ACCA F6 FA09 Study Text 2010

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Chapter 14: CGT – Shares and securities

Note

Shares sold from the pool are removed at average cost:

£50,000 × 3,000/3,500 = £42,857

Gross sale proceeds

60,000

Minus Cost (from pool, see working) (42,857)

Gain

17,143

4.3 Takeovers

An examination question involving a takeover will only involve a paper-for-paper

exchange, such as an exchange of shares in the acquired company for shares in the

company making the acquisition. As a result the treatment for capital gains tax

purposes is as follows:

 No chargeable gain or allowable loss arises at the time of the takeover.

 The new shares and securities received are deemed to be:

− acquired on the same day as the original shares

− for the same cost as the original shares.

 The original cost of the old shares is allocated to the new shares and securities

received, in proportion to the market values of the consideration received.

 Pools for the new shares and securities are set up.

Example

David owns 3,000 ordinary shares in Z Ltd, which he bought for £16,600 on 23 June

1993.

On 15 March 2010 Z Ltd accepted a takeover bid from A plc. The takeover offer

consisted of 1 ordinary share and 2 preference shares in A plc for every 3 shares

held in Z Ltd.

At the date of the takeover, the market value of A plc shares was as follows:

Ordinary shares £9 each

Preference shares £6 each

Required

State the chargeable gain arising at the time of the takeover, and calculate the cost to

be entered in the new pools for the A plc shares.

Paper F6 (UK): Taxation FA2009

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Answer

There is no chargeable gain at the time of the takeover as no cash consideration is

received.

Takeover consideration received by David:

Market value

1,000 Ordinary shares in A plc (1,000 × £9) 9,000

2,000 Preference shares in A plc (2,000 × £6) 12,000

21,000

Z Ltd: pool

Number

of shares

Cost

Balance at time of takeover 3,000

16,600

Allocation of the original cost of the Z Ltd shares Cost

1,000 Ordinary shares in A plc: 9,000/21,000 × £16,600 7,114

2,000 Preference shares in A plc: 12,000/21,000 × £16,600 9,486

16,600

4.4 Reorganisations

A reorganisation is where a company reorganises its equity and debt capital by

exchanging existing shares and securities for another class of share or security in the

same company.

As with takeovers:

 No chargeable gain arises unless cash consideration is received by the

shareholders.

 The cost of the original shares must be allocated to the new shares in proportion

to the market values of the new shares.

The allocation of the cost of the original shares depends on whether the shares are

quoted or unquoted as follows:

Basis of apportionment of original cost =

MV of new shares and securities on the date of the:

Quoted shares

Reorganisation

Unquoted shares First disposal

Paper F6 (UK)

Taxation FA2009

CHAPTER

Capital gains tax reliefs

Contents

1 Entrepreneurs’ relief

2 Rollover relief

3 Gift relief

4 Tax consequences of incorporation

5 Principal private residence and letting relief

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Entrepreneurs’ relief

 Overview of entrepreneurs’ relief

 Conditions

1 Entrepreneurs’ relief

1.1 Overview of entrepreneurs’ relief

Entrepreneurs’ relief is a new relief that is available to an individual who disposes

of a business or part of a business.

The relief covers the first £1 million of qualifying gains that an individual makes

during their lifetime. The qualifying gains are reduced by a factor of 4/9ths. This

results in an effective capital gains tax rate of only 10% (18% x 5/9) on those gains.

Gains in excess of £1 million are taxed at the normal CGT rate of 18%.

Example

Jan has qualifying gains of £1.2 million from the disposal of her business.

Required

Calculate the amount of capital gains tax payable by Jan, assuming this is her only

disposal in 2009/10.

