What is Capital Gains Tax for Small Businesses? A Comprehensive Guide

Small business owners, like any other business, must pay various taxes, such as goods and services tax (GST), income tax, corporate tax, and capital gains tax. Unlike some other taxes, capital gains tax doesn't come up as frequently. It's only applicable when a business sells off valuable assets, like properties or shares, for a profit. So, it's a tax on the money made from selling these assets, rather than on the regular income of the business.

Capital gains tax (CGT) is a tax that's paid on the profit made from selling or getting rid of an asset. These assets can include things like houses, lands, vehicles, animals, shares, or investments. Even items like artwork or other valuable possessions sold off can be subject to CGT. The reason it's called "capital gains" tax is because it's based on the gain or profit from selling these assets, rather than the regular income of the seller. One thing that's beneficial for small business owners is that CGT isn't calculated in the same way as other taxes, which can sometimes make it more manageable for them.

The tax is solely based on the profit earned from the sale, not the total capital involved in the transaction. This means that regardless of how much money is involved in the sale, the tax is only calculated on the profit gained by the small business owner.

For instance, if a property was purchased for £500,000 and sold for £600,000, the tax is only applied to the additional £100,000, which represents the profit made from selling that specific property or asset. The tax you owe is solely based on the profit you make from selling an asset, not on the total amount of money involved in the sale.

This means that no matter how large the initial investment, the tax is only calculated on the profit earned by the small business owner. For example, if you buy a property for £500,000 and sell it for £600,000, you'll only pay tax on the additional £100,000, which represents the profit from selling that specific property or asset. So, it's not about the total amount of money changing hands, but rather the extra money you make from the sale.

When selling a valuable asset for less than its initial purchase price, the Capital Gains Tax is calculated based on the asset's current market value. For instance, if you acquire an asset for £700,000 and later sell it for £650,000, but the present market value is assessed at £600,000, the tax is levied on the difference of £50,000. This adjustment reflects the fact that the asset's value has decreased since its purchase, thereby determining the taxable profit accordingly. So, even if the selling price is lower than the initial purchase price, the tax is still calculated based on the asset's current market worth, ensuring a fair assessment of the taxable gain.

Who Pays Capital Gain Tax

Capital Gains Tax (CGT) is predominantly paid by small business owners, although it's not exclusive to them. Other individuals and entities who may be subject to CGT include:

1. private individuals
2. self-employed individuals
3. sole traders
4. partners in a business partnership
5. company owner
6. business trustee and
7. personal representatives of deceased individuals.

Limited companies, however, are not liable to pay CGT; instead, they are obligated to pay corporation tax. Nevertheless, even as a limited company, if you sell a portion of your company or any of its assets, you are required to pay capital gains tax on any profit generated from the sale. Similarly, as a small business owner, you are also liable for CGT if you sell a part of your company or any of its assets, reflecting the broader applicability of CGT beyond just small business owners.

Assets That Require CGT

Business assets that hold significant value play a crucial role in enhancing the overall worth of a company. However, when these assets are sold, whether it's a company or a small business, they are obligated to pay the capital gains tax (CGT).

Various types of assets fall under this category, including landed properties and buildings, vehicles and machinery, fixtures and fittings, plants and livestock or animals, registered company or business trademarks, bonds or shares of companies that are not held within an Individual Savings Account (ISA) or a Personal Equity Plan (PEP), and even the business brand and reputation, often referred to as goodwill.

Thus, when any of these assets are sold off, the entity is required to settle the CGT, which is calculated based on the profit generated from the sale of these valuable assets.

Chargeable assets are those assets that can incur a capital gains tax when they are disposed of or sold. The assets mentioned earlier fall under this category, as there must be a capital gains tax applied to the profit realized after the sale.

All chargeable assets are subject to a capital gains tax if certain conditions are met: firstly, if the asset is sold for a higher price than it was originally purchased for; secondly, if the asset is sold for a lower price than it was purchased for; thirdly, if the asset is given away as a gift and transferred to someone else; fourthly, if the asset is traded for another item or asset; and finally, if compensation, such as an insurance payout, is received for the asset.

These conditions outline the scenarios in which a capital gains tax applies to chargeable assets, ensuring that any gains or profits made from the disposal of these assets are appropriately taxed.

How CGT Works

Capital Gains Tax operates in a manner that varies depending on the type of company and individual involved. The way CGT is applied differs for entrepreneurs and small business owners compared to other entities. In the context of entrepreneurs and small business owners, CGT is designed to be more favourable in tax calculations, allowing them to pay tax solely on the gain derived from selling an asset.

