To take advantage of indexation relief, yet be taxed personally
Indexation relief provides relief for the effects of inflation, and therefore whilst it may not be a significant relief in times of low inflation, when the RPI rises rapidly it can amount to a substantial sum. For instance individuals who had owned assets at March 1982 and who sold after April 1998 used to be able to qualify for indexation relief roughly equivalent to the cost of the asset. Therefore for long term holders indexation relief can be very attractive.
After 2008 the rate of CGT was reduced to 18% (with the top rate now being 28%), but indexation relief and taper relief have both been withdrawn.
This doesn’t apply to companies though. Even on disposals after April 2008 companies can qualify for indexation relief based on the RPI’s at acquisition and disposal.
So how can individuals still obtain indexation relief?
There is still one occasion where indexation relief can be taken into account for individuals and this applies when an offshore company is used.
In terms of CGT, offshore companies are exempt from corporation tax on any investment gains. However to combat the potential misuse of this by UK residents, when you have a UK resident owning shares in an offshore company, one of the anti avoidance rules applies to attribute gains of the offshore company to the UK shareholders (see Capital Gains Tax anti avoidance rules).
So if you have UK residents owning a property via an offshore company, although the company itself may be exempt from tax on any gain, the UK residents could be taxed on the gains of the company.
The UK resident shareholders are taxed according to their respective shareholding in the company, subject to a de minimis limit of 10%.
Therefore if a shareholder owned 25% of the shares in the offshore company they would be charged to CGT on 25% of the company gain. If they only owned 5% there would be no attribution of the gain.
The crucial point to note though is that the gain that is attributed to the UK resident shareholders is the gain based on the company tax rules.
So the company gain will taken into account indexation relief right up to the date of disposal.
When the gain is then attributed to the shareholders it is subject to CGT at 18% or 28% depending on their other income.
There is therefore a good combination of indexation relief and the individuals 18%/28% rate of CGT.
Indexation relief can be particularly useful where there is a large base cost. So if you had a large base cost of £500,000 for instance, indexation relief of just 5% would represent a deduction of £25,000.
One point to bear in mind is that any extraction of proceeds from the offshore company back to the UK would be charged to income tax.
There are however provisions to offset the CGT charged on the individual against any CGT on the shares in the offshore company if they liquidate the company. However, if you did want to maximise the benefit of this establishing non residence and extracting cash as a dividend free of income tax would be a good option.
It’s also worth noting that this advantage does not depend upon the shareholder being a non-domiciliary. It applies as well to UK domiciliaries. The above also applies where gains arise within a non-resident company held in an offshore trust.