Are you thinking of selling an asset? Or have you recently sold or gifted an asset that gave rise to a Capital Gains Tax (CGT) liability? If so, there is an often underutilised relief that could improve your cash position; Capital Gains Tax Deferral Relief.
If you pay income tax at the higher or additional rate, you will be faced with a 20% CGT charge on any capital gains in excess of the annual exempt amount. This is increased to 24% for gains made on residential property disposals. It was 28% until April 2024.
Where gifts of non-business assets are made, this can often result in a sizeable CGT liability and no proceeds that can be used to settle the tax owed.
How does the deferral relief help my CGT position?
You may well already be relatively familiar with the income tax advantages that can be obtained from the UK’s EIS scheme.
Perhaps less known is the scheme’s ability to allow individual investors to defer their CGT liability by subscribing for shares in EIS qualifying companies; this is otherwise known as EIS reinvestment relief.
EIS qualifying companies are small, trading companies that are not listed on a recognised stock exchange.
Gains that can be deferred are those made on the disposal of a chargeable asset, and the reinvestment must occur within a qualifying period between 12 months before and 36 months after the gain arises.
The deferral relief is also independent from the income tax relief, which means it can be claimed separately. In order to claim the relief, it is necessary to wait until you receive an EIS3 form from the issuing company; you do not need to have claimed income tax relief on the subscription for shares.
When can I claim the EIS reinvestment relief?
EIS reinvestment relief is flexible in that it allows the capital gain on the disposal of any asset to be deferred, as long as the proceeds are reinvested in qualifying EIS shares. The amount of capital gain that can be deferred is the lower of three amounts:
- The capital gain
- The amount reinvested
- The specific amount claimed
Clearly, claiming a specific amount could be the most advantageous approach as it would capitalise on any unused annual exempt amount or capital losses. This is best shown by the example below.
Example
Individual A sells a painting for £200,000, which originally cost £120,000, resulting in a gain of £80,000.
They then decide to subscribe for £120,000’s worth of EIS qualifying shares from the proceeds received. Therefore, all or part of the gain of £80,000 can be deferred as this is lower than the amount reinvested of £120,000.
If individual A makes no other disposals in the tax year, they will have a fully intact annual exempt amount of £12,300. It would, therefore, be tax efficient to claim to defer £67,700 of the gain to ensure the annual exemption isn’t wasted. The computation would be as follows:
| £ | |
| Capital Gain | 80,000 |
| Less: Reinvestment Relief | (67,700) |
| Net Gain | 12,300 |
| Less : Annual Exemption | (12,300) |
| Taxable Gain | NIL |
Another advantage of the relief is that there is no requirement for the individual to not be ‘connected’ with the company as there is for income tax relief. Connected for these purposes means owning more than 30% of the ordinary share capital of the relevant company.
Considering this, a taxpayer could sell an asset, set up their own qualifying EIS company in which they own all the shares, and make a claim to defer the capital gain.
The Deferred Gain – what happens
As the relief operates as a deferral and not an exemption, there could be a point in time when the deferred gain crystallises and becomes chargeable. Typically, the most common chargeable event is the sale of the EIS shares themselves. Other instances where deferred gains become taxable are:
- The EIS shares are sold or disposed of other than to a spouse.
- The EIS shares are exchanged for non-qualifying shares.
- The EIS shares cease to be eligible shares (e.g. conversion to deferred or preferred shares) within three years of issue or three years of commencement of trade, whichever is the later.
- The investor becomes non-UK resident within three years of issue or three years of commencement of trade, whichever is the later, unless he or she is going to work full-time offshore for three years or less.
- An EIS company ceases to qualify for any reason (e.g. starting a non-qualifying trade) in the three years following the issue of the shares, or in the three years from the commencement of trade, whichever is later.
- The investor receives certain prohibited benefits in the period beginning one year before and ending three years after the issue of the shares or three years after the commencement of trade, whichever is the later.
These can include directors’ remuneration, rents, loans or interest, which HMRC regards as excessive. Even a small amount of ‘excessive’ benefit can trigger the whole of the deferred gains although there are de minimis levels. Value can be repaid to the company if it has inadvertently been withdrawn.
There may also be a gain on the shares themselves; however, if the shares qualified for income tax relief and were held for more than 3 years, the gain on their disposal is exempt from CGT, and only the crystallised gain is chargeable.
Deferred gains will not be taxed on death as it completely eradicates the deferred gains. If the shares are transferred to a spouse, this will also not ‘revive’ the deferred gains, but the spouse will face a CGT charge on the deferred gains if they dispose of the shares.
As an aside, taxpayers can potentially benefit both from the deferral of gains reinvested under EIS and Business Asset Disposal Relief (formerly Entrepreneur’s Relief) on those same deferred gains. This drops the applicable rate of CGT to 10%, subject to a lifetime limit of £1,000,000.
Illustration
The illustration below provides a good example of the interaction between income tax relief and crystallisation of the deferred gain:
| Initial Investment | £100,000 Capital Gain Invested via EIS |
| Income tax relief @ 30% | (£30,000) |
| Capital Gains Deferral (CGT @ 20%) | (£20,000) |
| Net Cost to Investor | £50,000 |
| Shares Sold – Hypothetical Value | |
| Assumed return of 2x amount invested | £200,000 |
| Capital Gain | £100,000 |
| Chargeable Gain (if shares held >3 years) | Nil |
| Deferred Gain Becomes Chargeable | |
| Tax Payable on Deferred Gain | (£20,000) |
| Net Profit on Net Cost to Investor | £130,000 |
This is a complex area of tax and one that requires thought and knowledge. Do check in on us before you decide.
You can email your normal director at Myers Clark or if you are not yet a client but would like some help from us email our tax manager Luke Gainham at luke.gainham@myersclark.co.uk