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Blog: Blog2
Writer's pictureAlan Pink

Why Pay Today What You Can Pay Tomorrow (or Never)?

Capital gains tax is an oddball and very nasty tax in many ways, and one which deserves to be better understood. It repays a bit of study, particularly, because there are a lot of ways of getting out of it by sensible planning. Let’s have a look at a comparatively little used relief from CGT, with some unusual and interesting features.


One of the most unusual and interesting features of the relief is that it can apply to any type of gain – yes, any. Most reliefs depend on it being certain type of asset you dispose of: for example, if you’re disposing of a business, you might get Business Asset Disposal Relief (formerly known as entrepreneur’s relief) if the business and you qualify. If a property has been your main residence at any time your period of ownership, you can claim main residence relief.


If you sell an asset which you’ve used for the purposes of a trade, and buy another asset, also used for trading purposes, you can claim “rollover relief”, which enables you to offset the gain against the cost of the new asset, and thereby defer tax, perhaps indefinitely.


But where you’re selling an asset that doesn’t qualify for any of these reliefs, like a buy-to-let property for example, you need to scratch around a lot to find any way of avoiding the CGT.


One way, which I’ve often advocated before, is to look back over your whole history and see if you can recall any instances where you have made a capital loss. For example, you might have invested money in a business many years ago, and then watched the business go bust. At the time, this was an unalloyed pain, but in retrospect, if you have kept the evidence of the loss, and, if it was after 1996, have put in a formal claim within the time limit for that loss, you can effectively get some benefit from it now by way of bringing it forward against your current gains.


If you haven’t got such losses, then, is there any way at all that you can mitigate the capital gains tax? People normally come to me with this question after they have made their gain, and I point out to them that planning in arrears is never very easy!


However, there is one thing they can consider doing, and this is putting themselves in a position to claim Enterprise Investment Scheme deferral relief.


EIS Deferral Relief


The Enterprise Investment Scheme (EIS) is in some ways very generous indeed. In fact it’s not one relief but three reliefs. First of all, if you subscribe for shares in an EIS company, you can claim income tax relief equal to 30% of the amount you’ve subscribed (or 50% if it is a small and new “Seed Enterprise Investment Scheme” company). Secondly, if you hold on to the shares for at least three years, any gain you make on selling them is CGT exempt. Thirdly, there is deferral relief, which is a bit like the rollover relief I mentioned, except that it is not dependent on the asset you have sold being a trading asset. It could be shares in a company, or it could be investment property, or anything at all.


The first two EIS reliefs I’ve mentioned are only available for people who are at a sufficient distance from the company, so to speak. If you have no more than 30% of the EIS company, you can claim both the income tax relief and the CGT exemption for a sale after three years. But the third relief, deferral relief, is available however much of the EIS company you have: including if you have 100% of it.


What is an EIS Company?


Basically, any private company can be an EIS company providing it carries on a “qualifying trade”. Trades which don’t count as qualifying for these purposes are generally those which are heavily land based, such as farming, hotels and restaurants, care homes, etc. Also disqualified are companies which provide legal and accountancy services, and of course the “fiscal lepers”: companies whose business is dealing in land, shares, commodities etc. You’ll find a whole list by googling EIS qualifying trade, but suffice it to say that there are a large number of trades which are comparatively safe, which, as I say, you can control 100% if you set up the company yourself, and which will give you access to this potentially very useful CGT deferral relief.


The Sting in the Tail?


But the very word “deferral” suggests that we could be storing up difficulties for ourselves. After all, when you’ve just made a capital gain, say from selling an investment, is the time when you tend to have the free money in order to pay the tax. When, precisely, does this “deferred” gain come home to roost?


The answer is that it need not, in fact, necessarily come home to roost ever. There are three basic circumstance where the deferred gain pops up again and tax falls due:


· When you dispose of the EIS shares;

· If you emigrate from the UK within three years of the issue of the EIS shares; or

· If the company ceases to qualify as an EIS company.


You will notice that you’re allowed to die! If you still hold the EIS shares on death this is not an occasion of the gain becoming chargeable, and the shares in the EIS company will then presumably be passed on to the beneficiaries of your will.


Business Asset Disposal Relief


I’m not sure why the HMRC mandarins decided to rename entrepreneur’s relief as Business Asset Disposal Relief, especially as this gives us the acronym BAD. However, you could say that it is a different relief in a sense, because the lifetime allowance has been reduced from £10 million to £1 million (actually the original amount of relief that was available when entrepreneur’s relief was first introduced). What some people might be concerned about, however, is deferring a gain on which they were eligible for entrepreneur’s relief or BAD relief. If this comes popping up afterwards when the deferral ceases, perhaps because the EIS company is then sold, will the revived gain be eligible for relief? Fortunately, in recent years the answer to this question has been “yes”.


I always think it’s useful to illustrate the point by giving a (fairly) hypothetical example, so let’s look at one story with a sad ending, and then a story with a happy ending.


Phillip invests £100,000 in a company set up to develop innovative software for share trading. This is promoted by Sam Snide, whose eyes are very close together, but who promises Phillip that the money will be spent on top grade computer programmers, who will be working 24/7 to develop the new software. The first few quarterly reports from Sam, as the Managing Director, look hopeful, showing how much of Phillip’s money has been laid out so far, and how much progress has been made. Then, suddenly, it all goes quiet. When Phillip calls the office, there’s no answer, and in fact this is because the phone is ringing in an empty room. Sam has scarpered with not only Phillip’s money but all of the money invested by the other hopeful shareholders. The company ceases to trade, and therefore ceases to be a qualifying EIS company. Not only does Phillip has his EIS income tax relief withdrawn, but it turns out that he also deferred a gain of £100,000, on selling a furnished holiday apartment into the investment in the EIS shares. So this gain becomes chargeable now, albeit at the 10% rate which is the result of Phillip’s holiday accommodation gain qualifying for entrepreneur’s relief, or rather it having qualified for the relief if it had been needed at the time.


Harriett sells out of her nursing home business in 2018, realising a gain of £1 million (the proceeds are about £3 million, but Harriett had costs to offset of £2 million). She then goes on to invest £1 million, within the three year qualifying period for EIS deferral relief, in subscribing for new shares in an EIS company set up to get gold out of sea water. In 2022, four years after subscribing for the shares in this company, she becomes non UK resident, moving permanently to Switzerland. Soon after emigration, the EIS company makes a breakthrough in its search, and suddenly becomes extremely valuable. The shares are floated on the stock exchange, and Harriett realises her investment. Because she is now non UK resident, though, the gain is not chargeable to UK capital gains tax (and, as it happens, she is in a canton which does not charge capital gains tax either). So the deferred gain disappears completely.

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