What is a capital gain?

If you own assets which increase in value you may find yourself having to pay capital gains tax (CGT). CGT can apply to shares, unit trusts, land, property and antiques which can all increase in price. If you sell them – or even give them away – you may be faced with a tax bill of up to 40 per cent of the chargeable gain.

The average taxpayer is unlikely to pay capital gains tax because there are various tax-free allowances and taper reliefs that can be claimed to reduce any potentially chargeable gains. But people with expensive second homes, high-performing investments and growing businesses could find they have to pay CGT

What is the tax-free allowance?

You are allowed to make gains up to a certain amount each tax year which are exempt from tax. For 2005-6, the tax-free allowance was £8,500; for 2006-7, the allowance is £8,800. If your profits come to more than your allowance, you have to pay tax on the excess.

Is there such a thing as a capital loss?

Yes, it is the reverse of a capital gain, and any capital losses are deducted from any capital gains that you make in the same year. If your capital losses exceed your capital gains, then you cannot claim tax back, but you can carry forward the losses against future gains.

Which assets are exempted from capital gains tax?

Any gain you make when you sell your primary residence is tax-exempt, unless you have let part of your home or used it to run a business. In those circumstances, a proportion of the gain may be taxable, depending on a new sliding scale. You also escape tax on money made in various other circumstances, including gains from the sale of your car; tax-exempt vehicles such as Isas or pensions, UK government bonds (gilts), personal belongings worth £6,000 or less. Betting, lottery or pools winnings are also exempt as are “wasting assets” which have an estimated life of less than 50 years such as wine or vintage cars.

How can I avoid CGT?

The main step to take is to ensure that you are making full use of the “free of tax” list above. For example, put some of your savings into Isas, pension schemes, National Savings, government bonds and various enterprise schemes.

For long-term holdings make full use of your Isa allowance. For large disposals, you could always sell a chunk of shares in March and then a further chunk in mid-April, thereby making use of two years’ worth of allowances in a concentrated period. You can also make use of other people’s CGT allowances by giving them shares as a gift.

Married couples and civil partners each get the annual exemption in their own right, but losses cannot be offset between husband and wife.

What rate of tax will I pay?

Individuals pay CGT on gains above the annual exemption limit at income tax rates as if the gains were savings added to total income. You may therefore pay capital gains tax at the starting rate of 10 per cent, or at 20 per cent or 40 per cent, depending on your other income, or a combination of the rates may be used if, for example, when added to your other income the gain takes you into the higher-rate band.

What about tapering relief?

It is possible to reduce the amount of tax that you pay. In April 1998 the chancellor introduced tapering relief, which replaced indexation relief for CGT. Under the previous system, the amount of CGT payable was linked to the rate of inflation. Indexation relief is still applicable to assets sold before April 6, 2000, although it will not take into account any inflationary changes since April 5, 1998, when the system was changed.

Taper relief is designed to encourage you to invest for the longer term. It reduces the amount of the gain according to the number of years the asset has been owned after 5 April 1998. The reduction is bigger for business assets.

Once you have held your investment for three years, the amount of the gain that is taxable is reduced at a rate of 5 per cent annually to a maximum of 40 per cent – leaving just 60 per cent of the gain taxable after 10 years. In other words, you need to hold on to your assets for 10 years to get the full taper relief.

For business assets – this also includes shares in unquoted and Aim-listed companies – the rate of taper relief is higher. After two years, a maximum of 75 per cent of the gain can escape CGT, leaving just 25 per cent of the gain chargeable.

How does the taxman work out how much an asset has cost?

For assets purchased or acquired since March 31 1982, the initial purchase price, plus acquisition expenses incurred will be the cost figure for calculating any capital gain or loss.

How would I calculate a capital gain or loss?

You need to prepare a schedule showing a brief description of all the assets you have sold; the date and cost of acquisition; value at March 31 1982 if held at that date; the date of disposal and disposal proceeds.

If I find out I do owe tax, when would I need to pay it?

CGT is payable, with any balance of income tax due, on the following January 31 each year. If you sell an asset on which you have a capital gain on April 6 rather than April 5 you will have an extra year before having to pay the tax.