Every business needs to replace business assets at regular intervals to keep up with the changing economic and business climate and to ensure that the business is well equipped with the latest technology to cope with competition in changing times. Much of the time, the sale of items such as used plant and equipment will not give rise to any capital gain, and sometimes such items will only have scrap value. However certain business assets, including land and buildings, may increase in value over time and are likely to give rise to a capital gain when disposed of.
This would give businesses a problem if it meant that they had to pay capital gains tax immediately on the replacement of their assets, and would perhaps make them more reluctant to engage in investment for the future. To ensure that businesses are not disadvantaged by the capital gains tax provisions, the UK capital gains tax legislation includes a provision for roll-over of capital gains on the replacement of business property.
Roll-over relief on business assets
The capital gain on the disposal of certain business assets can be rolled over against the cost of the replacement asset, thereby effectively deferring payment of tax on the capital gain until the replacement asset is sold. The disposal of the original asset is considered to have occurred at no gain and no loss, and the capital gain is deducted from the acquisition cost of the new asset so that when it is sold the deductible acquisition cost will be less and the ensuing capital gain will therefore be increased.
To obtain the full roll-over relief, the whole of the sale proceeds of the original asset must be rolled over against the cost of the replacement asset. Where only part of the proceeds are used in acquiring a new business asset, any capital gain arising on the disposal of the old asset will be chargeable immediately but restricted to the amount of the disposal proceeds that are retained and not used in the purchase of the replacement asset. This means however that if the money retained is more than the amount of the gain on the original asset, the whole of that gain will be chargeable.
Conditions for roll-over relief
For the relief to apply, the original asset must have been used only for the purposes of a trade during the period when it was owned, and the replacement asset must also be used only for the trade. There is a list of certain classes of asset to which the relief can apply, though the original and replacement assets do not have to be in the same category. The list is:
Land and buildings, fixed plant and machinery; Goodwill; Ships, aircraft, hovercraft, satellites, space stations and spacecraft; Milk, potato and fish quotas, and certain EU agricultural quotas; and Lloyds syndicate rights.
To qualify for the relief, the purchase of the replacement asset must take place in the period between one year before and three years after the disposal of the original asset. The relief must be claimed not later than four years following the tax year in which the old asset is disposed of, or the tax year in which the replacement asset is acquired, whichever is later.
The roll-over relief cannot operate in the same way if the replacement asset is a “depreciating asset”, defined as an asset with a remaining useful life of sixty years or less when acquired. The capital gain on the original asset can however be “held over”, in other words deferred until a particular future event takes place. The capital gain on the original asset is not deducted from the cost of the depreciating asset, but the gain is held over until it crystallises at the time of the earliest of the following events:
The disposal of the replacement asset; The date on which the replacement asset is no longer used in a trade; or Ten years after the acquisition of the new asset.
This hold over relief is still advantageous for the business as it defers the gain by up to ten years, while the replacement asset is still in use. Also, where a non-depreciating asset is purchased before the gain crystallises, the capital gain can again be rolled over, this time against the new non-depreciating asset.
Replacement of assets by companies
The capital gains relief for the replacement of business assets is available to companies as well as unincorporated businesses. Companies do not pay capital gains tax but they are subject to corporation tax on their capital gains. Companies can obtain the relief on replacement of business assets in respect of the same categories of asset apart from quotas and goodwill. Goodwill and other intangible assets of companies are subject to a separate intangible assets regime.
HM Revenue and Customs www.hmrc.gov.uk
“Taxation” by Alan Melville, fifteenth edition 2010, FT Prentice Hall