Capital Gains Tax: a timely guide for contractors

George Osborne may well make Captial Gains Tax reforms in next week’s July 2015 Budget, which could impact contractors looking to wrap up companies in a tax-efficient manner, writes Chris Deakin, an accountant at inniAccounts.

What is CGT?

Capital Gains Tax (CGT) was first introduced in 1965 by James Callaghan, the-then chancellor in Harold Wilson’s Labour government. The original aim was to prevent tax avoidance in the form of people switching their income into capital. Over the past 50 years, successive chancellors have brought about changes to both better align the tax with economic conditions, and also tighten up on abuse. With the Summer 2015 Budget around the corner, George Osbourne making changes (again) to CGT is a firm prospect.

When does CGT apply?

To refresh your memory, capital gains tax is a tax on the increase in value of possessions such as company shares, antiques or a second home during the time you have owned them. The tax is due when you dispose of them, when selling or giving them away.

But don’t worry, there’s a minimum tax-free allowance, meaning substantial gains can be made each year without becoming liable for the tax. It’s also worth noting you don’t normally pay tax on gifts to your husband, wife, civil partner or charities, and you do not pay CGT on NISAs, ISAs or PEPs, Premium Bonds or when you win money on betting, lottery or pools.

Currently the annual exemption is £11,100 and the rate of taxation you pay is based on your total personal income. You’ll pay 18% on gains above the exempt amount as a basic rate tax payer, and for higher rate tax payers it’s 28%.

When does CGT apply to contractors?

On personal assets and possessions

You may have to pay captial gains tax if your make a gain when you sell a personal posession for £6,000 or more. Common examples include jewllery, antiques, paintings, stamps or coins. Items with a predicted life of 50 years or less, known as 'wasting assets' are free from capital gains tax (provided they were not eligible for business capital allowances). Vintage cars, pleasure boats, carvans and even antique clocks and watches are all classed as 'wasting assets', meaning you won’t get taxed on any gains. This may present savvy contractors with an opportunity to follow their passions and make tax-free gains.

On property

For the property magnates out there, CGT is normally not payable on gains you make on your only or main home, because these qualify for private residence relief (PRR).  There are however taxable gains if you develop your home, for example by converting your garage into flats. Also, if you sell part of your garden and your total plot is over 1.2 acres, the gain on this is taxable. Many contractors convert spare rooms or outbuildings in to offices. If your business has paid for these improvements then part of the gain may be subject CGT.

Some contractors may well live in more than one house – a weekday pad close to the client, and a weekend family home, for example. In this case, you’re able to nominate which will be tax-free. And it does not have to be the one in which you occupy most of the time. It makes the most sense to nominate the one which is likely to make the most gain, but be quick -- you only have two years from purchase to do so.

Finally, if you have ever been a landlord and let part or all of your house, upon sale, the gain which relates to letting could be taxable. However, provided the house has been your main home at some time you can claim relief for the time it was your main residence.

When closing a company

Perhaps most interesting for contractors is the utilisation of capital gains when closing a limited company. It is possible to release the assets of the company (including retained profit) to shareholders as a capital gain. This would be taxed as a gain, rather than income, meaning a lower tax burden for the contractor. If the gain is below £25,000 then HMRC do not need to approve it, otherwise you’ll need to contact a liquidator to handle this for you.

You may also qualify for Entrepreneurs’ Relief when disposing of your limited company. You can claim this relief if you control at least 5% of a company whose shares or assets you are selling, but you’ll need to have owned the business for at least one year.

The advantage of Entrepreneurs’ Relief is that it reduces CGT to just 10% on the first £10m of gains you make over your lifetime from selling these assets. Any gains above this are then taxed at 18% or 28%.

But don’t rush to wind-up just yet: Entrepreneurs' Relief may well again be coming under the chancellor’s scrutinising gaze. Osborne tightened up the qualification rules in March (instantly, without warning), and we’re expecting further reform next week.

Editor’s Note: Related Reading –

Disincorporation Relief: overview for contractors

Contractors’ Questions: How to pay a final dividend tax-efficiently?

When there’s no penalty for an incorrect tax return

Contractors’ Questions: Can I pay less tax by incorporating offshore?