Taxation in business - Capital Gains Tax

Learning Outcomes

This article covers Capital Gains Tax (CGT) in business, including:

• Who pays CGT in business contexts (sole traders, partners, trustees and personal representatives)
• What constitutes a chargeable asset and a chargeable gain, and when market value rules apply
• Calculating CGT, including allowable expenditure, loss utilisation, and aggregation across the tax year
• The main business reliefs—Business Asset Disposal Relief (BADR), roll-over relief, hold-over relief and incorporation relief—and when to claim them
• Distinguishing CGT from corporation tax in company scenarios
• Share disposals and gifts of business assets, including spousal/civil partner transfers and basic share identification rules
• Practical consequences for partners and shareholders: rate application, annual exemption use, and reporting/payment requirements (e.g., 60-day UK residential property)

SQE2 Syllabus

For SQE2, you are required to understand capital gains tax in the context of business structures and transactions, supporting both advising clients and identifying issues in exam scenarios, especially regarding calculations and practical tax consequences, with a focus on the following syllabus points:

• recognising when CGT arises for individuals, partners, trustees and personal representatives in business scenarios
• identifying what constitutes a chargeable gain and a chargeable asset, including market value rules and connected persons
• calculating capital gains, applying allowable deductions (acquisition/disposal/ enhancement costs), losses, reliefs and exemptions
• understanding reliefs such as business asset disposal relief (BADR), roll-over relief, hold-over relief and incorporation relief
• explaining the tax treatment of asset disposals, gifts (including spousal/civil partner transfers), and business sales
• identifying who is responsible for CGT in partnerships and on shares, and how capital gains are shared between partners
• applying CGT rates correctly as “top-slice” of income, including residential property rates and BADR’s flat 10%
• addressing share disposals in trading companies, including basic share identification rules for CGT
• distinguishing CGT from corporation tax on capital gains for companies
• understanding reporting and payment deadlines (e.g. 60-day UK residential property returns; self-assessment timings)

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Who is liable to pay capital gains tax on a gain arising from the disposal of an asset by a sole trader?
2. Which relief potentially reduces the CGT rate to 10% on the disposal of a qualifying business asset?
3. How does the annual exemption operate when a taxpayer claims hold-over or roll-over relief?
4. List at least two types of assets that are not chargeable for CGT purposes.

Introduction

Capital Gains Tax (CGT) is a charge on the increase in value of certain assets when they are disposed of by individuals or partners in a business, including business owners and shareholders. Understanding CGT is essential for advising on business sales, gifts, disposals of shares, and succession planning. This article sets out when CGT is payable, what reliefs and exemptions may apply, and how to approach common scenarios tested in the SQE2.

Who pays capital gains tax in business?

CGT is paid by individuals—including sole traders and partners—when they dispose of chargeable assets. Trustees and personal representatives can also be charged when trust or estate assets are disposed of. Companies do not pay CGT; instead, they pay corporation tax on capital gains.

Key Term: capital gains tax
A tax charged on the increase in value (gain) realised by individuals (including sole traders and partners), trustees and personal representatives when a chargeable asset is disposed of.

Key Term: chargeable person
Any individual, partner, trustee or personal representative (not a company) who makes a chargeable gain when disposing of a chargeable asset.

Key Term: chargeable asset
Most tangible and intangible items of property, other than sterling and certain exempt assets. Includes land, shares, goodwill, and business equipment used for trade.

What triggers capital gains tax?

CGT is triggered when a chargeable person disposes of a chargeable asset. Disposal includes sales, gifts, exchanges, part disposals, and certain insurance-related realisations. Market value is substituted for the actual consideration when assets are gifted or sold at undervalue, and when transactions occur between connected persons.

Key Term: disposal
Any action by which legal ownership of a chargeable asset changes: sale, gift, exchange, part disposal, or transfer of ownership.

Key Term: market value rule
For CGT, market value is used instead of actual consideration where assets are gifted, sold at undervalue, or transferred between connected persons.