This means that they are taxed based on the profit they make from the sale, rather than on the total value of the asset or transaction. By tailoring the tax calculation in this way, CGT aims to support entrepreneurs and small business owners by ensuring that their tax obligations are proportional to the gains they accrue from asset sales, thereby facilitating their business activities and growth.

How CGT Works in Sole Traders

In the case of a sole trader, if you decide to sell your sole trader business or a partnership, you will be required to pay Capital Gains Tax (CGT) on the profit derived from selling the business. This profit can come in the form of monetary gain or from the sale of business assets acquired during your trade.

When calculating the CGT, you'll need to determine the value of the assets acquired for personal use, and the tax will then be calculated based on the current value of those assets. Essentially, the tax payable will be assessed on the profit realized from the sale of the business or its assets, ensuring that any gains made are appropriately taxed according to the current market value.

This process helps maintain fairness and transparency in tax obligations for sole traders and partnerships, aligning with broader tax principles aimed at equitable taxation across different business structures.

How CGT Works in Limited Companies

If a limited company is sold, or if the shares of the company are sold, shareholders are obligated to pay Capital Gains Tax (CGT) on the personal gains derived from the sale. These gains can stem from various sources, including the money received from the sale of owned shares, any assets of the company retained by the shareholder, or the profit realized from the sale of the entire business entity, encompassing all trades, assets, and shares collectively.

The amount of CGT payable is determined solely by the disparity between the initial acquisition cost of the company, shares, or asset, and its value at the time of sale. This discrepancy between the purchase and sale values serves as the basis for calculating the capital gains tax owed by the shareholder, ensuring that any accrued gains are subject to taxation fairly and equitably.

This process underscores the importance of accurately assessing the financial implications of selling a limited company or its shares, thereby facilitating compliance with tax regulations and obligations associated with such transactions.

CGT for Shareholders and Directors

When it comes to selling an entire company or business, particularly for directors or significant shareholders, there are distinct tax implications to consider. In such cases, if you opt to sell the company as a whole, rather than individually disposing of shares, you'll be subject to corporation tax following the sale of the company as an asset, before any proceeds are distributed to shareholders.

However, it's worth noting that when selling a business or company, it's generally more advantageous from a tax perspective for the taxpayer to structure the sale as a disposal of shares, rather than categorizing it as the sale of an asset. This is because if the sale is treated as an asset sale, it will attract both corporation tax and capital gains tax.

If the sale is structured as a disposal of shares, it will only incur capital gains tax, thereby potentially reducing the overall tax liability associated with the transaction. This underscores the importance of carefully considering the tax implications and structuring the sale in a manner that minimizes tax obligations while maximizing the financial benefits for the taxpayer.

CGT for Small Business Owners

As a small business owner, once you've sold a business asset, it's crucial to assess the profit or gain derived from the sale and determine whether it qualifies for capital gains tax relief. If it's determined that capital gains tax is applicable, you'll need to calculate the amount of tax owed. An important consideration in this process is the Annual Exempt Amount, which represents a tax-free allowance for capital gains tax.

This means that you won't be required to pay any tax on your gains in a tax year if they fall within this allowance. For the tax year 2023/24, the Annual Exempt Amount stands at £6000 for individuals and £3000 for trustees. However, it's worth noting that as of 6 April, this allowance is reduced to £3000 for individuals and £2500 for most trustees.

Understanding and utilizing this tax-free allowance can help minimize your tax liability and maximize your gains from the sale of business assets, providing a valuable opportunity for small business owners to optimize their financial outcomes.

However, if the total gain from the sale exceeds the tax-free allowance, your Capital Gains Tax (CGT) rate will depend on your tax status. For individuals classified as basic taxpayers in the tax year of the disposal, the CGT rate is set at 10%. On the other hand, if you fall under the high-rate or additional-rate taxpayer categories, and your gain surpasses the basic income tax band, you'll be subject to a 20% CGT rate. It's important to recognize that the amount of capital gains tax you owe as a small business owner typically contributes to your overall taxable income.

This means that when determining your tax bracket, it's essential to factor in the CGT amount alongside other sources of income.

By understanding how your capital gains tax obligations integrate with your overall tax position, you can effectively manage your tax liability and plan your finances accordingly.

As a small business owner, it's important to recognize that the amount of capital gains tax you owe typically contributes to your overall taxable income. This means that a significant gain from a sale has the potential to elevate your total annual earnings beyond the basic rate threshold, which stood at £50,270 for the 2023/24 tax year. Should your total income surpass this threshold, you would be categorized as either a higher-rate taxpayer or an additional-rate taxpayer.

