Risks and Mitigation Strategies for Chargeable Gains in Companies: A Comprehensive Guide, Summaries of Accounting

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Chargeable Gains for

Companies Toolkit

2017-18 Company Tax Returns

Published May 2018

Index

• Introduction
• Areas of risk within chargeable gains for companies
• Using links within this document
• Checklist for chargeable gains for companies..............................................................................
• Explanation and mitigation of risks

This toolkit aims to identify risks for chargeable gains for companies only. Capital Gains Tax may be due on gains arising from assets disposed of by directors and/or shareholders on their own behalf.

For further guidance on the types of asset on which Capital Gains Tax may be due see Capital Gains Tax - what you pay it on.

For any other questions or advice please refer to Chargeable gains and Corporation Tax and Capital Gains Manual.

The main areas of risk for chargeable gains for companies broadly fall into five categories:

Record keeping

Good record keeping is essential. Poorly kept records can mean that information provided is not accurate and may result in expenditure or reliefs being claimed incorrectly. Conversely allowable expenses or reliefs may not be claimed.

The nature of chargeable gains means that relevant events may have occurred in the distant past yet still affect the current transaction, for example, a previous part disposal. Having access to detailed histories of assets also makes it easier to gather the relevant information when disposals occur and help complete the company tax return correctly and in full.

For Corporation Tax purposes, the general record keeping requirement is six years from the end of the accounting period. Records connected with the acquisition and enhancement of a capital asset will need to be retained until the asset is disposed of, which may be longer than six years. After disposal, the records will need to be retained for a further six years from the end of the accounting period in which the disposal is made in line with general record keeping requirements. In the case of a part-disposal of an asset, records will need to be retained until the remainder of the asset is disposed of, and then the further six years.

For further guidance on record keeping see Running a limited company - company and accounting records.

Disposals

Disposals include the sale, exchange or gift of all or part of an asset. It can also include the loss or destruction of an asset and the receipt of capital sums derived from assets.

It is important to establish the date of disposal to ensure that chargeable gains are calculated for the correct Corporation Tax accounting period. Often the date of disposal will be clear, such as when the disposal is made under an unconditional contract where the date of disposal is the date of the contract. However there are occasions when this will not be straightforward, for example when a contract is 'conditional'.

A contract is only conditional if particular conditions have to be satisfied before the contract becomes legally binding. The date on which these conditions are met and the contract becomes legally binding is the date of disposal.

Valuations

Valuations are the biggest single area of risk, accounting for a large part of our compliance checks. It is important to instruct an independent valuer, and make sure the valuation is made for the purposes of relevant legislation and meets Royal Institution of Chartered Surveyors or equivalent standards in appropriate cases.

Issues that are sometimes overlooked when instructions are given to a valuer include:

 the potential for development of land or the existence of tenancies or restrictive covenants

 the inclusion of intangible or other assets in a sale of land and buildings

 the full history of a shareholding

 relevant close company information in respect of unquoted shares

Where we are satisfied that all the relevant information has been fully considered by an independent valuer, the valuation is less likely to be challenged.

It is often necessary to establish a market value for assets held at 31 March 1982 but there are other occasions when it may also be required. Such occasions can be overlooked.

Expenditure

Certain expenditure is allowed against the disposal proceeds in calculating the chargeable gain. The main rules are contained in S38 Taxation of Chargeable Gains Act 1992 and cover:

 acquisition costs

 enhancement expenditure

 incidental costs of acquisition and disposal

The expenditure should be capital and not allowable elsewhere against income profits. There are specific rules for apportioning the allowable expenditure on a part disposal.

To be allowable, enhancement expenditure must be incurred for the purpose of enhancing the value of the asset and reflected in the state or nature of the asset at the time of disposal.

For further guidance see CG15150+.

Reliefs

There are several reliefs that may apply to a chargeable gain. There are certain conditions that must be met before each relief is due. If these conditions are not met, the relief may not be available.

There are some reliefs which require specific associated documentation without which the claim for relief is invalid. It is important to ensure that all necessary documentation is available and complete before making a claim for relief.