Answer

The first £1 million of gains qualifies for relief. The balance is taxable at the normal

rate of CGT:

Total qualifying gains 1,200,000

Less Entrepreneurs’ relief: £1,000,000 × 4/9

(444,444)

––––––––––––––––––––––––––––

–

––––––

–

––––

–

Chargeable gain 755,556

Less Annual exemption (10,100)

––––––––––––––––––––––––––––

–

–––––

–

––––

–

Taxable gain 745,456

––––––––––––––––––––––––––––

–

–––

–

––––

–

CGT at 18% 134,182

––––––––––––––––––––––––––––

–

–––

–

––––

–

1.2 Conditions

Relief is available for disposals of the following:

 The whole or part of a business run by a sole trader or a partnership. However,

the relief only applies to gains arising from the disposal of assets used in the

business; it does not apply to gains arising from the disposal of investments.

Chapter 15: Capital gains tax reliefs

 The disposal of shares in a trading company, provided the individual:

− has a 5% shareholding in the company, and

− is an employee of the company.

The company itself may hold investments without it affecting the availability of the

relief.

Note that a mere disposal of assets used in a business is insufficient to qualify for

entrepreneurs’ relief; the relief requires the disposal of all or part of a business as a

going concern. In addition, in order to qualify for relief, the business must have

been owned throughout the year leading up to the date of disposal.

The relief is not given automatically. It must be claimed within one year of the 31

January following the end of tax year in which the disposal takes place (i.e. the 31

January immediately prior to the second anniversary of the end of the tax year).

Example

On 1 August 2009, Agnes sold a business that she had operated as a sole trader for

ten years.

The disposal resulted in the following gains:

Goodwill 100,000

Freehold premises (used by the business) 500,000

Freehold premises (held as an investment) 200,000

Required

Calculate the capital gains tax payable by Agnes on the disposal of her business.

Answer

Total gains 800,000

Less Entrepreneur’s relief: £600,000 × 4/9

(266,667)

–––––––––––––––––––––––––––––––––

–

Chargeable gain 533,333

Less Annual exemption (10,100)

–––––––––––––––––––––––––––––––––

–

Taxable gain 523,233

–––––––––––––––––––––––––––––––––

–

CGT at 18% 94,182

–––––––––––––––––––––––––––––––––

–

Notes

1 The gain on the investment property does not qualify for relief.

2 The remaining £400,000 of entrepreneurs’ relief (£1,000,000 – 600,000) is

available to set against any future qualifying gains.

Paper F6 (UK): Taxation FA2009

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Rollover relief

 Overview of rollover relief

 Qualifying business assets

 How much gain can be deferred?

 What happens to the deferred gain?

 Non-business use

2 Rollover relief

2.1 Overview of rollover relief

A chargeable gain is usually taxed in the year of disposal. However, if a rollover

relief claim is made, the gain is deferred to a later tax year.

Rollover relief (technically known as replacement of business asset relief) is a tax

relief to encourage businesses to reinvest in capital assets and continue in business.

The relief is available if the sale proceeds received from the disposal are used to

purchase a replacement asset and all the following conditions are satisfied:

 The asset being sold is a qualifying business asset.

 The replacement asset is a qualifying business asset (but it does not need to be

the same type of asset as the asset being sold).

 Both assets are used for the purposes of the trade.

 The replacement purchase takes place in the four-year period running from 12

months before, to three years after, the date of disposal.

 The new asset is brought into business use at the time that it is acquired.

 A claim for relief is made within four years of the end of tax year in which the

disposal takes place.

2.2 Qualifying business assets

The main examinable assets eligible for rollover relief are:

 Land and buildings used for the purposes of the trade

 Fixed plant and machinery (but not moveable plant and machinery such as fork

lift trucks).

 Goodwill. (Note, however, that goodwill is not a qualifying asset if disposed of

by a company.)

It is important to note that:

 rollover relief is never available on a gain arising from the disposal of shares,

and

 the purchase of shares is not a qualifying replacement asset for rollover relief

purposes.

Chapter 15: Capital gains tax reliefs

2.3 How much gain can be deferred?

If all the sale proceeds are reinvested, it is presumed that the taxpayer will not have

cash available to pay any tax on the gain. All the gain arising on the disposal can

therefore be deferred and none of the gain is taxed immediately.

