Capital Gains; Who loses?

By Hugh Scanlan

OVER the past 25 years or so, since their introduction in the mid '70s, Capital Acquisitions Tax (CAT) has posed the major worry for farmers, while Capital Gains Tax (CGT) has been significantly less of a problem.

These roles have now tended to be reversed and quite a few farmers are being caught unawares, with hefty CGT bills, as a result.

This situation has come about for a number of reasons -

• The raising of Agricultural Relief to 90 per cent of the market value of qualifying agricultural assets, combined with the indexation of the tax exempt thresholds, means that the vast majority of farm transfers no longer give rise to a CAT liability.
• Increased demand, and prices, for land suitable for sites, residential developments, motorway by-passes, waste treatment works, etc, mean that more farmers are now selling lands giving rise to significant capital gains. Milk quota sales have also exposed farmers to a liability for CGT.

Details of CGT

Capital Gains Tax (CGT), as the name implies, is a tax which is levied on any gains arising on the disposal of a capital asset.

It is important to note that a "disposal" is the transfer of an asset by either sale or gift. It does not arise on inheritances.

The tax is levied on the person who makes the transfer. So if you give an asset away for nothing, you could end up with a CGT bill!

The capital gain is the difference between the cost price, or market value in 1974, adjusted for inflation, and the selling price (less the sale costs), or market value, if not sold.

How the tax is calculated is best illustrated by an example. Assume that a farmer sells two half acre sites for £30,000 each. He bought this land for £2,000 per acre, in 1983 so the relevant inflation multiplier is 1.68.

After deducting legal and auctioneering fees, and the annual personal exemption, the capital gain is £53,640.

The standard rate of CGT is levied at 20 per cent of the taxable gain, with development land being subject to 40 per cent tax.

However, a concession exists, until April 5, 2002, whereby gains on the disposal of development land, the whole of which has planning permission for residential development, or is zoned for residential development in a current County Development Plan, are taxed at 20 per cent.

After this date, gains on the disposal of development land, which is zoned for residential development, will be taxed at 60 per cent.

Having zoning/planning permission has an enormous impact on the amount of tax that has to be paid.

Retirement reliefs

Farmers can avail of two significant forms of relief from CGT, when they dispose of all or part of their lands, subject to certain conditions. Commonly referred to as "Retirement Reliefs", these seem to be giving rise to quite a lot of confusion, not merely among farmers, but also among some of their advisers, and there have been a number of cases where unexpected CGT liabilities have been incurred, as a result.

1. Inter family transfers:- A person aged over 55 years can transfer all or part of his/her land to a son or daughter, without incurring any CGT liability, provided that they have owned and farmed this land for a period of at least 10 years prior to the transfer.

This relief can apply to transfers to a niece or nephew who has worked substantially, on a full time basis for five years prior to the disposal.

2. Transfers outside of the family:- Relief is also available, under the same conditions, where the transfer is to an unconnected person, provided the value of the transfer does not exceed £250,000. Marginal relief applies if the value exceeds this amount.

It should be obvious that these reliefs cannot be claimed unless the landowner meets all the conditions but there seem to be quite a few who misunderstand this.

The most common problem arises because of the requirement to both own and farm the land for the 10 year period prior to making the transfer. Under the regulations, leased land, or land let on conacre, do not qualify as farming and many overlook this fact.

It is interesting to note that the Income Tax regulations encourage leasing by those aged over 55 years, so these two elements of the tax code do not seem to gel together very well.

It is also worth noting that these reliefs can apply to land which has been owned for less than 10 years, in situations where this land was purchased to replace land previously disposed of, provided the combined ownership period amounts to at least 10 years.

Treat all transfers with care

It is important to treat all transfers with care and not to assume that there is no CGT liability involved, or that one transfer does not have CGT implications for later transfers. For example -

• Once a person reaches 55 years of age, all disposals of qualifying assets are aggregated together when it comes to deciding whether or not the £250,000 exemption threshold has been breached.

So a transfer of qualifying assets valued at £200,000, will not give rise to a CGT liability but, a subsequent transfer, valued at £100,000, will bring that person into the net.

• If qualifying assets are being transferred, the £250,000 relief will be applied, irrespective of whether or not you need to avail of it.

Take a situation where a person aged over 55 years disposes of qualifying assets worth £500,000, and pays the required amount of CGT.

If that individual subsequently disposes of £50,000 worth of qualifying assets, he/she will not be entitled to claim the retirement relief on it, because it will be deemed to have been used on the earlier disposal.

This is the case, despite the fact that they will have gained no benefit as a result of the relief being applied to the earlier disposal.

• The other side of the coin is that, if you are over 55 years of age and dispose of an asset that has not been owned for 10 years, you do not erode the £250,000 threshold.
• Transfers between spouses, who are living together, are not liable to CGT but these transfers can significantly affect the availability of the £250,000 retirement relief threshold.

Take the situation of a 54 year old farmer who owns £600,000 of land, which he has farmed for at least 10 years. He transfers £300,000 worth of this to his wife and, by so doing, may enable both of them to qualify separately for the £250,000 retirement relief, once they reach 55 years of age.

Note that, in order for this to happen, the wife does not need to have owned the land for 10 years but she will need to prove that she has been actively involved in farming it during the 10 years preceding the disposal. In other words, she will need to be a partner in the business.

If this farmer waits for another year, until he is 55, in order to make the transfer to his wife, he will be deemed to have used up his £250,000 retirement relief.

Being unaware of this, clearly, presents problems for this farmer because he may assume that he can claim it and end up making a transfer which will leave him liable to CGT.