Additionally, if you use all or part of your main residential building for business purposes and subsequently sell it, any gains from the sale may be subject to Capital Gains Tax (CGT). If you don't qualify for Private Residence Relief, you'll face a CGT rate of 18% as a basic taxpayer, and 28% as a higher-rate or additional-rate taxpayer, instead of the usual rates of 10% and 20%, respectively. Understanding these implications is crucial when assessing the potential tax impact of selling business or residential properties, as it allows you to plan your finances accordingly and manage your tax liabilities effectively.

CGT for Gifts

If you decide to donate a business asset to a charity organization, you won't be liable to pay capital gains tax. However, if you choose to sell the asset to a charity for a price higher than what you initially paid for it but less than its market value, then you will be required to pay capital gains tax on the profit earned from the sale. Similarly, if you gift or sell a business asset to your spouse or civil partner, you generally won't have to pay capital gains tax on the transaction, unless certain conditions apply.

For instance, if you and your partner were separated and didn't reside together throughout the entire tax year, or if you provided your spouse or civil partner with the goods or business assets for them to sell through their own business, then capital gains tax may be applicable.

Additionally, it's worth noting that you can potentially defer your capital gains tax payment or reduce the amount owed by claiming various tax reliefs on costs associated with the assets being sold. These reliefs can help alleviate the tax burden and optimize your financial outcomes when disposing of business assets or making transfers to charitable organizations or partners.

Working Out Your CGT

For small business owners, entrepreneurs, sole traders, shareholders, directors, and private individuals, the gains accrued from the sale of an asset are determined by the difference between the price initially paid for the asset or its value at acquisition, and the price for which it is eventually sold or its present market value.

When calculating gains in certain scenarios, it's essential to use the market value of the asset. This applies when the asset is being gifted to a spouse, legal partner, or charity organization, as well as when it is sold for a price higher than the purchase price. Additionally, if the asset has been inherited, and the exact tax value of the inherited assets is unknown, or if the asset has been owned since before April 1982, using the market value becomes imperative for accurate gain calculation.

By adhering to these guidelines and utilizing the appropriate valuation methods, individuals can ensure compliance with tax regulations and accurately assess their gains from asset transactions.

If you decide to sell an asset that was previously gifted to you and you've already utilized Gift Hold-Over Relief, you'll need to determine the actual price of the asset when it was originally purchased to calculate your gain.

However, if you acquired the asset for a lower price than its market value, you'll use the amount you paid for it as the basis for calculating your capital gains tax. Additionally, if you're unsure about the valuation of the asset, you have the option to request a valuation from HMRC's Shares and Assets Valuations (SAV) team.

To initiate this process, you'll need to complete a 'post-transaction valuation check for capital gains' form after the sale of the asset has been completed. This allows you to verify the accuracy of your valuation and ensure compliance with tax regulations when determining your capital gains tax liability. By taking these steps, you can effectively manage your tax obligations and ensure that your asset transactions are conducted by HMRC guidelines.

When computing your overall taxable gains and subsequent tax liability for a given tax year, it's essential to aggregate all gains derived from the sale of each business asset and then subtract any allowable losses, expenses, or tax reliefs. The total amount of gains exceeding the Annual Exempt Amount will be subject to capital gains tax. However, if your total gains for the tax year fall below your tax-free allowance, you are not obligated to pay any capital gains tax.

Nonetheless, it's still necessary to report your gains to HMRC under certain circumstances. This includes being registered for self-assessment or if the total proceeds from selling the asset exceed four times your capital gains tax allowance. By adhering to these reporting requirements, you ensure compliance with HMRC regulations and maintain transparency in your financial affairs.

How to Reduce Your CGT

The extent to which you can reduce your capital gains tax liability depends on various factors, including the nature of the asset and how it was sold. By carefully considering these factors, you may be able to minimize your CGT liability through the deduction of certain costs, expenses, and losses incurred in the process of selling the asset.

Additionally, you can explore opportunities to claim tax reliefs that apply to the gains realized from these sales. Furthermore, your capital gains tax-free allowance for the tax year serves as another avenue for potentially reducing your tax liability.

By leveraging these allowances and deductions effectively, you can optimize your tax position and mitigate the impact of capital gains tax on your overall financial situation. It's important to thoroughly assess all available options and consult with tax professionals or advisors to ensure that you're maximizing your tax-saving opportunities within the confines of applicable tax laws and regulations.

