The amount of capital gains tax (“CGT”) you will pay when you sell an asset depends on a number of factors, but one of the most important is “Taper Relief”.
This relief was introduced in 1998, and applies to individuals (including partnerships) and to trustees of settlements.
Taper relief reduces the capital gain chargeable to CGT according to three factors:
- How many complete years have you owned the asset?
- Is it a “business asset” or not?
- Has it got a tail? – seriously, this is important!
The rates at which gains are tapered are:
Number of complete years asset owned | % of capital gain charged to tax BUSINESS ASSETS | % of capital gain charged to tax OTHER ASSETS |
One | 50 | 100 |
Two | 25 | 100 |
Three | 25 | 95 |
Four | 25 | 90 |
Five | 25 | 85 |
Six | 25 | 80 |
Seven | 25 | 75 |
Eight | 25 | 70 |
Nine | 25 | 65 |
Ten or more | 25 | 60 |
In other words, if you are a 40% taxpayer, after two years only 25% of the gain on a business asset will be taxed, so the effective rate of CGT on the gain will be only 10%. For a non-business asset, even after ten years or more, 60% will still be taxable, so the effective rate of CGT will be 24%.
What is a Business Asset?
This is seldom a simple question, and the problem is made even worse because the rules have changed several times since 1998 when taper relief began. As at January 2006, the following are business assets:
- Assets used for a trade carried on by a sole trader, a partnership, or a “qualifying company”
- Shares in a “qualifying company”
The definition of a “qualifying company” currently includes:
- An unlisted trading company (that is, one whose shares are not traded on a recognised Stock Exchange)
- A listed trading company, provided the shareholder works for that company, OR if he has 5% or more of the votes on the shares
- Any company, including non-trading companies, provided the shareholder works for it AND controls 10% or less of the votes on the shares (including shares held by people “connected” with him such as relatives)
That was the easy part – now it starts to get complicated!
What is a “Trading Company”?
For most family companies, the crucial question is therefore whether the company is a “trading company” or not.
A “trading company” means “a company carrying on trading activities whose activities do not include to a substantial extent activities other than trading activities”
“Substantial” means “more than 20%”.
The “20% test” can be applied to:
- Turnover
- Assets
- Expenses incurred and time spent on trading versus other activities
To take a simple example, if a company carries on a trade and also owns an investment property which it lets to a third party, then if the rent is more than 20 % of the turnover of the company, or the market value of the investment property represents more than 20% of the market value of all the company’s assets, then it is likely that the company is not a trading company for taper relief.
What about the tail?
“The tail” is sometimes used to describe the history of an asset for taper relief purposes. As I have said, the rules have changed several times since taper relief was introduced in 1998, and when calculating the taper relief due on a disposal of an asset, we have to look back to the history of its ownership by the person disposing of it. This “tail” can be up to 10 years long – though as taper relief has only been with us for just under 8 years, the tail currently begins at 5 April 1998 (or in some cases 17 March 1998, but that’s another story!).
It is easiest to illustrate the tail by way of an example:
Chris owns 24 of the 100 shares in FamilyCo Ltd – which is an unlisted trading company. Chris was given his shares by his father on 6 April 1998. He does not work for the company, having a full time job as a teacher, and he is not a director. On 7 August 2005, the company is sold, and Chris’ share of the proceeds gives him a capital gain of £100,000.
From 1998 to April 2000, the definition of a “qualifying company” was different, and FamilyCo did not qualify as far as Chris was concerned. The calculation of the taper relief goes like this:
Total period of ownership (6 April 1998 to 7 August 2005) is 88 months. For 24 of those months, the shares were not a business asset for Chris, and for the remaining 64 months they were.
Non-business gain = £100,000 times 24/88 = £27,273. Seven complete years ownership, so 75% is taxable = £20,455
Business gain = £100,000 times 64/88 = £72,727. More than two complete years of ownership, so 25% is taxable = £18,182.
Total taxable gains (£20,455 + £18,182) = £38,637. CGT at 40% = £15,455. Effective rate of tax on gain = 15.46%
If only Chris’ father had given him one more share in 1998, Chris would have qualified for business taper relief throughout, in which case he would have only paid £10,000 tax – a saving of £5,455.
Business Taper Planning
The above is only a taste of the complexities of taper relief – the important thing is not to assume that just because your family company carries on a trade, all the shareholders will qualify for business taper relief in full if they sell their shares. Your tax adviser will be able to help you:
- Decide if your shares currently qualify for business taper relief
- Find out if your shares have a “tail”, and if it is still growing!
- Find out if you can stop the “tail” growing
- (In some circumstances) explain how the “tail” can be painlessly removed!