Key Term: connected person
Broadly includes close relatives (e.g. spouse/civil partner, parents, children, siblings), certain trusts, and companies under common control. Transactions with connected persons are treated at market value for CGT.

Transfers on death are not chargeable to CGT; the estate’s personal representatives acquire assets at market value at the date of death. Inheritance tax may apply, and business property relief (BPR) can reduce IHT on qualifying business interests.

Worked Example 1.1

Eva runs a bakery as a sole trader and sells her business premises for more than she originally paid. Is this transaction subject to capital gains tax?

Answer:
Yes. Eva is an individual disposing of a chargeable asset. If she makes a gain after deducting allowable costs and reliefs, she will pay CGT on that gain.

Calculating the basic gain

The basic gain for CGT is the difference between:

• The disposal value (market value if transferred at undervalue or as a gift)
• Less the original acquisition cost
• Less allowable expenses (such as professional fees, incidental acquisition/disposal costs, and capital improvements)

Key Term: allowable expenditure
Deductible costs incurred wholly and exclusively for acquiring, improving, or disposing of a chargeable asset. Includes incidental costs of acquisition/disposal (e.g. legal, estate agency, valuation fees) and enhancement expenditure that adds enduring value; routine repairs do not qualify.

Key Term: basic gain
The gain before reliefs and exemptions—disposal value minus (cost + allowable expenditure).

CGT is then charged after deducting available reliefs and the annual exemption. Gains are treated as the “top slice” of income: they are added to taxable income to determine rate bands, then taxed at the applicable CGT rates.

Key Term: annual exemption
A set annual amount of capital gain each individual can realise tax-free. Only applies where tax is paid now (not when gain is deferred/held over).

When calculating gains on shares, the share identification rules apply: same-day acquisitions, “bed and breakfast” acquisitions within 30 days, and otherwise the Section 104 pool (average cost).

Worked Example 1.2

Nathan sells machinery bought for £10,000 for £17,000. He spent £1,000 on buying and selling costs. What is the basic gain before reliefs?

Answer:
£17,000 – (£10,000 + £1,000) = £6,000

Reliefs and exemptions

Taxpayers can claim a range of reliefs and exemptions to reduce CGT.

Main reliefs

• Business asset disposal relief (BADR): Formerly “entrepreneurs’ relief.” Gains on disposal of a qualifying business asset (sole trade, partnership, or shares in a trading company) may be taxed at 10% up to the lifetime allowance. For shares, the disposer must normally hold at least 5% of ordinary share capital and voting rights, satisfy the 5% economic entitlement test, be an officer or employee, and meet a two-year qualifying period. EMI shares may qualify under modified rules.
• Roll-over relief (replacement of business assets): When qualifying business assets are sold and proceeds are reinvested in other qualifying assets, tax on the gain can be deferred by reducing the base cost of the replacement asset. Time limits apply (generally one year before to three years after disposal). Partial relief is available if only part of the proceeds is reinvested.
• Hold-over relief (gifts of business assets): A gain may be held over when business assets are gifted, so the donor’s gain is deferred and the donee takes the donor’s base cost (the held-over gain crystallises on the donee’s disposal). Available under specific statutory routes, typically requiring a joint claim.
• Incorporation relief: If a sole trader or partnership transfers a business to a company in exchange for shares, gains on the assets transferred can be deferred into the base cost of the shares, provided the business is transferred as a going concern and the consideration includes shares.

Key Term: business asset disposal relief (BADR)
Relief giving a 10% CGT rate on up to £1 million of qualifying business disposals per individual, subject to conditions, including a two-year qualifying period.

Key Term: roll-over relief
Defers tax on a gain when qualifying business assets are sold and replaced with new qualifying assets within statutory time limits by reducing the base cost of the replacement asset.

Key Term: hold-over relief
Defers CGT on certain gifts of business assets so the recipient inherits the donor’s base cost and pays tax on the total gain when disposing.

Key Term: incorporation relief
Defers gains when a business is transferred to a company wholly or partly in exchange for shares, by reducing the base cost of the shares.

