How Capital Gains Tax (CGT) works – a guide for contractors

Capital Gains Tax is charged when you sell or dispose of an asset which has grown in value and you have made a profit from the sale. Here we look at how the CGT rules work in practice.

Under the CGT tax regime, you are only taxed on the amount you have gained, rather than on what you have received for the overall sale of an item/asset.

For example, if you were to buy a valuable watch for £5,000 and sell it for £15,000, you would have gained £10,000. That’s the £15,000 sale minus the £5,000 original purchase price.

You would face a potential tax liability on the £10,000 gain, as this is the amount you have profited.

Some disposals are tax-free

Some assets are considered tax-free, such as gifts between a husband, wife, civil partner or charity.

However, this is only if you are still with your partner and they plan to keep the item.

If you are separated or have stopped living together during the tax year, or the goods you gave them were deliberately sold on as a business venture, they may be required to pay tax.

The Annual Exempt Amount

You won’t need to pay Capital Gains Tax on the value of any gains which fall below the tax-free allowance (or Annual Exempt Amount).

The exempt amount has been eroded significantly over the past years – from £12,300 in 2022/3 to £6,000 in 2023/4.

For the 2024/5 tax year, the exemption is a mere £3,000.

You don’t pay Capital Gains Tax on any premium bonds, government gilts, lottery winnings or betting wins.

What do you pay CGT on?

Items you may find yourself paying Capital Gains Tax for include almost all personal possessions with a value higher than £6,000, aside from your car.

Additionally, if you sell a property that isn’t considered your main residence or sell your main home that you have let out or used for business purposes, you will need to pay CGT.

You will also pay capital gains tax on any business assets or shares, apart from assets held in an ISA.

On top of this, if you inherit assets from someone who has died, you may need to pay Capital Gains Tax if you later dispose of this asset, even if it has been subject to inheritance tax previously.

Selling is not the only way to dispose of an asset. Also included in the definition of disposal are giving the asset away as a gift or transferring it to another individual.

Additionally, you could swap the item for something else or receive compensation for the asset if it has been lost or destroyed and you are getting an insurance payout.

There are different rates of CGT

The amount you need to pay for Capital Gains Tax depends on your earnings.

If you are a basic rate income taxpayer, how much you pay will vary depending on the size of your gain, whether it has come from a residential dwelling or another asset, and what your other taxable income is.

Disposals falling within the prevailing basic rate band are taxed at 10% (or 18% for residential properties).

If you are a higher rate taxpayer, you pay either 20% on any gains from assets or 24% on anything gained from residential dwellings.

Here are the CGT rates for the 2024/25 tax year:

BADR (formerly Entrepreneurs’ Relief)

It is worth noting that you may be eligible for Business Asset Disposal Relief (Entrepreneurs’ Relief), which can help to reduce the amount you need to pay in Capital Gains Tax if you are disposing of a business asset that would otherwise require you to pay tax on your gains.

Instead of the standard rates, you would be required to pay a 10% tax on all gains of any qualifying asset up to the current lifetime limit of £1m.

This includes selling shares or securities in a business in which you have a minimum of 5% shares or voting rates, any assets that you lent to your company, shares you got after 5 April 2013 through the Enterprise Management Incentive (EMI) scheme, or if you dispose of all of your business, or part of it, as a sole trader or business partner.

This includes any business assets disposed of after the sale.

Entrepreneurs’ Relief is now known as Business Asset Disposal Relief. You can read our in-depth guide here.

Can I close down my company and extract the capital?

If you’re planning to exit contracting or take an extended break, you may be able to close down your limited company and claim Business Asset Disposal Relief (formerly Entrepreneurs’ Relief) when extracting any remaining cash.

However, this largely depends on your personal circumstances.

You need to demonstrate that any substantial funds remaining on the company’s balance sheet were for trading purposes; otherwise, the company could be classified as a close investment company (CIC), which may have different tax implications.

Anti-avoidance rules, introduced in April 2016, target the artificial use of Members’ Voluntary Liquidations (MVLs) and participator loans to extract capital from companies at lower tax rates.

These rules are designed to prevent individuals from using these methods purely for tax benefits.

If you’re considering closing down your company, seeking expert professional advice is crucial to ensure you proceed in the most tax-efficient manner.

For more information, read the GOV.UK CGT guides.