Capital Gains Tax: a Brief Snapshot
Although many accountants would have you believe otherwise, the basic capital gains tax calculation is pretty straightforward.
Once you sell shares you have what are called 'disposal proceeds'. Subtracting the purchase cost of the shares you end up with what most investors would describe as their profit.
However, this is not the amount that gets taxed. From your profit you can deduct certain expenses, such as stamp duty and stockbroker's fees.
There is then the potential to offset some reliefs depending on the shares in question and the circumstances of the disposal.
From this you can deduct your annual capital gains tax exemption. Whatever's left gets taxed at either 18% or 28%.
A typical capital gains tax calculation is summarised in Table 1.
Table 1: Typical CGT Calculation
Proceeds = X
Less:
Acquisition cost = (X)
Deductible expenses = (X)
Reliefs = (X)
Chargeable gain = X
Less:
Annual exemption = (X)
Taxable gain = X
Example
Aaron sells shares for £16,000. He bought them for £5,000. His profit is therefore £11,000. From this we subtract deductible expenditure of, say, £75 (representing stamp duty and broker's commission).
He can offset the annual CGT exemption of £10,600 and deducting this leaves a taxable gain of £325. If he is a basic-rate taxpayer he'll then pay CGT at 18%, producing a tax bill of £58.50.
Of course, matters aren't always this simple. Every step of the typical CGT calculation outlined above has a variety of 'ifs', 'buts' and 'maybes'. In the next chapter we'll analyse the CGT calculation in more detail before getting stuck into some constructive tax planning from Chapter 10 onwards.
The CGT Rate
For disposals after 5th April 2008 and before 23rd June 2010 CGT is levied at a flat rate of 18%. No matter how much income you have earned or the size of your capital gains, tax is payable at just 18%.
For disposals on or after 23rd June 2010 capital gains are taxed at either 18% (basic-rate taxpayers) or 28% (higher-rate taxpayers), or maybe a combination of both, depending on how much income you earn and the size of your capital gains.
If you have no other income (or it is covered by your income tax personal allowance) then the first £34,370 of your capital gains is taxed at 18%. £34,370 is the basic-rate tax band for the 2012/13 tax year.
If you have income which completely uses up your basic-rate tax band you will pay 28% tax on your capital gains.
If your income is within the basic-rate tax band, you can use the remainder for capital gains tax purposes, which means you will pay 18% CGT on some or all of your gains. Any gains in excess of the basic-rate band will be taxed at 28%.
Example
Patrick sold some shares in July 2012. He realised a capital gain of £50,000 after deducting his annual CGT exemption.
He has taxable income of £20,000 for the 2012/13 tax year, after deducting his income tax personal allowance.
The basic-rate band is £34,370 for 2012/13. Of this £20,000 is used up by Patrick's income, leaving £15,000 for capital gains tax purposes.
His £50,000 capital gain will therefore be taxed as follows:
£14,370 @ 18%= £2,587
£35,630 @ 28%= £9,976
Total = £12,563
The effective rate of CGT for Patrick is therefore 25.12% (£12,563/£50,000) and is a mixture of the 18% and 28% tax rates.
Note that if you have no other income, your income tax personal allowance CANNOT be offset against your taxable capital gains.
For example, if your spouse earns no income but realises a capital gain that is £1,000 more than the annual CGT exemption, this will be fully taxed at 18% or 28%.
Example
In the 2012/13 tax year, Steven earns a salary of £28,000 and has taxable gains of £12,500 from selling shares. His annual exemption is already utilised. His tax calculation is as follows:
Salary = £28,000 Less: Personal allowance - £8,105 £19,895 Tax on salary: 19,895 @ 20% £3,979 Income tax £3,979
Next we calculate Steven's capital gains tax liability:
Tax on share disposal: £12,500 @ 18% £2,250 Total CGT £2,250
The capital gain of £12,500 will be taxed at 18% because it is fully covered by Steven's remaining basic-rate tax band.
Although the maximum rate of CGT has been increased from 18% to 28% for disposals after 22nd June 2010, you can reduce your tax bill much further by claiming all the reliefs you're entitled to.
Effective CGT Rates
Before we go on to examine the capital gains tax calculation in detail it's worth pointing out that CGT is often not as onerous as most investors expect.
Although the maximum tax rate is now 28%, when you take into account the annual CGT exemption, which protects a further £10,600 per person, and other deductions, your 'effective tax rate' will often be much lower than 28%.
By 'effective tax rate' we mean the total tax expressed as a percentage of your profits.
For example, a married couple with capital gains of £50,000 will pay capital gains tax at an effective rate of just 16%, even if both are higher-rate taxpayers.
What Assets are Subject to CGT?
It's also important to point out that not all assets fall into the capital gains tax net. The table below lists some of the more popular types of investment, along with their capital gains tax treatment.
Subject to CGT?
UK shares = Yes
Overseas shares = Yes
Unit trusts = Yes
Enterprise investment scheme shares= No
Venture capital trusts = No
Gilts = No
Corporate bonds = Usually No
Warrants/options = Yes
CFDs = Yes
Futures = Yes
Spread betting = No
Venture capital trust profits and spread betting profits are completely tax free, as are capital gains from gilts and most corporate bonds. Shares in unquoted companies that qualify under the Enterprise Investment Scheme are also free of capital gains tax. Hedge fund profits are usually subject to income tax.
Who Pays Capital Gains Tax?
Most investors are subject to capital gains tax when they sell shares or other assets. However, if the taxman classes you as a trader you will instead pay income tax on your profits.
You also have to be UK resident and UK 'ordinarily resident' to pay UK capital gains tax.
Share trader status is not easy to acquire (and usually not very desirable!) and becoming non-resident does not appeal to the vast majority of investors (especially if it's done for tax reasons only) so the vast majority of those buying and selling shares will pay capital gains tax on their investment profits.
About the Author
The Author of this article is our site Editor, Lee Hadnum. Lee is a rarity among tax advisers having both legal and chartered accountant qualifications. After qualifying a prize winner in the Institute of Chartered Accountants exams, he also went on to become a chartered tax adviser (CTA).
He worked in Ernst & Youngs Entrepreneurial Services department for a number of years before setting up his own tax planning practice. He is now a full time tax author.
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