Taper relief has been lauded by some as one of the government’s most successful enterprises for encouraging entrepreneurs.
The Treasury estimates that in the next year £6.3bn will be claimed in tapered tax relief and the cost to the government has risen more than 10 times in the past four years.
The different rates of taper relief can appear daunting and it is thought that many individuals do not claim it because they are unsure how it should be calculated.
Why was taper relief introduced in the first place?
Taper relief came into being on March 17, 1998 and was set up to replace indexation for inflation.
The basic premise for tapered relief is to reduce the capital gains tax that an individual must pay when they dispose of an asset.
The longer you hold an asset, the more profit you may gain from it. You are then taxed on the whole of this gain at whatever tax band you fall into. You can deduct the costs of any improvements you may have made to the asset, and your yearly capital gains tax allowance of £9,200 for, say, the 2007/08 tax year.
Tapering relief reduces the amount of gain that is taxable.
It is at this point, says John Whiting, tax expert at PricewaterhouseCoopers, that the road forks. To one side lie business assets and to the other lie non-business assets.
“The road for business assets is wide whereas the road for non-business is narrow. The relief that you are able to obtain for each is different,” he says.
How do I know if my asset is business or non-business?
A business asset is something you use for your business. If you run a shop and own the premises from which you work then the building counts as a business asset. This might sound simple, but it can become a little more complicated when shares are involved.
Which shares count as business assets?
Unquoted shares, including Aim shares, count and so do shares you own in a company you work for. If you own 5 per cent or more of one company then these will also count as business assets, although this is an unusual scenario.
Shares you may have bought in routine quoted companies do not count and these are ones that make up the majority of most people’s portfolios.
Can second properties count as business assets?
Primary residences are exempt from capital gains tax but profit made on most second properties, such as buy-to-let houses or holiday cottages, is generally taxable. The exception is holiday lettings. If you rent out your second property for short periods and for a significant part of the year you can claim business asset taper relief on it.
Once you have worked out whether your asset is business or non-business you need to work out how many complete tax years you have held it for, then you can work out the taper relief you can claim.
How do I work out taper relief on a business asset?
The reason Whiting described the road for business asset taper relief as wide is that the calculations are simple and the reduction in liability is generous.
If you have held the asset for at least one year then only 50 per cent of the profit you have made is chargeable. If you have held it for two or more years only 25 per cent of the profit is taxed.
Many people find that the profits they make on assets they dispose of push them into the top tax band, meaning they have to pay 40 per cent in capital gains tax.
But if you have owned the asset for more than two years and therefore only need to pay tax on a quarter of the profit, this effectively brings your tax rate down to 10 per cent.
However, the rules of what is and is not a business asset have changed so there can be tripwires.
What should I be careful of?
Whiting says that husbands and wives who swap assets between them must check whether the assets count as business or non-business for each one.
If you hold shares in your company and pass these on to your spouse, they will no longer be eligible for business taper relief.
Shares held in a company that the individual works for were only deemed business assets in April 2000.
If you held shares in your company from 1998, when taper relief was introduced, and sold them in 2002, there are only two years in which they counted as business assets. For the rest of the period they count as non-business assets.
How does taper relief work for non-business assets?
If you owned your asset before March 17, 1998, when taper relief was introduced, you can add a year’s worth of taper relief to your calculations.
You need to have held the asset for at least three years to obtain relief. If you have held it for only two years, then all the gain you make is chargeable at whatever rate of tax you pay.
If you have owned the asset for three years, you pay tax on 95 per cent of the gain. If you have held it for four years, then 90 per cent is chargeable. For each consecutive year you have held the asset another 5 per cent of the gain is deemed not liable for tax. This ends at 10 years of ownership, at which point 60 per cent of the gain is taxable.
