ATXP6 UK
Syllabus A4. Corporation Tax A4a. Chargeable gains for companies

A4a. Capital gains computation

Syllabus A4a)

E3 Chargeable gains for companies

How to calculate capital gains?

Capital gains and losses are netted off for each tax year

Corporation tax is paid upon this net gain.

For a company’s capital gain, the following computation can be used:
Disposal proceeds X
Less: Incidental cost of disposal (X)
Net proceeds X
Less: Acquisition Costs (X)
Capital Gain / (Capital loss) X / (X)
Less: Indexation allowance (X)
Taxable gain X
After all individual indexed gains and losses have been computed, then they must be aggregated and the following computation can be used. 
Capital Gains in tax year X
Less: Capital losses in tax year (X)
Net Capital Gains in tax year X
Less: Capital losses brought forward
Taxable Gains

This final figure is then taken to the TTP computation if it is a gain and carried forward if it is a loss.

What is the indexation allowance?

The indexation allowance is an allowance given to companies to remove the part of the gain that has been produce by increases in inflation rather than genuine increases in the value of the asset. Indexation therefore reduces the chargeable gain.

This allowance is given to companies, instead of the annual exemption.

How do we calculate the indexation allowance?

Prices increase due to inflation, therefore to avoid a company paying tax due to the increases in inflation, an indexation allowance is calculated based on retail price indexes to remove the effects of inflationary increases in the capital gain.

Total cost of asset *
(R.P.I disposal date or Dec 17 – R.P.I. acquisition date)/R.P.I. acquisition date = Indexation allowance 

You will not be expected to calculate indexation allowances in your exam. You will be given the correct figure to use.

Other things regarding the Indexation allowance:

  1. The indexation allowance can only reduce a capital gain to Nil, it cannot create a capital loss or increase a capital loss.

  2. If an asset has been enhanced, therefore capital expenditure has been incurred to improve the earning capacity of the asset, then another indexation allowance must be calculated for this enhancement expenditure. 

    The same calculation is used, replacing “cost” with the “enhancement expenditure” and the “R.P.I acquisition” with R.P.I at enhancement date. 

    Total enhancement expenditure of asset * (R.P.I disposal date or Dec 17 – R.P.I. enhancement date)/R.P.I. enhancement date = Indexation allowance for enhancement expenditure

  3. If there are incidental costs to acquisition or enhancement, for example, legal costs incurred on the date of purchase, this cost also needs to be included in the “total cost” and indexed along with it.

  4. If the R.P.I factor has fallen from the month of acquisition to the month of disposal, the indexation allowance is Nil.

  5. Indexation was frozen in December 2017 so any inflation element of a gain from January 2018 will be taxable.

Illustration:

Greenwood Ltd. disposed of an investment property on 31/12/2018.

He received disposal proceeds of £115,000 for the property and incurred legal fees on disposal of £5,000. 

He has initially purchased the property for £15,000 and incurred incidental costs on acquisition of £1,500 on 31/12/2008. 

He had spent £25,000 to extend the property on 31/12/2010.

Relevant indexation factors are:

On cost 0.306

On enhancement .0218

What is his capital gain for the tax year 18/19?

Solution:

Disposal proceeds £115,000
Incidental costs to dispose (£5,000)
Net sale proceeds £110,000
Acquisition cost (£15,000)
Extension cost (£25,000)
Unindexed gain £70,000
Indexation allowance for acquisition (£5,049)  (W1)
Indexation allowance for extension (£5,450)  (W2)
Capital gain £59,501

The unindexed gain is a capital gain from which indexation allowance has not been deducted from yet.

W1:

0.306 x £16,500 = £5,049

Note that the incidental costs to acquire are included (15,000 + 1,500) = 16,500.

W2:

0.218 x £25,000 = £5,450

Note even though the asset was not sold until December 2018, indexation is only calculated to December 2017.