Corporation Tax, Capital Gains Tax & Indexation

Many investors find themselves confused by Capital Gains Tax, so let’s have a think about this tax and when it would come into play. When you’re talking about Capital Gains Tax, you might imagine that it covers capital increases in the value of the property – but Capital Gains Tax isn’t really about this.

Capital Gains Tax is primarily a tax for someone who holds an investment and who finds (at some point in the future) that they need to sell the investment. However, HMRC does not see Capital Gains Tax as being a tax for someone who buys (in our case) a property, and who then decides to hold it for six months (or a year) just to try to get the benefit of a Capital Gains Tax Allowance.

In fact, if HMRC has even the slightest inkling that this is what you’re doing, then they will look at “the intent” – and they would consider the intent to be that you were perhaps wanting to flip properties. They would assume that in order to use Capital Gains Tax Allowance, that you bought the properties in your own name and have sold them to try and use this allowance. In this scenario, HMRC would not be happy.

As such, the purpose of Capital Gains Tax on the Capital Gains Tax Allowance is really for anybody who has held an investment for a long time and who has found that they needed to sell. So, if you purchase buy to lets in your own name and keep them, and if your intention is to keep them but perhaps at some point in the future you sell them, then this would come under Capital Gains Tax and you’d be able to use your allowance.

But if instead you wanted to flip properties, then HMRC would say that this is a trade and that this is trading income. As such, and assuming that you’re doing this in your own name, you would pay Income Tax and wouldn’t be able to use Capital Gains Tax and Capital Gains Tax Allowance.

With all this in mind, let’s have a think about Capital Gains Tax, Corporation Tax and holding our properties in a limited company, which is probably the most tax efficient route following the changes to Section 24.

One of the big problems with owning your properties within the corporate structure and with Corporation Tax is that you won’t get the equivalent of a Capital Gains Tax Relief when you sell.

It hasn’t always been this way, in fact things were very different before 1^st January 2018 when Indexation was scrapped. Up until the end of last year, if you sold an asset within a limited company you would head over to HMRC’s website and would refer to the Indexation Table which would tell you how much to inflate your asset using a multiplier.

To give an example, if you’d purchased a property for £50,000 five years back and then sold it for £100,000, you would inflate the £50,000 purchase price by the multiplier in the table. This multiplier would take into account inflation, so, the £50,000 would have inflated to say £75,000. Then, rather than pay Corporation Tax on the full £50,000 (the difference between the purchase price and the sale price), you would only pay Corporation Tax on the difference between the inflated figure and the sale price. In which case, in this scenario, instead of paying tax on £50,000, you would only pay tax on £25,000.

Sadly, this has been scrapped. So, this is how things are when we own our properties in a limited company.

Now let’s think about what happens when we own them in our own names – and let’s think about the rates we might be paying if we were paying Capital Gains Tax.

The Capital Gains Tax Allowance for 2017/18 was £11,300 and for this new tax year, this figure has gone up to £11,700. This is the amount that we can get tax free.

However, you might be wondering what happens to the amount that isn’t tax free. Unfortunately, the Government isn’t looking particularly fondly on property investors. They’ve now brought in a double band of Capital Gains Tax for properties and another band for other types of investments.

On normal investments such as stocks and shares etc., if you’re in the higher bracket then you’ll pay 20% on the chargeable gain. However, on property investments if you’re a higher rate tax payer then you’ll pay 28% on the chargeable gain. This is quite a jump.

This can be compared to those in the lower tax bracket. If you’re a lower rate tax payer, you pay somewhat less. If it’s just a general investment that isn’t property, i.e. stocks and shares, then you would pay 10% on the chargeable gain. But, if it’s a property investment, then you would pay 18% on the gain. Again, a considerable jump!

Having said this, the received wisdom is still that the best way forward today is to go into a limited company. Whilst the situation isn’t ideal – especially with Indexation Relief now gone – you have to think that with Corporation Tax at 19%, at least it’s just 19% and not 28% if you’re a higher rate tax payer.

Here’s to successful property investing

Peter Jones B.Sc FRICS

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