If some of the sale proceeds have been retained, it is presumed that the taxpayer

does have some cash available to pay some tax on the gain. The amount of relief

available is therefore restricted and some of the gain is taxed immediately. The

amount that is taxed immediately is the lower of:

 all the gain, or

 the sale proceeds not reinvested in QBAs.

2.4 What happens to the deferred gain?

The treatment of the deferred gain depends on whether the replacement asset is a

depreciating asset or a non-depreciating asset:

Type of QBAs

purchased:

Non-depreciating QBAs

Depreciating QBAs

Expected life More than 60 years. 60 years or less.

Examples Freehold land and buildings.

Leasehold land and buildings

with more than 60 years left

on lease.

Fixed plant and machinery.

Leasehold land and buildings

with up to 60 years left on lease.

Mechanics of

the deferral

 The gain to be deferred is

deducted from the cost of

the new asset to calculate

the revised base cost of the

replacement asset (i.e. the

cost minus rollover relief).

 On the subsequent

disposal of the

replacement asset, the

revised base cost is

deducted in the gain

computation instead of the

original cost – thus

increasing the gain

chargeable on this

disposal.

 The gain to be deferred is not

deducted from the cost of

replacement asset.

 A separate record of the

deferred gain is kept.

 The deferred gain is taxed 10

years after the date the

replacement asset was

acquired unless, within the 10

year period, the replacement

asset is either sold or ceases to

be used in the trade.

 If sold, a normal computation

of the chargeable gain on the

replacement asset is made,

using the original cost.

 The original gain has

therefore been rolled over

(i.e. deferred) until the

disposal of the

replacement asset.

 In this situation, the deferred

gain is sometimes referred to

as a held-over gain, rather

than a rolled over gain.

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Rollover relief is an all or nothing relief. It is optional but, if claimed, the taxpayer

must defer (roll over) the maximum amount of gain allowed by the legislation.

On the disposal of the replacement asset, the deferred gain becomes taxable, unless

a further rollover relief claim can be made.

With good tax planning, gains on QBAs can be deferred potentially indefinitely,

provided the conditions are satisfied at each disposal date.

Example

Ellen is self employed. She prepares her accounts to 31 March each year. On 30

November 2009 she sold a freehold warehouse for £230,000, which was purchased in

August 1994 and gave rise to a gain (before considering reliefs) of £65,000.

On 24 January 2010 Ellen purchased a 70-year lease on a new warehouse for

£218,000. She expects to sell the warehouse on 31 December 2011 for £550,000.

Required

Calculate Ellen’s chargeable gains arising in 2009/10 and 2011/12.

Explain the difference in treatment if the replacement warehouse is a 40-year

leasehold interest.

Answer

Is the asset a QBA for rollover relief purposes? Yes

Has it been replaced with a QBA? Yes

Has it been replaced in the four-year qualifying period?

(30 November 2008 – 30 November 2012)

Yes

Have all the sale proceeds been reinvested in a QBA? No

Gain arising in 2009/10

Lower of

(1) The gain £65,000, and

(2) The sale proceeds not reinvested in QBAs (£230,000 - £218,000) =

£12,000

Rollover relief = The rest of the gain (£65,000 - £12,000)

53,000

Base cost of replacement 70-year leasehold interest

Cost 218,000

Minus: Rollover relief (53,000)

–––––––––––––––––––––––––––––––––

–

Base cost 165,000

–––––––––––––––––––––––––––––––––

–

Chargeable gain arising in 2011/12

Sale proceeds 550,000

Base cost (165,000)

–––––––––––––––––––––––––––––––––

–

Gain 385,000

––––––––––––––––––––––––––––––––

–

‐

Chapter 15: Capital gains tax reliefs

If the replacement had been in a 40 year leasehold interest

A 40-year leasehold interest is a QBA, but is a depreciating asset.

