Casebook - Arthur's Good Result

MARK McLAUGHLIN ATII, ATT, TEP and MICHAEL DAWSON MA, FCA, ATII of Forbes Dawson explain how allocating gains between new assets can work to the taxpayer's advantage for capital gains tax rollover relief purposes.

UNCLE ARTHUR AND his nephew Terry are in partnership together, having operated a successful car wash business for a number of years. Profits are divided 60:40. They sell the business in August 2003, realising gains (before taper relief and annual exemptions) as follows:

New trades

Soon afterwards, in order that, for capital gains tax rollover relief purposes, on the replacement of business assets the old and new trades are regarded as carried on 'successively' under Statement of Practice 8/81 and reinvestment takes place within the statutory three-year period for claiming the relief, Arthur and Terry decide to buy two new businesses, namely, a used car showroom and their local public house (the Winchester). The combined cost of qualifying assets, i.e. land and buildings and goodwill, is £1.1 million, attributable as follows:

Both individuals have therefore reinvested their full shares of the proceeds from the sale of the car wash business, enabling their entire gains to be rolled over against the cost of qualifying assets in their new trades under section 152(1), Taxation of Chargeable Gains Act 1992.

A change of plan

Arthur and Terry intend holding on to the public house for the long term. After all, owning their local public house is a dream come true for them. However, following problems with the local Trading Standards Office, Arthur and Terry decide that they should sell the used car showroom, only ten months after acquiring it. They accept an offer of £450,000 for the land and buildings and goodwill in June 2004. The proceeds belong to Arthur in accordance with his initial capital contribution. He intends using the net proceeds as his retirement fund, and wants to ensure that 'the taxman sees as little of it as possible'.

Arthur and Terry seek tax advice from their accountant, who recommends that Terry claims rollover relief on his share of the car wash business gain. While mindful of the fact that 75 per cent business asset taper relief is effectively wasted if rollover relief is claimed, the accountant concludes that this is not a problem as Terry intends running the public house for much longer than the two-year period necessary to accrue maximum business asset taper relief in respect of the new business. Terry is warned that the tax rules could always change for the worst in the future, but he is optimistic that capital gains tax will be abolished soon anyway!

Rolling over?

However, Arthur is rather less impressed when he is advised to claim rollover relief as well. One of Arthur's friends (a regular at the Winchester, who apparently knows everything) told him that not only would full taper relief be lost in respect of the gain on the car wash, but that a proportion of the car wash gain would become chargeable when he sold the used car showroom.

Was Arthur's friend correct? The answer is 'yes' and 'no'. Yes, because as explained the taper relief 'clock' is reset for a new business asset when a gain is rolled over from the old business asset. No, because there are no specific rules dealing with the allocation of gains if more than one qualifying asset is acquired. There is a general 'just and reasonable' apportionment provision in section 52(4), Taxation of Chargeable Gains Act 1992, but the Revenue's Capital Gains Manual indicates (at paragraph 60775) that the taxpayer's allocation of the gain against the cost of the new assets is acceptable.

Which asset?

Arthur's gain from the car wash was £300,000, which was also the capital gains tax base cost of his share in the public house. His gain should therefore be allocated against the base cost of the public house as follows:

The allocation of the car wash gain against the public house assets is disclosed by the accountant when submitting Arthur's tax return and supporting capital gains tax computation and rollover relief claim to the Revenue. The effect is that on a future disposal of the public house, Arthur's base cost is reduced to nil, although 75 per cent business asset taper relief is in prospect to reduce the gain after two years. His gain on disposal of the used car showroom is limited to £50,000, i.e. proceeds of £450,000 less unrestricted base cost of £400,000. Arthur defers this gain by investing it in a venture capital trust. He learns that the rolled-over gain from the car wash into the public house could escape tax on his eventual death, and that the deferred gain from the used car showroom into the venture capital trust would not be triggered by his death.

Make it a double!

Arthur heads to the Winchester to celebrate the receipt of a good amount of money from the sale of the car wash business and used car showroom, with no immediate tax to pay and the possibility of escaping tax on rolled over and deferred gains completely. This was 'a good result'!

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