Capital Gains Tax planning
Capital gains tax on investment gains is currently charged at reasonably low rates (10% and 20%) especially if you are a basic rate tax payer. Tax on second homes has been kept higher (18% and 28%) and with the new rule that tax on the sale of a second property has to be accounted for and paid within 30 days it is clear that the Government is taking a penal attitude towards investing in residential property.
However, certainly for investment gains, there are many tools that you can use to reduce your liability to Capital Gains Tax. For the majority of investors, with the tools that are available, Capital Gains Tax effectively becomes a ‘voluntary tax’ paid by those who fail to take appropriate action at the proper time.
Proper record keeping is essential
You should keep accurate records of every purchase and sale of assets that are likely to involve you in making capital gains over time.
If you sell a portfolio of shares and do not have proper records to hand, you are likely to find that the professional fees for calculating your liability to Capital Gains Tax make an unwelcome dent in the gain that you have made.
If you inherit assets you should keep a record of their valuation at the date of the donor’s death, which you should obtain from the solicitor or executor handling the deceased person’s estate.
If you have gains from both residential property and other assets you can set the annual exempt amount against the gains that would be charged at the highest rates
Make use of the annual exempt amount
If you decide to dispose of an asset you should be aware of the annual exempt amount and whether you have already used up some or all of this in the current financial year.
So, for example, if you wish to sell a second property that you own, you might wish to delay the sale until the next tax year if you have already used up your Capital Gains Tax exemption elsewhere in the current tax year. The same might apply if you wish to dispose of a large shareholding. It might make sense to sell half of the shares now and the other half at the beginning of the next tax year so that you use the annual exemption twice.
Of course, tax is only one consideration and you will have to take account of the fact that the price of your property or shares might fall while you delay, or indeed, you might be in a hurry to realise the capital.
As the Capital Gains Tax annual exemption is not cumulative and is lost if not used, you should be aware of the usefulness of ‘crystallising gains or losses’ in a tax year.
Such gains or losses can also be transferred to your spouse (i.e. by transferring the asset to them) to be used by them.
By taking positive action before the tax year end you may be able to save 20% on your Capital Gains Tax bill and recoup part of the loss you have suffered on a disappointing investment.
A benefit of using investment portfolios held on an online investment platform is that it is very much easier to monitor capital gains rather than having individual investments with a selection of investment houses. It is also easier to ‘wash out’ gains each year by selling units which have made gains and repurchasing units in other funds (or in cash for 30 days).
Whenever portfolios are ‘rebalanced’ the effect is to wash out gains well within the annual exempt amount.
Moving money from a General Investment Account into a Stocks and Shares ISA Account each year also allows gains to be dealt with annually.
In these notes ‘spouse’ includes civil partner. As each spouse has their own annual exempt amount and the rate of Capital Gains Tax is determined by adding the gain to your income it makes sense to:
- hold assets in joint names, where possible, so that any gain can be reduced by two annual exempt amounts and any gain can use up any excess of basic rate tax allowance for both of you, and
- transfer assets from you to your spouse if you have already used up your Capital Gains Tax exempt amount for the year. It is particularly important for higher-rate taxpayers to pass assets to a basic rate or non tax paying spouse.
Dealing with losses
If you have already made capital gains within the current year which would otherwise be covered by the annual exemption, you might want to consider deferring the sale of the asset which will produce a loss until the next tax year. Otherwise you could be effectively wasting the losses.
If you are carrying forward a loss from a previous tax year or years you have to offset it against any gains in the current tax year that are in excess of the annual exempt amount. However, once you have done that you can continue to carry forward to future years any excess loss which is not required to reduce your current gain to the level of the annual exempt amount.
Use of tax efficient investments
There is no Capital Gains Tax to pay on ISAs, National Savings Certificates, Gilt-edged securities, qualifying corporate bonds or VCTs (venture capital trusts).
The gains made on Life Assurance Bonds will not involve you in Capital Gains Tax. In this case, however, you are not escaping the payment of tax, it is just that the life assurance company has already paid corporation tax on the profits made by the underlying funds so you do not have to pay it again.
Enterprise Investment Scheme (EIS)
Enterprise investment schemes are very high risk investments and not suitable for most investors but they are useful in the right circumstances.