There are occasions when certain reliefs that are only available for business assets are claimed incorrectly when the activities may not amount to a business, for example the holding of investment property will not normally amount to a business.

Using links within this document

Blue underlined text are links within this document.

Green bold text are hyperlinks to external documents on the internet (access to the internet is necessary to view these).

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Allowable costs continued

If there has been any enhancement expenditure since the asset was acquired, is the expenditure all allowable?

Has there been a disposal of part of an asset, and if so, have the part disposal rules been applied?

Where a lease has been granted over all or part of a property, have the part-disposal rules been considered?

0 Where a short lease has been disposed of, have the correct rules been applied?

Reliefs, allowances and exemptions

Roll-over Relief

1 If Roll-over Relief has been claimed on the disposal of a business asset, have the relevant conditions for relief been satisfied?

Have the extended rules been applied in considering a Roll- 2 over Relief claim made by a company which is a member of a group of companies?

3 Has a qualifying replacement been acquired within the time limits?

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Roll-over Relief continued

Has a declaration to obtain provisional Roll-over Relief been confirmed or withdrawn?

Where the cost of the asset was reduced as a result of an earlier claim to Roll-over Relief, has the reduced cost been used in computing the gain?

Has the Roll-over Relief claimed been restricted where all of the disposal proceeds have not been reinvested in new qualifying assets?

Indexation Allowance

Has Indexation Allowance been calculated only up to December 2017?

Has Indexation Allowance been calculated by reference to the correct dates of disposal and expenditure (if before January 2018)?

Substantial Shareholdings Exemption

Have all the necessary conditions been met so that there is no chargeable gain under the Substantial Shareholdings Exemption?

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Groups of companies continued

Have the degrouping charge rules been applied where a company, which acquired an asset from another group company, has left the group?

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Explanation and mitigation of risks

Disposals

1. Has the correct date of disposal been established?

Risk Proceeds for the disposal of an asset may be received (and recorded for accounting purposes) in a different accounting period to that in which the disposal arises for chargeable gains purposes.

A gain may therefore be returned in the wrong accounting period if the date of disposal for chargeable gains purposes is not properly identified. Where the date of disposal is not correctly identified and the gain is returned in the wrong period, there may be significant tax consequences. For example, the rate of tax charged could be affected, as could the availability of reliefs or losses.

Mitigation Ensure that the correct date of disposal has been identified. This will normally be easily identifiable but there are specific rules which determine the date of disposal in particular circumstances, as explained below.

Explanation Where an asset is disposed of other than under a contract, the date of disposal will depend on the nature of the transaction. For further guidance on the specific rules see CG.

Where an asset is disposed of under a contract, the date of disposal will depend on whether the contract is unconditional or conditional. Where the contract is unconditional, the date of disposal will be the date of the contract. However, where the contract is conditional, the date of disposal will be the date on which the conditions are satisfied.

A contract is conditional only if particular conditions have to be satisfied before the contract becomes legally binding. For further guidance see CG14270+.

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2. Has market value been used instead of actual disposal proceeds, where

appropriate?

Risk In a number of circumstances market value must be used instead of the actual disposal proceeds. If market value is not used the consideration may be incorrect resulting in an under or overstatement of a chargeable gain.

Mitigation Establish whether the disposal involves any of the criteria for using market value. Ensure market value is used in place of the actual disposal proceeds when calculating any chargeable gain or loss.

Explanation Market value is the price which the asset disposed of might reasonably be expected to fetch on a sale in the open market.

There are many circumstances in which a valuation of an asset may be needed for capital gains purposes. The most common are:

'Control' has the same meaning as it has for close companies for Corporation Tax, for further guidance see Company Taxation Manual (CTM) CTM60200+.

For further guidance on companies and connected persons see CG.

When an asset is transferred by a company to a connected person, there may be other tax consequences as well as use of the market value rule as described above. For further guidance see CG16270+.

Where an asset is transferred by a company to an employee or director at less than its true market value, the difference between the price paid by the employee or director and the value of the asset received will usually be chargeable as employment income. For further guidance see Employment Income Manual (EIM) EIM00540 and EIM08001+.

