How To Use Capital Losses Efficiently

Malcolm Finney illustrates that offsetting of capital losses may not be as straightforward as often thought.

Income v capital gains

The UK’s tax system distinguishes between income and capital gains. Income is subject to income tax at rates of 20%, 40% and 45%, and capital gains are subject to capital gains tax (CGT) at rates of 18% and/or 28%.

A capital gain arises when a disposal of an asset occurs. Typically, a disposal occurs when an asset is sold or even if gifted. Such assets may comprise shares; paintings; jewellery; buy-to-lets; land; foreign currency; goodwill; etc. Some assets are, however, exempt from a CGT charge on disposal (e.g. a main residence; some boats; motor cars; life insurance policies; etc).

CGT computation

To ascertain an individual’s CGT liability for a tax year requires an aggregation of the individual’s capital gains made in the tax year less any capital losses made in the same tax year further reduced by any capital losses made in earlier tax years which have been brought forward (as not having been used). Having arrived at a net figure this net figure is then reduced by an annual exempt amount to give the net capital gains chargeable to CGT. The annual exempt amount is a fixed amount of capital gains which is exempt from the CGT charge. For the tax years 2012/13, 2013/14 and 2014/15 this amount is equal to £10,600, £10,900 and £11,000 respectively.

Example 1: CGT computation

Sammy Small sold the following assets in the tax year 2013/14 making capital gains of £12,000; £10,500 and £22,000.

He also sold one asset realising a capital loss of £15,500.

Sammy’s net capital gain = [£12,000 + £10,500 + £22,000] - £15,500 = £29,000

Net capital gain chargeable to CGT: £29,000 - £10,900 = £18,100

It is important to note that capital losses of a tax year must automatically be offset against any capital gains for that tax year. This may mean that the annual exempt amount is wasted.

Example 2: Wastage of annual exempt amount

Mary Tall sold two assets in the tax year 2013/14, making a capital gain of £10,900 on one asset and a capital loss of £10,000 on the other asset.

This produces a net capital gain of £900 which is reduced to nil (and hence no CGT charge) when the £10,900 annual exempt amount is deducted.

However, £10,000 (ie £10,900 less £900) of the annual exempt amount has been wasted.

Although £10,000 of the annual exempt amount of £10,900 was not used in 2013/14, it cannot be carried forward (or backward) for use in a later (or earlier) tax year; it is lost forever.

Example 3: Deferring a capital loss

Mary (in Example 2) could have avoided this situation if she had deferred making the capital loss to the next tax year 2014/15.

In this case she would still have had no CGT liability for 2013/14 (ie £10,900 less £10,900) and, in addition, would have a capital loss of £10,000 to use in the tax year 2014/15 and/or later tax years.

Capital losses brought forward

Where capital losses are brought forward from one or more prior tax years such losses may be offset against any net capital gains as appropriate so as to avoid losing any annual exempt amount.

Example 4: Effective capital loss utilisation

Tom White made capital losses of £3,000 and £4,000 in the tax years 2011/12 and 2012/13 respectively. Tom thus had £7,000 of capital losses to carry forward.

In the tax year 2013/14, he made a capital gain of £13,900 and a capital loss of £2,000.

Net capital gain 2013/14: [£13,900 - £2,000] - £1,000 - £10,900 = £nil

Net capital gain chargeable to CGT = £nil

Note only £1,000 of the capital loss of £7,000 was used. This then left £10,900 subject to CGT before deduction of the £10,900 annual exempt amount, reducing net capital gain to nil.

Thus, £6,000 of the £7,000 capital losses brought forward remain available to be carried forward.

Thus, whereas capital losses of a tax year must be offset against capital gains for that tax year, capital losses brought forward may be used in such a manner so as to maximise use of the annual exempt amount.

Other uses for capital losses

As indicated above, capital losses are used primarily to reduce the amount of capital gains subject to CGT.

However a capital loss, which arises on a disposal of shares in certain trading companies or in respect of which enterprise investment scheme income tax relief was attributable, may be offset against income (not capital gains) of the tax year in which the capital loss is incurred and/or the preceding tax year.

Practical Tip :

Before making a disposal of an asset, check whether it may be more CGT efficient to perhaps defer disposal to the following or later tax year.