Deducting Costs

Costs or expenses incurred during the acquisition, maintenance, improvement, or sale of an asset can be deducted from the total gains obtained from the sale.

1. These costs may include incidental fees such as valuation, advertising, acquisition, or disposal fees.
2. Expenses related to the improvement of an asset beyond routine maintenance and repairs are also deductible.
3. Stamp Duty Land Tax and Value Added Tax (VAT) can be deducted, except in cases where VAT reclamation is intended.
4. However, certain costs cannot be deducted from your gains.
5. Interest payments on loans used to purchase the asset cannot be deducted.
6. Business expenses or fees incurred cannot be deducted from capital gains.
7. If you're unsure about which costs are deductible and how to go about deducting them, you can seek guidance from HMRC for clarification and assistance in navigating the process of deducting costs.

Reporting Losses

If you incur a loss during the sale of an asset, you have the option to reduce your total taxable gains by claiming 'allowable losses' when filing your self-assessment annual tax returns. These allowable losses can be subtracted from the overall gain you've made in the specific tax year. Moreover, you have the flexibility to claim losses for up to four years following the tax year in which the asset was sold.

Additionally, you can utilize losses that were not utilized in previous tax years, allowing you to carry forward any remaining allowable losses to future tax years. This strategy enables you to utilize your Annual Exempt Amount effectively each year while mitigating the impact of losses on your tax liabilities over time. By taking advantage of these provisions, you can optimize your tax planning and manage your finances more efficiently.

Tax Relief

As a small business owner, sole trader, shareholder, director, or private individual, you have the opportunity to mitigate or defer your capital gains tax liability on assets owned by your business through various forms of tax relief if you meet the eligibility criteria. These tax reliefs serve to reduce the amount of tax you owe or postpone the payment of tax to a later date. Some of the tax reliefs that you may qualify for include:

1. Business Assets Disposal Relief (BADR)

As an entrepreneur, if you decide to sell all or part of your company, you may qualify for a special tax relief known as Business Assets Disposal Relief (BADR). This relief allows you to pay a reduced capital gains tax rate of 10% on any profit generated from the sale of your business assets, instead of the standard rates.

BADR is available to various individuals, including partners in a business partnership who are self-employed, shareholders in a personal company, trustees who sell assets held in a trust, and sole traders. However, to be eligible for BADR as a sole trader or partner in a partnership, you must have owned the company or business for a minimum of two years from the date of the sale. By meeting these criteria, you can take advantage of BADR to minimize your tax liability and maximize the returns from the sale of your business assets.

If you're selling shares in a company, it's important to note that you must have been a shareholder for a minimum of two years before the sale. Additionally, certain conditions must be met for you to qualify as a shareholder eligible for this tax relief. Firstly, the primary business activity of the company should be trading, rather than being categorized as a non-trading entity such as an investment business.

Alternatively, the company may function as the holding company of a trade group. Secondly, you must hold a position as a director, company secretary, or employee within the company you're selling shares from, or within another company that is part of the same group as the selling company.

Furthermore, the business from which you're selling shares must have maintained its status as a personal or private company for at least two years leading up to the disposal of shares, unless the shares in question are part of an Enterprise Management Incentive (EMI) scheme. By meeting these criteria, you can potentially qualify for special tax treatment when selling shares in a company, enabling you to optimize your tax position and maximize the benefits derived from the sale of shares.

To qualify for the Business Asset Disposal Relief (BADR), you need to hold at least 5% of the shares and voting rights in the company. Additionally, you must meet certain criteria regarding your entitlement to company profits, total assets, or disposal proceeds. Specifically, you must be entitled to at least 5% of the distributable profits and assets upon the company's dissolution, or have at least 5% of the disposal proceeds from the company.

If your shareholding falls below the 5% threshold due to the issuance of additional shares by the company, you can still be eligible for relief. In such cases, you have the option to be treated as if you sold the shares and immediately purchased new ones before the issuance of the additional shares. By taking this approach, you can maintain your eligibility for BADR and potentially benefit from the associated tax relief.

2. Business Asset Rollover Relief

Business Asset Rollover Relief allows you to defer capital gains tax when you sell a company or business asset and reinvest the proceeds into another qualifying asset. By utilizing this relief, you can postpone the tax liability on the gain from the initial asset until you dispose of or sell the replacement asset. To qualify for this relief, the new asset must be acquired within three years of selling the previous one. This provision offers flexibility and encourages reinvestment in business assets, facilitating continuity and growth within the business.

