Businesses replacing assets – how to roll over the gain?

Friday, May 11, 2018

What does it mean to roll over the gain? Rolling over the gain is a way of deferring the tax charge which arises when a business sells an asset at a gain and replaces it with another. Provided that the entire sale proceeds are used to buy the replacement, the tax arising on the first asset need not be paid until the second asset is sold. And if the sale proceeds of the second asset are again reinvested, the tax can be deferred a second time. In theory, it is possible to defer the tax continuously in this way until the business is eventually sold.

 

The idea is that no tax should be payable as long as the funds are still tied up in the business. The deferred tax can be though of as an interest free loan from HMRC, to be repaid when the money becomes available once the replacement assets have served their purpose.

There are two types of rollover relief, one for capital assets such as land, and plant and machinery used in the business, the other for intangibles such as intellectual property and goodwill. Both types of relief are similar in their operation, but with subtle differences. In this article we shall be concentrating on capital assets.

How does rollover relief work?

The relief only applies to assets used in a trade, as opposed to an investment business such as property letting. The trade may be conducted by an individual, whether as a sole trader or in partnership, or by a company. It is also possible for an individual to claim relief where he owns the asset personally, but it is used in the trade of his personal company. A company is an individual’s personal company if he holds at least 5% of the voting rights.

It is possible to “mix and match” where a person has more than one trade. In other words, the gain on an asset used in one trade can be rolled over into an asset used in a different trade. This concept extends to corporate groups where one company can roll over the gain into an asset acquired by another member of the group.

The way in which the relief works is as follows:

  • The old asset is treated as having been disposed of on a “no gain no loss” basis – so no tax is due at the point of sale;
  • The base cost of the new, replacement asset is reduced by the gain arising on the sale of the old asset – this is the “held over” gain;
  • The held over gain is brought into the tax net when the new asset is sold, or otherwise disposed of. But the held over gain can be “carried over” if a further rollover claim is made;
  • Partial relief applies if only part of the sale proceeds of the old asset are used to acquire the new asset. In these circumstances, only part of the gain will be held over, the other part will be immediately chargeable;
  • If the new asset is a depreciating asset, the held over gain is brought into charge at the end of ten years, unless a further rollover claim has been made. However, the charge is brought forward if the asset has been disposed of, or is no longer in use before that date. A depreciating asset is an asset with a predictable life not exceeding 50 years, or an asset whose predictable useful life will satisfy this condition within ten years of purchase. Without this rule, it might not otherwise be possible to recover the deferred tax –one could simply hold on to the new asset until its value depreciates to such a negligible amount, that no one will buy it!

The following time limits apply:

  • Firstly, the sale proceeds need to be reinvested within a certain time period – the business has three years in which to acquire a new asset OR the sale proceeds can be “backdated” to apply to any relevant trading asset that was acquired within the previous year  – “three years forward, one year back”;
  • Having reinvested the proceeds, one must then make a claim for relief. The time limit is four years from the end of the relevant tax year. The relevant tax year is the year in which the new asset was acquired, unless it is a “backdated” claim, in which case time runs from the tax year in which the old asset was sold.

Example 1 – full relief when entire proceeds reinvested

Consider the case of a company whose business is expanding and has decided to move from its old premises to brand new offices. The company holds a long leasehold which it acquired for a cost of £100,000. The lease is sold for £300,000, and the company subsequently enters into a new lease, paying a premium of £400,000.

