FOOL SCHOOL
CGT & Shares (Part 1)

September 23, 2002

Capital Gains Tax has grown progressively more complex over the years -- a victim of politicians' inability to leave things be. As a result, the number of manifestations of this tax over time has led us to the point where the calculation of a taxable gain in some cases is barely comprehensible. The latest changes, being as recent as the year 2000, introduced a number of radical alterations -- yet again.

It might be helpful to start with exemptions. That is, situations and types of security that are not liable to CGT. Here is a list of some common areas:

• Government securities
• Qualifying corporate bonds -- broadly, interest-based corporate loan stocks, excluding convertibles
• Venture capital trusts -- subject to conditions
• Enterprise investment schemes -- subject to conditions
• ISAs and PEPs, whatever securities are held within them
• Transfers between spouses. This is not restricted to shares and applies to any asset so transferred

Apart from these, the disposal of shares and other securities will in general give rise to a potential capital gains tax liability, or an allowable loss. Note that disposal does not necessarily mean a market sale. Gifting the shares in general to any person other than a spouse is deemed to be a disposal at market value, whatever the amount of money changing hands.

Every person, including minors, is exempt from CGT on the first slice of their net gains in any tax year - up to a figure called the 'personal exemption'. For the 2002/3 tax year, the personal exemption is £7,700. That is not only on shares but gains on all chargeable assets. "Net gains" means profits minus losses, after deducting all other reliefs that may be available, including losses brought forward from previous years. Following on from that, net losses in a year can be carried forward indefinitely and will be set against gains as they arise in future. The personal exemption is given for each tax year alone, and cannot be carried forward.

Note that disposals of shares where new securities are received in exchange for the shares are not treated as disposals for CGT purposes. This happens often in takeovers and company reorganisations. In such a case you are deemed to hold the new paper at the original cost of the old paper. No CGT disposal occurs until you sell the new shares for cash. If all cash is received in the deal, though, this is like any other sale for CGT purposes. If, as sometimes happens, it is a mixed cash and paper deal then there may be a partial CGT disposal or, if the cash element is small, then it is not treated as a sale but as a reduction of cost.

Rates of CGT

Any net taxable gain in the year (that is, after deducting all reliefs and the exemption of £7,700) is added to total income from other sources in the year to determine the tax band applicable. The tax bands concerned are 10%, 20% and 40%, and the levels are the same as those shown for income tax in our income tax guide:

• 10% on gains up to £1,920
• 20% on gains between £1,921 and £29,900
• 40% on gains over £29,900.

Thus the gain is treated as though it were marginal income, the slight difference being that the middle band is 20% and not the 22% applicable to earned income.

As a consequence, anybody who is a higher-rate income tax payer, and has a taxable gain, will pay 40% tax on it. That is the worst case. However, the taxable gain may often be much less than the actual gain because of various reliefs.

Reliefs

Indexation
The law changed in a serious way from 6 April 1998. Until then, and from March 1982, an indexation allowance was given. Broadly, this allowed the cost of the shares to be increased by the change in the retail price index, thus reducing the gain. It was effectively an allowance for inflation. It could not though be used to create or add to a loss. Also shares were "pooled", i.e. averaged. This meant that where there were several purchases and sales of the same share, the cost per share became the average purchase price of all of them, plus indexation. So for shares acquired before that date, indexation can be applied. The pool is then frozen at that date as the law changed.

Taper relief
From that date (6th April 1998), any further indexation was abolished along with the concept of pooling the same shares to arrive at an average cost per share. In its place taper relief was introduced. This is a system of a deduction from the gain based on the number of years held. And instead of pooling we have the Last In First Out (LIFO) method of identifying which shares are being sold. This is a far more complex approach where there are multiple trades in a particular share.

Taper relief is then split into two types -- business assets and non-business assets. The former is far more generous and grants a reduction in the gain of from 12.5% after one year building up to 75% for business assets held for over four years. The latter grants a reduction of from 5% after three years up to a maximum of 40% of the gain, but only after ten years.

The effect is that for a 40% taxpayer, the maximum CGT on a business asset share is 10% and 24% on a non-business asset share.

Unquoted shares, including AIM-listed companies, are treated as business assets. Also, employee scheme shares are generally treated as business assets in any company. Other than these, straight investments in fully listed companies, where there is no employee involvement by the shareholder, are treated as non-business assets.

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