Stand-out Q- annual exemption for CGT…

by

TUE, 06 FEB 2018

Our Technical Hub provides access to a wide range of pension tax and trust technical resources. Every now and then we post tweets covering stand out questions from our technical content and our answers in case others might also find them helpful. As Twitter’s character restrictions only allow for the bare bones of the Q&A we link to the details here, too.

Question:

A client has a shareholding with a large gain. Can they crystallise some of the gain to use their annual exemption for CGT?

Answer:

Yes. Make a part disposal to crystallise enough gain to use the annual exemption.

The annual exemption for individuals in 2018/2019 is £11,700 for capital gains tax. Gains covered by the exemption do not attract any CGT, and it is only once net chargeable gains exceed the annual exemption in the tax year that CGT will arise.

If the annual exemption is not used in the current tax year it will be lost, as it cannot be carried forward. Many advisers will therefore consider making part disposals so that their client uses their annual exemption each year.

Shareholdings can sometimes cause confusion for clients and advisers, as the method of calculating the acquisition cost of shareholdings have been subject to legislative changes on several occasions. We will assume, that there have been no prior disposals within the shareholding and there are no further purchases of the same shares within the next thirty days of the sale.

Under the current rules, the legislation says that a shareholding is treated as one asset. This is the case even where the shares have been purchased over several tranches. This means that the shares are all held in one pool (the ‘section 104 pool’) and the acquisition cost of all the shares within the pool is the total of all the shares purchased, even where they have been purchased over several separate transactions.

When disposing of some of the shares within a shareholding, the calculation of the acquisition cost of those shares is a straightforward part disposal calculation. The legislation gives the following fraction, which is multiplied by the acquisition cost of the whole shareholding:

A


A + B

A is the market value of the shares disposed of

B is the market value of the shares retained

For a shareholding, A and B can be simplified to the number of shares disposed of and retained respectively, as in the worked example below.

Example
Terry owns 100,000 shares in Hoboken Plc. They were purchased for £5 each and are now worth £9 each. He wants to sell enough shares to use up his annual exemption.
If Terry sells 2,925 shares, his CGT calculation will be as follows:

table 1 updated FEB 2018


By using the part disposal formula, the base cost of the 2,925 shares in Hoboken Plc was

2,925 x (100,000 x £5) = £14,625

Now we can look at how the base cost of accumulation units is calculated.

Q: The part disposal will be of accumulation units. How do you calculate their base cost?

A: Multiply A/(A+B) by (cost + accumulated income – equalisation payment). See above.

The same A/(A+B) part disposal formula applies where the part disposal is of accumulation units. When calculating the acquisition cost of the units, however, the acquisition cost calculation is slightly more complicated due to the way accumulation units work and in particular how the income within the units accumulates.

Understanding the peculiarities of the accumulation units helps us understand how the calculation of the acquisition costs of accumulation units is achieved.

The key to understanding accumulation units is as follows. Whenever any income entitlement arises on accumulation units, it accumulates within the units. Effectively, it is added back in to the value of the units.

The income entitlement of accumulation units technically accrues to the owner of the units on a daily basis. There is no entitlement to income for those days where the owner was not the beneficial owner of the units.

In practice, however, the unit manager will simply pay an equal income entitlement for each unit to all the holders of the units at a specific date. If the units have been purchased since the last income accumulations were made within the units, this means that the current owner has received income which they were not technically entitled to.

To rectify this, an adjustment called an equalisation payment is made by the unit manager to the owner of the units at the same time as the income distribution is made. The equalisation payment is not a cash payment and will simply be deducted from the acquisition cost of the units when they are sold.

Equalisation payments cause a lot of confusion for advisers and their clients when preparing capital gains tax calculations. HMRC’s CGT manual discussed them in more detail here .

When the time comes to dispose of accumulation units, the acquisition cost is calculated as follows:

Original purchase cost of all units

Plus accumulated income

Less equalisation payment

The example below shows all the steps which need to be undertaken where there is a part disposal of accumulation units.

Example
Terry also holds 10,000 units in the J Friendly accumulation trust. He bought them in June 2016 when they were worth £4 each. They are now worth £8.50 each.

He has received the following income entitlements which have accumulated within the units:-

table 3 updated FEB 2018

He also received an equalisation payment in September 2016 of £1,000.

The base cost is calculated as follows:-

table 4 updated FEB 2018

Terry sells 2,500 units. The base cost of these units is

table-for-blog-5-updated-2nd

The capital gain calculation is therefore

table-for-blog-6-updated

Follow us on Twitter – @JHPartnership