Individuals can also use the annual exemption, but this cannot be combined with roll-over or hold-over relief—the exemption only applies when a capital gain is actually charged to tax and payable now.

Key Term: exemption
The part of a gain on which no tax is charged, such as the annual exemption or gains arising on exempt assets (e.g. main residence under PPR).

Worked Example 1.3

Raj sold his shop and reinvested all proceeds in a new trading asset within the required time. Will he pay CGT now?

Answer:
No. Roll-over relief can be claimed, so CGT on the gain is deferred until he disposes of the new asset.

Exam Warning

When clients sell or gift business assets, always check if BADR, roll-over, incorporation or hold-over relief applies. Do not combine the annual exemption with deferred gains under roll-over or hold-over relief until a disposal triggers a charge.

Tax rates and business asset sales

The CGT rate for business sales depends on the asset type and the taxpayer’s income:

• 10% on gains qualifying for BADR (up to the lifetime limit)
• 10% on gains falling within the basic rate band (non-residential assets)
• 20% on gains above the basic rate band (non-residential assets)
• 18%/24% for gains on residential property (basic/higher-rate respectively, for UK residential property that is not the main residence)

CGT is applied to chargeable gains after deducting reliefs and the annual exemption, with capital gains treated as the top slice of income. A higher-rate taxpayer may still have part of their gains taxed at 10% if some basic rate band remains when gains are added to taxable income.

Calculating CGT for business sales

• Start from the gain after deducting acquisition cost and allowable expenditure (including incidental costs and enhancement costs)
• Apply any available reliefs (BADR, roll-over, hold-over, incorporation), noting deferral vs immediate charge
• Aggregate gains and losses across the tax year; set capital losses against gains in the most tax-efficient order
• Deduct the annual exemption (if relief does not defer the gain)
• Tax at the appropriate rate(s) using the top-slice approach
• Check reporting and payment obligations: UK residential property disposals by individuals must be reported to HMRC and CGT paid within 60 days of completion; other CGT is generally reported via self-assessment by 31 January following the tax year

Owners of partnerships and sole traders are assessed on their fractional share of gains and may claim individual exemptions and reliefs. Partners usually share capital gains based on the agreed capital profit-sharing ratio, which may differ from income profit shares.

Disposal of shares by business owners

Disposing of shares in a trading company may incur CGT. BADR can apply if conditions are met: the company is a trading company (or holding company of a trading group); the disposer is an officer or employee; holds at least 5% of ordinary share capital and voting rights; and meets the economic entitlement and two-year tests. Share disposals follow identification rules (same-day, 30-day matching, then Section 104 pooling) to determine the base cost used in the gain calculation.

Qualifying EMI options can benefit from BADR even if the 5% tests are not met, provided other conditions are satisfied. BADR does not apply to investment companies or shares that do not meet the trading/personal company criteria.

Gifts of business assets

Gifting business assets may trigger CGT, but relief (hold-over or roll-over) can defer the charge until the donee disposes of the asset. Transfers between spouses or civil partners are generally “no gain/no loss,” so the recipient takes the donor’s base cost and the donor has no immediate CGT charge. Transfers on death are not chargeable to CGT; assets are rebased to market value at death for the estate. Inheritance tax may apply, and business property relief (BPR) can reduce IHT by 100% for certain business interests and unlisted shares, or 50% for certain assets like land or buildings used by the business.

Key Term: no gain/no loss (spouses/civil partners)
Transfers between spouses/civil partners are treated at the transferor’s base cost, so no CGT arises at the time of transfer.

Key practical points and exam pitfalls

• Gifts and sales at undervalue are always treated as if made at market value; transactions with connected persons also use market value.
• Annual exemption cannot be used now if the gain is deferred under roll-over or hold-over relief; use the exemption when the deferred gain crystallises.
• Gains on main homes are usually exempt under Principal Private Residence Relief—but this does not apply to business property or to residential investment property.
• For UK residential property disposals, individuals must file a CGT return and pay the CGT within 60 days of completion, in addition to normal self-assessment reporting.
• Losses should be used before the annual exemption to preserve the exemption where possible; losses cannot be used to create or increase a deferred gain.
• For partnerships, check the agreed capital profit-sharing ratio and apply reliefs at partner level; partnerships are transparent for CGT.
• For shares, apply the identification rules and consider BADR conditions carefully (ownership, role, two-year period).

