CAPITAL GAINS TAX - 31.01.2008

Preserving indexation

Problem

Recap. Indexation Allowance (IA) compensates for the decrease in the purchasing power of money over time, known as inflation. For example, £10,000 of goods bought in November 1997 would now cost £12,580 to replace on a like-for-like basis. So when an asset that cost £10,000 in 1997 is sold, IA of £2,580 is added to the cost, giving a total deduction of £12,580.

What’s changed? The IA for assets held by individuals was frozen at April 1998 levels, and replaced by taper relief for the ten years to April 2008. However, for gains made after April 5 2008, IA and taper relief are both withdrawn. Instead, all the gain will be taxable at 18% rather than at a top rate of 40%.

Example. You’ve held some land since April 1982. The indexation factor for the period to April 1998 is 1.06, and as the land has not been used for business purposes, taper relief is also due at 40%. If you sell the land before or after April 6 2008, the tax payable would vary as follows:

Delay the sale. We assume you’ve used your annual exemption (£9,200 for 2007/8) against other gains in both tax years. By delaying the sale you save tax of £4,800 (£94,800 - £90,000), but you lose the benefit of both the IA and taper relief.

Our solution

Transfer the land to your spouse before April 6 2008, in a so-called no gain/no loss transfer. The deemed cost of the land for your spouse includes your IA. When they sell the land at a later date the IA is included and the tax payable is only £70,920. You and your spouse have saved further tax of £19,080 (£106,000 x 18%).

Practical issues

Tip 1. Undertake the transfer to your spouse well before the asset is advertised for sale. If the sale negotiations start before the spousal transfer is done, the Taxman will say the transfer is an inserted step to reduce the tax payable and will ignore that transaction for tax purposes.

Tip 2. Ensure the transfer to your spouse is legal and complete. Land must be transferred by deed, and shares must be recorded against the new owner’s name on the company’s share register.

Most suitable for assets:(1) With significant cost. Preserving IA is only worthwhile when the base cost of the asset is significant. Shares acquired for only £10 in 1982 will have an IA of £10.60 for the period to April 1998. (2) Held for some years. IA does not apply where an individual acquired the asset after March 31 1998. It will only be worth transferring the asset to your spouse where you’ve held it for 15 years or more.