Where you have become liable for a taxable capital gain you could use an Enterprise Investment Scheme to delay paying the tax and possibly to remove it altogether. You would do this by reinvesting the taxable capital gain in an Enterprise Investment Scheme.
Deferring the chargeable gain in this way means that it is reduced by the effects of inflation and by a further annual exemption in the year that the Enterprise Investment Scheme is encashed.
If you were to die with the chargeable gain outstanding it is not payable by your estate.
The rate of Capital Gains Tax is determined by adding the gain to your other taxable income as a ‘top slice’. Therefore, if you can reduce your other taxable income you may be able to reduce the rate of tax on a capital gain.
Making an additional pension contribution in the same tax year as the gain is created could therefore reduce the resultant Capital Gains Tax charge.
Bed and breakfasting
Let us assume that you have shares, which have increased in value by an amount just within your annual exemption after available reliefs. You could previously have sold the shares, creating a gain, which escaped Capital Gains Tax. If you immediately bought the shares back, the ‘new’ shares would have had a new higher base cost, reducing your gain at a subsequent disposal.
Because shares were often sold last thing one day and bought first thing the next, the practice became known as ‘bed and breakfasting’. In 1998 an enforced delay was introduced so that there has to be 30 days between the sale and repurchase of shares in the same company or fund for any gain to be created. This spelt the death of ‘bed and breakfasting’.
Bed and spousing
We have seen that if you transfer assets, such as shares or units in a fund, to your spouse, their gain on a subsequent disposal would be based on your acquisition cost.
Instead, suppose you sell the shares or units, and at the same time your spouse buys identical shares or units. The eventual gain made by your spouse on disposal will be based purely on their own period of ownership. The gain on your shares or units has been crystallised without a Capital Gains Tax liability arising, and without the investment risk of a 30 day delay.
Both spouses can crystallise gains in this way.
Bed and ISAing
The 30 day rule does not apply where shares or units are held in different products. If you are using an online investment platform such as a wrap platform or fund supermarket you can therefore sell shares or units in a General Investment Account and immediately repurchase those same shares or units in a stocks and shares ISA Account.
Providing tax free ‘income’
Investors in shares or unit trusts typically rely on dividends to provide them with an income. Such dividends can be quite variable and are typically only paid twice a year. Dividend income after the first £2,000 a year is also taxed at the ‘top slice’ of a person’s income.
ISAs are the most efficient way of producing tax free income, however, even with an allowance of £20,000 a year, some people might need more tax free ‘income’ than can be obtained from an ISA portfolio.
Mr and Mrs Lawrence have recently retired and both enjoy large final salary pensions which together with their State pensions means that they are both higher-rate tax payers. Mr Lawrence has recently inherited £500,000 from his mother’s estate and wishes to invest this to produce further income. He and Mrs Lawrence have already invested their full ISA allowances for this year.
They have considered a buy-to-let but paying higher-rate tax on the rental income and 28% on any capital gains is not attractive.
The £500,000 could be invested in a General Investment Account in their joint names using a suitable portfolio. From this they can have easy access to their capital should they decide to purchase a buy-to-let at some future date. They can also switch funds into their ISA Accounts each year.
Having set up the General Investment Account they could arrange for monthly withdrawals of 3% of the initial investment starting after six months to allow time for the initial charge to have a chance to be covered. They will each receive £625 a month (i.e. a total of £15,000 pa) and as these are withdrawals of capital there will be no income tax and no CGT as they are within their joint annual exempt amounts. Provided the portfolio produces average growth after charges of around 4.5% or more the withdrawals will effectively provide a tax free ‘income’.
As money is gradually switched into ISA Accounts so an increasing part of the withdrawals should come from those.
This information does not constitute personal advice and should not be treated as a substitute for specific advice based on your circumstances.
Information given relating to tax legislation is based on my understanding of legislation and practice currently in force. Whilst I believe my interpretation of current law and practice to be correct in these areas, I cannot be responsible for the effects of any future legislation or any change in interpretation or treatment. In particular you are warned that levels of tax and tax reliefs are subject to alteration and, in any case, the value of such reliefs and benefits may depend on an individual’s circumstances.
If you are in any doubt as to whether any course of action is suitable for you, then you should discuss the matter with a suitably qualified independent financial adviser or other specialist.