Worked Example 1.4

Maia and Leo are equal partners in a business. They sell a trading property used in the partnership and make a gain of £80,000. How is CGT assessed?

Answer:
Each partner is assessed individually on their £40,000 share of the gain and can claim their annual exemption and any available relief.

Worked Example 1.5

Harriet owns 10% of the ordinary shares in H Designs Ltd, a trading company. She has been a director for 5 years and meets the 5% voting/economic entitlement tests. She sells her shares for £900,000; her base cost is £150,000. She has not used BADR previously this lifetime. What rate applies to her gain?

Answer:
The gain is £750,000 (£900,000 – £150,000). As the conditions for BADR are met and she is within the lifetime cap (£1 million), the gain is taxed at 10% (subject to deducting the annual exemption where applicable). BADR gives a flat 10% rate on the qualifying gain.

Worked Example 1.6

A sole trader gifts their workshop (a business asset) to their adult child who will continue the trade. The workshop has a market value of £200,000 and a base cost of £80,000. Can CGT be deferred?

Answer:
Yes. Hold-over relief can be claimed for the gift of a qualifying business asset, so the donor’s gain (£120,000) is deferred. The child’s base cost becomes £80,000 (adjusted to reflect the held-over gain) and CGT will arise on their disposal. The annual exemption is not used now.

Worked Example 1.7

Priya, a higher-rate taxpayer, sells a UK residential investment flat (not her main residence) on 1 July. She makes a chargeable gain after deducting allowable costs of £100,000. What are her immediate obligations?

Answer:
She must report the disposal and pay the CGT due on that gain within 60 days of completion. The gain will be taxed at 24% to the extent it falls above her remaining basic rate band (18% for any part within it). She must also include the disposal on her self-assessment return by 31 January following the end of the tax year.

Revision Tip

When examining a potential CGT liability, list the type of asset disposed of, the way in which it was disposed of (e.g., sale, gift), who held it, and what reliefs apply. State if the annual exemption or a 10% CGT rate may be available. For shares, apply the identification rules; for property, check the 60-day reporting requirement.

Key Point Checklist

This article has covered the following key knowledge points:

• CGT is charged on gains made by individuals and partners, trustees and personal representatives—not companies (companies pay corporation tax on gains).
• Gains arise on the disposal of chargeable assets, including sales, gifts, exchanges and part disposals.
• The basic gain equals disposal value (or market value) minus acquisition cost and allowable expenses; enhancement costs qualify, routine repairs do not.
• Capital gains are the top slice of income; apply rates after reliefs and the annual exemption.
• Principal reliefs include BADR (10% up to lifetime cap), roll-over relief, hold-over relief and incorporation relief.
• The annual exemption can only be used when a gain is taxable now—not when deferred under roll-over or hold-over relief.
• Residential investment property gains are charged at 18%/24% (basic/higher-rate respectively); non-residential gains are 10% within the basic rate band and 20% above.
• Partnerships are transparent for CGT: each partner is assessed individually (usually on the capital profit-sharing ratio).
• Gifts and sales at undervalue use market value (especially for connected persons); spousal/civil partner transfers are “no gain/no loss.”
• Shares in a trading company can qualify for BADR if conditions are satisfied; apply share identification rules when calculating gains.
• UK residential property disposals by individuals must be reported and paid within 60 days of completion, with self-assessment reporting thereafter.
• Losses should be applied before the annual exemption, and reliefs must be claimed in the correct order to maximise tax efficiency.

Key Terms and Concepts

• capital gains tax
• chargeable person
• chargeable asset
• disposal
• market value rule
• connected person
• allowable expenditure
• basic gain
• annual exemption
• exemption
• business asset disposal relief (BADR)
• roll-over relief
• hold-over relief
• incorporation relief
• no gain/no loss (spouses/civil partners)