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:|
|Less: Incidental cost of disposal||(X)|
|Less: Acquisition Costs||(X)|
|Capital Gain / (Capital loss)||X / (X)|
|Less: Indexation allowance||(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|
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|
Other things regarding the Indexation allowance:
The indexation allowance can only reduce a capital gain to Nil, it cannot create a capital loss or increase a capital loss.
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
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.
If the R.P.I factor has fallen from the month of acquisition to the month of disposal, the indexation allowance is Nil.
Indexation was frozen in December 2017 so any inflation element of a gain from January 2018 will be taxable.
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?
|Incidental costs to dispose||(£5,000)|
|Net sale proceeds||£110,000|
|Indexation allowance for acquisition||(£5,049) (W1)|
|Indexation allowance for extension||(£5,450) (W2)|
The unindexed gain is a capital gain from which indexation allowance has not been deducted from yet.
0.306 x £16,500 = £5,049
Note that the incidental costs to acquire are included (15,000 + 1,500) = 16,500.
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.