There may also be a charge as employment income where an employee or director transfers an asset at overvalue to the company, for further guidance see CG.

Where a company transfers an asset to a member, who is not an officer or employee of the company, at less than its true market value, any difference between the cash consideration and the market value of the asset may be treated as a distribution. For further guidance see CG16280 and CTM.

A transfer at undervalue by a company may also reduce the value of the company's shares, and S125 Taxation of Chargeable Gains Act 1992 restricts the advantage a shareholder may have gained. For further guidance see CG.

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4. Where an apportionment of the sale consideration for a disposal is required,

has the apportionment been made on an appropriate basis?

Risk Where an apportionment of consideration is required to compute chargeable gains, the apportionment must be made by a method which is just and reasonable and the terms of any agreement made at arm's length in relation to the apportionment must be respected. If this is not the case, then any chargeable gain or allowable loss computed by reference to an inappropriate adjustment will be under or overstated.

Mitigation Check whether an apportionment is necessary to compute any chargeable gains or allowable losses. Also check whether any agreement has been made at arm's length, specifying the apportionment for both parties to the transaction. If an apportionment has been specified, that apportionment should be used in the computation. Any apportionment should be checked to see whether it has been made by a method which is just and reasonable.

Explanation An apportionment of the disposal consideration, or the allowable costs, in respect of one or more assets is often required so that any chargeable gains or allowable losses may be calculated correctly. For example, an apportionment may be necessary where:

 a number of assets are sold or acquired in a single transaction

 a single asset is sold or acquired but only part of it qualifies for some relief

Any apportionment must be necessary and made by a method which is just and reasonable. For further guidance see CG.

When the parties to an arm’s length transaction have agreed an apportionment between them, either in the contract or separately, such apportionment should be used in completing the chargeable gains computation and the company's tax return. However, if that apportionment

has not been made using a method which is just and reasonable that should be clearly stated in both the computation and the return.

If the parties to the transaction are connected persons, or the transaction in relation to each asset involved is otherwise than by way of a bargain made at arm’s length, the consideration or expenditure is the market value of the asset - see Q2 and Q3 above. In such a transaction the consideration and any apportionment agreed between the parties is not relevant.

For further guidance on apportionments for capital gains purposes see CG14771+.

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5. Where a valuation is necessary, has the asset disposed of been valued by a

properly instructed, independent valuer?

Risk Valuation is an area of high risk, especially in connection with 'unquoted' shares, land and buildings. This is particularly so where the valuation is not referred to a qualified, independent valuer. However, it is not sufficient simply to refer a valuation to a valuer. In the absence of proper instructions, the valuer will not understand the context nor have all the necessary details on which to make a proper valuation.

For land and buildings, areas that are frequently overlooked include:

 tenancies

 development potential (even where this has not been pursued)

 inclusion of other assets in the transaction, such as goodwill or farm machinery

 restrictive covenants over the land

For 'unquoted' shares, areas that are frequently overlooked include:

 The size of the holding

 A full description of the rights attaching to the shares

 The class (for example, ordinary, preference, A, B etc.) and denomination of the shares (disposals of different classes of share in the same company must be shown as separate transactions)

 A history of the holding, particularly if there has been a reorganisation or takeover - in which case all the above details in respect of the original shares held will need to be included. For further information on share reorganisations see CG51700+

There are also other assets which may need to be valued when disposed of, and also on occasion when acquired.

Mitigation Valuations are not a precise science and lengthy correspondence may be avoided if it is demonstrated that all the relevant factors have been taken into consideration. It is important to:

 engage an independent valuer (qualified to Royal Institution of Chartered Surveyors or equivalent standards in respect of land and buildings)

 explain the context, for example, a valuation for the purposes of rebasing to 31 March 1982 (S35 Taxation of Chargeable Gains Act 1992)

 draw attention to the definition of market value for chargeable gains purposes

 provide all relevant details concerning the asset, and in particular, the points mentioned in the bullet points under 'Risk' above

For further guidance on the valuation of assets see CG16200+ and Valuation of Assets.

 costs of transfer or conveyance (including Stamp Duty)

 costs of advertising to find a buyer or seller

 costs reasonably incurred in making any valuation or apportionment required for the purposes of the chargeable gains computation

For further guidance see CG15160+.

