture and trademarks, even the goodwill built up by your company could ultimately be taxable.
Everything, it seems, comes under the Capital Gains Tax umbrella. Shares bought at a low price and sold on for a higher price count as Capital Gains Taxas does money received in compensation. Personal possessions, such as jewellery, artwork or antiques, which have been inherited or bought for a low sum, if sold on for profit are also liable for Capital Gains Tax.
Capital Gains Tax can seem like a potential minefield for any entrepreneur. However it's only the gain you make, not the amount of money you receive for the asset, that is taxed.
For example if you bought a house for £240,000 and sold it for £260,000, you will only need to pay tax on the £20,000 gain – not the whole £260,000.
How much is Capital Gains Tax?
To calculate your Capital Gains Tax bill, start off by working out all of your individual gains and losses for each asset you have sold or ‘disposed’ of for that tax year. Deduct any losses you’ve made from the tax year from the gains to calculate the overall net gain.
If your overall gain is less than the annual tax-free allowance, known as the Annual Exempt Amount, then you have no Capital Gains Tax to pay. The Annual Exempt Amount for 2012-13 is £10,600.
If your overall net gain is higher than the Annual Exempt Amount, you can then deduct unused losses from a previous tax year and deduct enough of these losses to reduce your gains so it meets the Annual Exempt Amount. You can then carry the rest forward to future tax years.
If your overall gain is still more than the Annual Exempt Amount then you are liable for Capital Gains Tax.
You will then need to work which rates of tax to use.
Mr Smith made a gain of £30,000 on offices he sold in March 2012, in the same month he also sold some shares to make a gain of £40,600. He made no losses so his overall net gain is £70,600.
As Mr Smith’s gains are higher than the Annual Exempt Amount for 2012-13 of £10,600, he will have to pay Capital Gains Tax on the £70,600 minus the Annual Exempt Amount. His amount which he owes tax on then amounts to £60,000.
Capital Gains Tax rates:
- If your overall net gain is more than £10,600 then your Capital Gains tax is based on a flat rate, either 18% or 28%, depending on the total amount of your taxable income.
- If your combined taxable gain and income fall beneath the upper limit of the basic rate of income tax (which currently stands at £32,010), you will have to pay the 18% rate.
- If your combined taxable gain and income reaches above the upper limit of the basic rate of income tax, then you are liable to pay28%.
- If you’re an entrepreneur selling your business, you may be able to receive entrepreneurs’ relief (see below), which provides a reduced Capital Gains Tax rate of 10%.
For more information about Capital Gains Tax rates, visit HM Revenue and Customs’ (HMRC) website.
Entrepreneur’s Relief carries a maximum lifetime allowance of £10m – so, if you sell several businesses in multi-million pound deals over your business life, you’ll only get Entrepreneurs’ Relief on the first £10m you make.
To qualify for Entrepreneur’s Relief, you must have owned at least 5% of the company, or the voting rights for the past twelve months; you must be an individual, as opposed to a company; and you must work as an officer, or employee of the company.
How to pay Capital Gains Tax
If you have Capital Gains Tax to pay then you need to report this to HMRC by sending a Self-Assessment tax return. You must register for Self-Assessment before you do can do this. The latest you can register is by October 5 after the end of the tax year for which you need a tax return. You may have to pay a penalty if you do not tell HMRC in time that you have Capital Gains Tax to pay.
To register for Self-Assessment, click here.
If you normally complete a Self-Assessment tax return online then you need to select the Capital Gains Tax pages at the start of the Self-Assessment form and these will be added to your return.
If you normally complete a paper copy Self-Assessment tax return then you can download a paper copy of the Capital Gains tax pages here.
You will need to make a separate note of each gain and loss on the Self-Assessment tax form. Every instance of profit or loss, no matter how small, needs to be included. When filling out your self-assessment form, you’ll need to include the following information:
- A brief description of the asset (make, model, size, age, location, quantity etc.)
- The dates you bought/acquired the asset, and sold/disposed of it
- The amount you paid for the asset, or the market value if it was inherited
- The total amount you got for the asset – or the market value if you gave it away
- The costs run up in buying and selling the asset – such as stockbrokers’ fees or construction costs
- Details of any relief you’re getting
Assets not liable for Capital Gains Tax
Not all assets are liable for Capital Gains Tax, your car and any personal possessions disposed of for £6,000 or less are exempt as is your main home, in most circumstances.
Similarly, you don’t have to pay Capital Gains Tax on the money you receive from ISAs, pensions, or government bonds, the windfall you receive from a bet or lottery, or the compensation you receive from personal injury.
You can avoid Capital Gains Tax by transferring assets to your spouse (although note that you will need to pay the tax on gifts transferred to your children), or funnelling profits into an Enterprise Investment Scheme.
Finally, you can cut your Capital Gains Tax bill by making the odd small loss – so if you’re struggling to get rid of one of your properties at a decent rate, or you have shares in a firm which is struggling, you could achieve an overall gain by selling at a low rate – and slashing your tax liability in the process.