The gain on the disposal of the old lease is calculated as follows, assuming an allowable expenditure of £50,000:

 

£

£

Sale proceeds

 

300,000

Less

Base cost

100,000

 

Allowable expenditure

50,000

 

 

 

(150,000)

Gain

 

150,000

 

The entire sale proceeds of £300,000 have been reinvested in acquiring the new business premises. If the acquisition takes place within the required timeframe, full rollover relief is available. No tax is payable on the disposal of the old lease, but the gain is rolled over into the acquisition cost of the new premises:

 

£

Actual cost of new premises

400,000

Less rolled over gain on old premises

(150,000)

Adjusted base cost

250,000

 

By reducing the base cost, the deferred tax is triggered on a subsequent disposal of the new premises. For example, suppose that the new lease is subsequently sold for £700,000. Assuming an allowable expenditure of £50,000 the following gain becomes taxable:

 

 

£

Sale proceeds

 

700,000

Less

Adjusted Base cost

250,000

 

Allowable expenditure

50,000

 

 

 

(300,000)

Gain

 

400,000

 

The following is the gain that would have been taxable had no rollover relief been claimed:

Sale proceeds

 

700,000

Less

Base cost

400,000

 

Allowable expenditure

50,000

 

 

 

(450,000)

Gain

 

250,000


The result of claiming rollover relief is an increase in the taxable gain by £150,000. This is the exactly equal to the gain held over on the sale of the old lease.

It is important to note that the adjustment to the base cost of the new asset is only made by the person claiming the relief. The tax position of the person selling the new asset is not affected. So in this example, the person granting or assigning the new lease to the company is still treated as having received a sum of £400,000, not the reduced amount of £250,000.

Full rollover relief requires the entire sale proceeds to be reinvested. However, partial relief may be available where only some of the proceeds have been applied in buying the new asset, as long as the amount not reinvested is less than the gain. If a claim for partial relief is made, the following rules apply:

  • The disposal of the old asset gives rise to a tax charge, but the gain is reduced to the amount of the sale proceeds that have not been reinvested;
  • The amount by which this gain is reduced is rolled over into the acquisition cost of the new asset.

Example 2 – partial relief when entire proceeds reinvested

The same facts as in Example 1, except this time, the company pays a premium of £200,000 on acquiring its new business premises. So out of the £300,000 received from selling the old premises, £100,000 has not been reinvested.

The gain on the old lease is calculated as follows:

 

 

£

£

Sale proceeds

 

300,000

Less

Base cost

100,000

 

Allowable expenditure

50,000

 

 

 

(150,000)

Gain before partial rollover relief

 

150,000

Partial rollover relief

 

(50,000)

Gain reduced to amount not reinvested

 

100,000

 

The acquisition cost of the new lease is:

 

£

Actual cost of new premises

400,000

Less partial rollover relief for old premises

(50,000)

Adjusted base cost

350,000


What assets are eligible for the relief?

Relief is only available for specific assets that are listed in the legislation. Both the old asset and the new must be on this list, but there is no requirement for the new asset to be of the same class as the old. So it is not necessary to exchange one set of business premises for another – in the above examples, rollover relief would have been available if the business had bought new plant and machinery with the sale proceeds.

Author’s suggestion – put the following text in a box:

The following list applies to individuals, trustees and other non-corporate persons carrying out a trade:

  • Land and buildings
  • Fixed plant or machinery
  • Ships, aircraft and hovercraft
  • Satellites, space stations and spacecraft (including launch vehicles)
  • Goodwill*
  • Milk quotas and potato quotas*
  • Ewe and suckler cow premium quotas*
  • Fish quotas*
  • Payment entitlements under EU farm subsidies*;
  • Lloyd’s of London members’ syndicate rights*.

*Denotes an intangible asset.

For companies subject to UK corporation tax, the list is modified. All those items which constitute intangible assets are removed from the list so that rollover relief is only available in respect of the remaining items. This is because profits and gains arising on corporate intangibles are not taxed under the capital gains regime but on revenue account. There is a separate relief whereby the gain on an intangible asset can be rolled on acquiring another intangible asset.

Practical points – don’t throw away the receipts!

A business should normally keep records for the purpose of capital gains tax computations as a matter of course. However, one should also bear in mind that these computations will be require adjustments when making a claim for rollover relief. This is especially the case if there is a series of rollover events with a long gap between the original claim and the final sale which triggers the deferred liability.

Conclusion

Rollover relief is an important relief in the armoury of business owners. With careful planning, it can be used to defer tax which would otherwise be effectively employed in the trade.