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7. If there has been any enhancement expenditure since the asset was acquired,

is the expenditure all allowable?

Risk Not all enhancement expenditure is allowable, for example if the enhancement is no longer reflected in the state or nature of the asset at the time of disposal. Some expenditure on the asset may be properly relievable against income and deductible in computing income profits and so must not be used in the calculation of any chargeable gain or allowable loss.

Mitigation Obtain a full history of the asset and details of the expenditure. Ensure that the expenditure meets the conditions detailed below and that it is neither relievable against income nor has it been deducted in computing profits in the year in which the expenditure was incurred.

Explanation In order to qualify as enhancement expenditure, expenditure must satisfy all the following conditions. It must be:

 incurred on the asset

 incurred for the purpose of enhancing the value of the asset

 reflected in the state or nature of the asset at the date of disposal

Enhancement expenditure incurred prior to March 1982 will already be reflected in the March 1982 valuation and should not be deducted separately in calculating the chargeable gain or loss.

Example 1 A company buys some land and has a factory built on it. The building of the factory is an enhancement. It is still standing in its entirety at the time of disposal so all the expenditure is allowable.

Example 2 A company buys some land and has a factory built on it. The building of the factory is an enhancement. A few years later the original building is knocked down to make way for a new factory building. The original factory is not reflected in the state or nature of the asset at the time of the disposal so expenditure attributable to its construction in the first place is not allowable.

For further guidance see CG15180+.

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8. Has there been a disposal of part of an asset, and if so, have the part disposal

rules been applied?

Risk It is not always obvious that a disposal is of only part of the asset originally acquired. If this is the case but the part disposal rules are not applied, or are applied incorrectly, then the incorrect amount of allowable expenditure may be deducted in computing the gain.

For example, a 60 year lease is granted at a premium on a shop unit. The disposer retains the freehold (reversionary interest), which itself has value. The right to receive rental income also has value. Both of these values are used in apportioning allowable expenditure in order to compute the gain on the grant of the lease.

Mitigation Check the history of the asset and the disposal contract to identify the part of the asset disposed of. Where there has been a part disposal, ensure the part disposal rules have been applied - see below for part-disposal formula.

Explanation The allowable acquisition cost (or March 1982 market value where appropriate), and any enhancement expenditure or incidental costs of acquisition, should normally be apportioned using a statutory formula. For further guidance see CG12731. The part retained must be correctly determined and valued.

Example A part of an asset which originally cost £40,000 in total is sold for £50,000 and the value of the remainder is £45,000. Using the formula below the adjusted cost would be £21,053.

Original cost × Consideration for part disposal = Adjusted cost

Consideration for part disposal + value of remainder

£40,000 × £50,000 = £21,

An alternative method applies to land only, as detailed in Statement of Practice D1 , which can only apply where the subject of the part-disposal is the entire interest in an identifiable part of the holding of land.

On a disposal of shares from the pool (the S104 holding) the associated cost may be calculated by applying the part disposal formula or by making a simple apportionment by reference to the number of shares in the pool. For further guidance see CG.

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9. Where a lease has been granted over all or part of a property, have the part-

disposal rules been considered?

Risk It is not always appreciated that there has been a part-disposal for capital gains purposes where a lease is granted over all or part of a property. Where a premium is received, not all of the allowable expenditure on the property will be deductible in computing any capital gain. The treatment for tax purposes is complex and depends on the precise nature of the lease granted and also the property interest out of which it is granted.

In the case of the disposal of a short lease, the allowable expenditure is restricted by a curved - line method in accordance with the table in paragraph 1, Schedule 8 of Taxation of Chargeable Gains Act 1992 and the formulae in paragraph 1(4), Schedule 8.

