What does CGT apply to?

CGT arises on the disposal of an asset - normally selling it. Most assets that people invest in are caught, for example shares, houses, antiques and paintings. Some things are outside the net - loan stock (including gilts) and cars are two examples. That exclusion extends to a vintage car so a profit on selling such a car won't be taxed unless you are trading in cars.

When does a disposal take place?

Most disposals are sales and for CGT purposes they take place on contract date, not completion date unless there is a conditional contract. An example of this might be a sale of a property subject to planning permission being granted - the sale wouldn't take place until permission was granted. A part disposal can give rise to a capital gain - selling part of a plot of land will usually produce a gain, with a proportion of the cost allocated against proceeds.

A gift is a CGT disposal - proceeds will be deemed to be market value at the time of the gift. If an asset is destroyed and you receive insurance money instead, that is also a disposal, with the insurance monies representing disposal proceeds.

How do you calculate the capital gain?

In essence it's simple - just proceeds less cost. But there are various things that can deducted as well; a property sale would deduct:

• costs of purchase (e.g. stamp duty)
• costs of sale (e.g. estate agent's costs)
• improvements during the period of ownership (which could range from an extension to the cost of installing double glazing)

At the moment, the rate of CGT is your marginal rate of income tax.

The idea is that the gains are notionally added at the top of your income and taxed accordingly. So anyone who is a higher rate taxpayer will

see CGT at 40%; someone who pays at basic rate will pay at 20% (not 22%), though the gain may well push the total above the higher rate threshold and mean some of the gain is taxed at 40%.

This is the big change for CGT - the rate is to be a flat 18% from 6 April this year.

Are there any reliefs from CGT?

Yes, quite a few - which is where it starts getting complex. The main reliefs include:

• annual exemption (everyone gets a first tranche of capital gains tax free; currently it's £9,200)
• indexation relief (adjustment for inflation)
• taper relief (which reduces the effective tax rate)
• rollover relief (for reinvesting gains on business assets)
• chattels relief (single items sold for under £6,000 are usually CGT free)
• losses
• main residence (an individual's home is outside the CGT net; a married couple get one CGT-free residence between them)

This was introduced in 1982 and gives an extra deduction for inflation on any asset owned in the period 1982-1998. It was stopped in April

1998 when taper relief was introduced but it was ‘banked' at that date. Indexation is calculated by reference to the increase in the retail prices index (RPI) over the period of ownership. So if an asset cost £100 in March 1987, as the RPI went up by 60% in the period up to April 1998, that would mean you can deduct an £160 not £100 when calculating the gain.

What about taper relief?

Taper relief - introduced from April 1998 - rewards longer term investment by reducing the proportion of the gain that is chargeable over time. It also encourages certain areas - business assets - by giving them a better taper and so lower tax bills to their owners.

Business assets are primarily your own business, assets used for the business, shares in unquoted companies and shares in the company you work for or in which you hold at least 5% of the shares (generally it has to be a trading business). Non-business assets are everything else: mainly second properties, buy-to-lets, antiques and shares in general plcs. The taper relief for business assets means only 25% of the gain is chargeable once it's been held for two years; non-business assets reduce to 60% chargeable, but only after 10 years.

But aren't these reliefs going?

Both indexation and taper relief are to be abolished for disposals after 5 April 2008. That's the other side of the reduction in rate to 18% and gives a mix of winners and losers. Winners are generally those with non-business assets (who currently pay an effective rate of at least 24% if they are higher rate payers); losers are those with business assets (who would have usually been expecting an effective CGT rate of 10% (i.e. 25% after taper relief of the 40% tax rate which equals 10%).

The scrapping of indexation can mean someone who has a long-held second property may lose more with the abolition of the indexation relief than they gain with the reduced rate. And anyone who would have paid at basic rate will almost always find their effective tax rate going up.

Is there any chance of some mitigation for these changes?

There will be a new "entrepreneurs' relief", modelled on the retirement relief that used to operate before taper relief came in. Someone selling a business, or shares in a business in which they own at least 5% (and which they've held for at least one year), will be allowed to make gains of up to £1m and pay tax at effective 10% rate before the full 18% rate kicks in on any balance. That £1m is a lifetime allowance so it doesn't just apply when someone sells up a small business and retires.

This doesn't help someone who just had a few shares in their employer, on which they would have received business asset taper.

Can you get relief for losses?

Yes: what happens is that you total up all your disposals for the tax year, so offsetting capital gains and any genuine capital losses you've realised in the tax year to get to a net result for the year. If that netting off produces a gain, you can offset your annual exemption to give a lower net gain or eliminate the gain entirely.

If the net result for the year is a loss, that carries forward to the next year (and so on indefinitely until used up) and offsets gains there. But you only offset enough to reduce the net for the year to the amount of the annual exemption. So if you have, say, £10,000 net losses in year 1 and £15,000 net gains in year 2, you might assume you use up all of your losses and end up with net gains of £5000 in year 2. In fact, you only have to use up £5,800 of the losses to give net gains in year 2 of £9,200 - neatly covered by the annual exemption - leaving £4,200 of losses to carry forward to year 3 - you don't waste any past losses.

Is CGT paid when someone dies?

No: there is no CGT on death; there is, of course, inheritance tax to consider so death is not a tax-free occasion. The deceased's heirs inherit the assets at probate value, i.e. market value at the time of death, so there is a tax-free uplift for CGT purposes.

How do you make best use of the annual exemption?

The annual exemption is valuable, covering as it does £9,200 of gains and saving up to £3,680 of tax in the current year (£1,656 from April 2008 onwards, though the £9,200 amount is likely to be increased in the Budget). Ideally taxpayers should aim to realise gains of this amount each year: splitting a disposal across the tax year end, if that's possible, can mean using the annual exemptions from two different years.

Do married couples get any advantages?

There is no capital gain on disposals between husband and wife (or civil partners). So couples can pass assets between each other without involving CGT. As married couples each have an annual exemption, splitting ownership of an asset between husband and wife can double up on annual exemptions that are used up.

 Do companies pay CGT?

Strictly no - they pay corporation tax on their capital gains. They pay at their normal rate of corporation tax (so currently 30%, or 20% for a company subject to the small companies' rate) with a slightly different calculation of the gain from individuals.

If I make a gain, do I have to tell HMRC?

In these days of self assessment, the basic answer is ‘yes'. The law says that, "if the net chargeable gains are under the annual exemption and the total proceeds of all disposals in the year are under four times the annual exemption", no return is required. Otherwise, you have to complete the CGT pages on the self assessment return. You don't have to report capital losses - but do keep a note of them.

John Whiting is chair of the Chartered Institute of Taxation's Management of Taxes subcommittee and a tax partner with PricewaterhouseCoopers LLP.

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