The calculation of the amount of rollover relief and the chargeable gain arising in

2009/10 would be the same as above. However, the amount relieved with a rollover

relief claim is not deducted from the cost of the replacement asset.

 A record of the amount of rollover relief is kept and that amount is deferred for

10 years from the date of acquisition of the replacement warehouse. However, as

the replacement asset is disposed of before 10 years have elapsed, the deferred

gain becomes chargeable in 2011/12 on the disposal of the asset.

 In addition, a chargeable gain arises on the disposal of the replacement asset

itself. The gain is calculated as normal, using the actual cost of the leasehold

interest with no rollover relief deduction.

Chargeable gain arising in 2011/12 £

Sale proceeds 550,000

Base cost (218,000)

–––––––––––––––––––––––––––––––––

–

Gain 332,000

–––––––––––––––––––––––––––––––––

–

2.5 Non-business use

If part of an asset is not used for trade purposes (for example, if part of a building is

let to another business), rollover relief is only available in relation to the business

proportion of the gain.

The non-business proportion of the gain is chargeable immediately in the tax year in

which the disposal occurs.

The rollover relief available on the business proportion of the gain is calculated in

the normal way. However, consideration is only given to business usage. To

calculate the amount of relief, the amount of sale proceeds received relating to the

business use of the asset is compared to the amount reinvested in QBAs.

Example

Ian owned a three-storey building. He purchased it in January 1988 for £65,070 and

sold it on 24 November 2009 for £200,000.

Ian used two floors for the purposes of his trade, but never occupied the ground

floor. This was let out to another business which operated as a shoe shop.

In November 2009, Ian relocated. He purchased a new building for £128,000 on 1

October 2009 and plans to use it exclusively for the purposes of his trade.

Required

Calculate the chargeable gain arising in 2009/10 and the base cost of the new

building.

Paper F6 (UK): Taxation FA2009

Answer

Gross sale proceeds (November 2009) 200,000

Cost (January 1988) (65,070)

–

–––––

–

––––––––––––––––––––––––––

–

Chargeable gain before rollover relief 134,930

–

–––––

–

–––––––––––––––––––––

–

––––

–

Is the asset a QBA for rollover relief purposes? Yes

Has it been replaced with a QBA? Yes

Has it been replaced in the four-year qualifying period?

(24 November 2008 – 24 November 2012)

Yes

Have all the sale proceeds been reinvested in a QBA? No

Split of chargeable gain before rollover relief Business

Non-

business

£ £ £

Chargeable gain before rollover relief (2/3:1/3)

89,953 44,977

–––––––––––––––––––––––––––––––––

–

Chargeable gain for the business element =

Lower of:

(1) the business proportion of the gain 89,953

–

–––––

–

––––––––––––––––––––––––––

–

(2) the sale proceeds for the business proportion

(= £200,000 × 2/3)

133,333

Minus amount reinvested in QBAs for the

business (= £128,000 × 100%)

(128,000)

–

–––––

–

––––––––––––––––––––––––––

–

5,333

–

–––––

–

––––––––––––––––––––––––––

–

Lower =

(5,333)

–––––––––––––––––––––––––––––––––––

Rollover relief = the rest of the business gain

(£89,953 – £5,333)

84,620

–––––––––––––––––––––––––––––––––––

Chargeable gains in 2009/10 =

5,333 + 44,977

–––––––––––––––––––––––––––––––––––

–––––––––––––––––––––––––––––––––

–

Total chargeable gains in 2009/10 =

£50,310

–––––––––––––––––––––––––––––––––––

Base cost of replacement building

Cost 128,000

Minus: Rollover relief (84,620)

–

–––––

–

––––––––––––––––––––––––––

–

Base cost 43,380

–

–––––

–

––––––––––––––––––––––––––

–

When the replacement building is eventually disposed of, the chargeable gain will

be calculated using this base cost, not its original cost.