Separate calculations are required for costs of acquisition, see CG71144+ , and for enhancement expenditure, see CG71147+.

These rules apply if the lease was a short lease at the date of its disposal whether or not it was a long or a short lease at the date of its acquisition.

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Reliefs, allowances and exemptions

Roll-over Relief

11. If Roll-over Relief has been claimed on the disposal of a business asset, have

the relevant conditions for relief been satisfied?

Risk A claim for Business Asset Roll-over Relief comprises several conditions, all of which must be satisfied for the relief to be granted. Incorrect claims are sometimes made where all of the conditions for relief are not satisfied.

Mitigation Check that all of the conditions for relief as shown below are satisfied and that claims are submitted with the correct information within the time limit.

Conditions for relief are:

 the relief must be claimed

 the company claiming relief must be carrying on a trade (for further guidance on exceptions to this condition see CG60260 )

 the old asset disposed of must have been used in the trade (and not held by the company as an investment or for use in non-trade activities)

 the new asset acquired must be taken into immediate use in the trade (and not held by the company as an investment or for use in non-trade activities)

 assets disposed of or acquired must be within one of the classes in S155 Taxation of

Chargeable Gains Act 1992, see CG

 the new asset must be acquired in the period between 12 months before and 36 months after the disposal of the old assets (these time limits can only be extended at HMRC's discretion - see Q13). Special rules apply where the new asset is a depreciating asset and relief in respect of depreciating assets is computed differently. For further guidance see CG60360+.

A depreciating asset is:

 any fixed plant or machinery

 any other asset that will have a life of 60 years or less from the date it is acquired (for example a leasehold interest in property where the lease has less than 60 years to run)

Where not all the disposal proceeds have been applied on the new asset see Q16 below.

Explanation Relief is available where all the conditions listed above are satisfied and where all or part of the consideration obtained for the disposal of the old asset is applied in acquiring the new asset(s).

If the old assets were not used for the purposes of the trade throughout their period of ownership, an apportionment is required on a just and reasonable basis. Land and buildings are treated as separate assets for the purposes of Roll-over Relief. Therefore separate claims can be made for each asset - a claim for the land and a claim for the building on that land.

Land and buildings must be occupied as well as used solely for the purposes of the trade in order to be eligible for relief.

Where land and buildings are let by the owner upon terms that give the tenant the right to occupy to the exclusion of all others, they are not normally qualifying assets of the owner for the purposes of the owner's trade.

For further guidance on Business Asset Roll-over Relief see CG60250c.

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12. Have the extended rules been applied in considering a Roll-over Relief claim

made by a company which is a member of a group of companies?

Risk The Business Asset Roll-over Relief rules are extended in relation to groups of companies providing for relief in circumstances where otherwise it might not be due. Where the extended rules are not applied the availability of Roll-over Relief might be overlooked.

Mitigation Check whether the extended rules have been applied in considering claims to Roll-over Relief by companies, which are members of a group of companies, and which make disposals and acquisitions of assets used in the trades carried on by the group.

Explanation The rules in S152 Taxation of Chargeable Gains Act 1992 onwards for Business Asset Roll- over Relief are modified by S175 in order to apply them to groups of companies.

For further guidance on what constitutes a group of companies see CG45100+.

There are five modifications of the rules:

The notional single trade rule: One of the main requirements for Business Asset Roll-over Relief is that the old asset and the new asset are used for the purposes of the taxpayer's trade.

All the trades carried on by members of a group of companies are treated as a single trade. Only trades whose profits are within the scope of Corporation Tax, that is those carried on by a company resident in the UK or carried on by a UK branch or agency of a non-resident company, can be part of the notional single trade.

For further guidance see CG.

Non-trading group companies: A non-trading group company is treated as if it were carrying on the notional single trade, in relation to assets which it owned and which were used for trade purposes by trading companies in the same group, for the purpose of the claim to Roll-over Relief.

For further guidance see CG. Depreciating assets: The Roll-over Relief rules where the new asset is a depreciating asset are extended in relation to groups of companies. Where the company making the claim is a member of a group, the