3. Disincorporation Relief

Disincorporation Relief is a provision that allows limited companies to transition their business structure to that of a sole trader or a partner in a partnership business while retaining the company's business assets. This relief enables a smoother transition for businesses looking to change their legal structure. However, it's important to note that if you later sell or dispose of these business assets after claiming Disincorporation Relief, you will be liable to pay Capital Gains Tax (CGT) on any gains made from the sale. This ensures that tax obligations are appropriately addressed even after the business structure has been altered.

4. Incorporation Relief

Incorporation Relief allows individuals who operate as sole traders or business partners to convert their business structure into a limited company. This relief comes into play when all business assets, except cash holdings, are transferred to the newly formed limited company in exchange for shares. By doing so, the individual can defer the payment of Capital Gains Tax (CGT) on the transferred assets. This provision offers flexibility for business owners looking to transition to a limited company setup while minimizing immediate tax liabilities associated with asset transfers.

5. Gift Hold-Over Relief

Gift Hold-Over Relief offers a tax advantage to business owners who choose to transfer or sell their business assets, including certain types of shares, at a price lower than their original acquisition cost or current market value. Under this relief, the seller is exempt from paying capital gains tax on the transaction. However, it's important to note that the recipient of the asset will be liable to pay capital gains tax upon disposing of or selling the asset in the future. This provision aims to encourage business asset transfers and facilitate business succession planning while mitigating immediate tax burdens for the seller.

6. Private Residence Relief

Private Residence Relief is a tax benefit you can qualify for when you sell or dispose of your main home, provided it has been your primary residence for an extended period and you have full ownership of the property. To be eligible for this relief, none of the property's sections should have been used for business purposes. However, if any part of your residence has been utilized for business activities, you'll be liable to pay capital gains tax on the portion attributed to those business uses. This relief aims to exempt homeowners from capital gains tax liabilities when selling their primary residences, encouraging stable homeownership and discouraging tax burdens associated with residential property sales.

How To Report CGT

All capital gains tax obligations must be reported and fulfilled to HMRC. Unlike other taxes where you receive a bill, with CGT, it's your responsibility to calculate the tax you owe and report your profits or losses, along with your tax liability. You have two main options for reporting your gains: you can either utilize HMRC's real-time capital gains tax service, which is accessible only to UK residents, or you can include your CGT information in your self-assessment return. This ensures that you accurately report your gains and fulfil your tax obligations by HMRC guidelines.

For partnership, a specific partner within a partnership business is required to fill out a form SA803 on behalf of the partnership. When reporting capital gains tax, you need to ensure that certain key information is included. This includes details such as the date you acquired the asset and the date you disposed of it, as well as the purchase price and selling price of the asset. Additionally, you must provide information about any deductible losses, allowable losses, and tax reliefs applicable to the transaction. It's essential to accurately calculate both your capital gains and losses when reporting them, regardless of the method you choose to report your CGT.

After you've submitted your capital gains tax (CGT) report to HMRC, you'll receive either an email or a letter from them. This correspondence will contain a unique 14-character CGT payment reference number, typically starting with the letter 'X'. It's essential to use this reference number when making your CGT payment, and you can do so through HMRC's online tax payment service. If you've reported your CGT as part of your self-assessment annual report, you'll need to pay your CGT along with your self-assessment tax bill.

Records You Need To Keep

To accurately calculate and report your capital gains tax (CGT), it's crucial to maintain certain records. These records should include bills, invoices, and receipts that detail the following information: the amount you initially paid for the asset, any additional expenses related to its purchase, improvement, or disposal, details of any tax reliefs claimed, the selling price of the asset, and any contracts associated with its purchase or sale. Additionally, it's advisable to keep copies of any valuations conducted for the asset. These records should be retained for a minimum of five years following the submission of your self-assessment return.

Conclusion

For sole traders, entrepreneurs, small business owners, directors, and shareholders of a company, the obligation to pay capital gains tax arises upon the disposal of a property or asset. It's important to note that capital gains tax is calculated based on the gain realized from the sale, rather than the total selling price of the asset. Therefore, individuals must accurately report their capital gains tax to ensure compliance with tax regulations. This reporting responsibility is particularly significant for small business owners, who should prioritize the timely and accurate reporting of their capital gains tax obligations. Capital Gains Tax for Small Businesses? If you have any questions about capital gains tax for small businesses, don’t hesitate to contact us here, and we’ll do everything we can to help.