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With quoted shares and securities (also unit trusts and OEICs) there is more scope for CGT tax planning than there is with most other chargeable assets. This is because it is easy to sell or gift the exact number of shares required to arrive at a particular chargeable gain or capital loss. Other assets, such as unquoted shares, are more difficult to sell, and with assets such as land and property it is not generally practical to dispose of just part of the asset in order to achieve a gain equivalent to, say, the annual exempt amount.
The introduction of the 28% higher rate of CGT means that there are more tax planning possibilities than was previously the case with just a flat rate of 18%. There are several million shareholders in the UK, and many of these will have built up portfolios of sufficient size to benefit from the type of planning outlined in this article. The article is aimed at investors with portfolios in the £50,000 to £250,000 range, and for such investors more advanced tax planning, such as the use of trusts, is probably not a realistic option.
Avoiding CGT altogether
The easiest way to avoid CGT is to build up a portfolio by using stocks and shares ISAs, since chargeable gains will be tax free. However, such a strategy will be constrained by the annual investment limit (currently £10,680), and it is not possible to transfer existing shareholdings into an ISA since subscriptions must normally be in cash.
If a share portfolio is retained until death then the shares will be completely exempt from CGT - and therefore there is no need for any CGT planning. However, people may have to sell shares later in life to top up their pension and investment income, while many other investors prefer to actively trade shares rather than just retain the same portfolio.
Such an approach must also be balanced against the possible inheritance tax implications. Although retaining a share portfolio until death will avoid CGT, such an approach may not be beneficial where the value of the portfolio is high in relation to the amount of chargeable gains. For example, a person has a share portfolio valued at £200,000 with potential chargeable gains of £50,000. Retaining the portfolio until death will result in a maximum CGT saving of £14,000 (£50,000 at 28%), but the inheritance tax cost could be £80,000 (£200,000 at 40%).
It is also possible to avoid CGT by becoming non-UK resident, although it is necessary to be non-resident for at least five tax years. Obviously, such tax planning is not appropriate for people with the modest share portfolios being discussed here, but if someone is already planning to retire overseas it would make sense to delay disposals until after they have left the UK - this assumes that the gains will not be taxed in the new country of residence.
Deferring gains
The only relief that is likely to be available is reinvestment relief as a result of investing in shares that qualify for the enterprise investment scheme. Such an investment is probably too risky for the type of investor being considered here, but it might be appropriate where an investor is investing in their own company (for reinvestment relief, it does not matter if the investor is connected with the company). It is not particularly difficult for a company to become an enterprise investment scheme company (simply complete form EIS1), and the main restriction will be that certain types of trade are excluded.
The investment must be made within a period starting one year before and ending three years after the date of the disposal. It is only necessary to reinvest the amount of chargeable gains in order to obtain full deferral, and there is no upper limit to the amount of gains that can be deferred. Gains are only deferred until the enterprise investment scheme shares are disposed of, but if the shares are held until death the deferred gains will then be exempt.
Basic tax planning
There are three main aspects to basic CGT planning.
Firstly, maximise the benefit of the annual exempt amount - currently £10,600. This can be achieved by making sufficient disposals each tax year so that chargeable gains are at least £10,600.
Secondly, where CGT will be payable, then (all other things being equal) delay a disposal until the start of the following tax year, since the due date will then be one year later. For example, for a disposal made on 4 April 2012 the due date will be 31 January 2013, but for a disposal made on 6 April 2012 it will be 31 January 2014.
And lastly, minimise the rate of CGT by making disposals during a tax year when an investor has some of his or her basic rate tax band available. Chargeable gains are taxed at the lower rate of 18% where they fall within the basic rate tax band (currently £35,000), and at the higher rate of 28% where they exceed this threshold. There are several relevant points here:
Table 1
Spreading the disposals over this and the next tax years will reduce the total CGT to £7,864 and delay the payment of some of the liability by one year.
Table 2
Married couples and civil partners
For married couples and civil partners the basic tax planning outlined above can be extended further. Prior to their disposal, shareholdings can be transferred to a spouse or civil partner if that person has some of their annual exempt amount or basic rate tax band available. Alternatively, shareholdings could be in joint names.
If one spouse (or civil partner) is a higher rate taxpayer, and the other has little or no income, the potential CGT saving each tax year is £6,468 ((£10,600 at 28%) + (£35,000 at 10% (28% - 18%))).
Bed and breakfasting
Bed and breakfasting is the simple procedure of selling (bedding) shares at the close of business one day and then buying (breakfasting) them back at the opening of business the following day. Such a practice means that a chargeable gain can be realised in order to make use of the annual exempt amount, or a capital loss can be established. Although bed and breakfasting is prevented by matching disposals with shares purchased within the following 30 days, there are still ways in which a similar result can be achieved:
Capital losses
Capital losses can only be set off against gains made in the same tax year or carried forward against future gains. Careful planning is necessary in order to make the best use of capital losses. The main problem is that capital losses of the same year have to be set against gains in full, with the result that the annual exempt amount may be wasted. In contrast, where capital losses are brought forward it is only necessary to offset sufficient losses to bring gains down to the level of the annual exempt amount.
For example, for 2011-12 an investor has chargeable gains of £10,000 and capital losses of £12,000. Although the gains are covered by the annual exempt amount, it is still necessary to offset £10,000 of the capital losses, leaving just £2,000 of losses to carry forward to 2012-13. The investor could have taken any of the following approaches to avoid this problem:
Tax planning with quoted shares will often involve incurring transactions costs now in order to save CGT in the future. A broker's fees will start from around £10 per transaction, and there will also be stamp duty at the rate of 0.5% on the cost of shares purchased. These costs could easily mount up if dealing with a number of small shareholdings. However, the higher CGT rate of 28% is still relatively low compared to the higher and additional income rates of income tax of 40% and 50%, so it would not be surprisingly if the 28% rate increased in the future.
David Harrowven is an ACCA tax examiner
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Capital gains tax planning with quoted shares
By David Harrowven
Studying this technical article and answering the related questions can count towards your verifiable CPD if you are following the unit route to CPD and the content is relevant to your learning and development needs. One hour of learning equates to one unit of CPD. We'd suggest that you use this as a guide when allocating yourself CPD units.
With quoted shares and securities (also unit trusts and OEICs) there is more scope for CGT tax planning than there is with most other chargeable assets. This is because it is easy to sell or gift the exact number of shares required to arrive at a particular chargeable gain or capital loss. Other assets, such as unquoted shares, are more difficult to sell, and with assets such as land and property it is not generally practical to dispose of just part of the asset in order to achieve a gain equivalent to, say, the annual exempt amount.
The introduction of the 28% higher rate of CGT means that there are more tax planning possibilities than was previously the case with just a flat rate of 18%. There are several million shareholders in the UK, and many of these will have built up portfolios of sufficient size to benefit from the type of planning outlined in this article. The article is aimed at investors with portfolios in the £50,000 to £250,000 range, and for such investors more advanced tax planning, such as the use of trusts, is probably not a realistic option.
Avoiding CGT altogether
The easiest way to avoid CGT is to build up a portfolio by using stocks and shares ISAs, since chargeable gains will be tax free. However, such a strategy will be constrained by the annual investment limit (currently £10,680), and it is not possible to transfer existing shareholdings into an ISA since subscriptions must normally be in cash.
If a share portfolio is retained until death then the shares will be completely exempt from CGT - and therefore there is no need for any CGT planning. However, people may have to sell shares later in life to top up their pension and investment income, while many other investors prefer to actively trade shares rather than just retain the same portfolio.
Such an approach must also be balanced against the possible inheritance tax implications. Although retaining a share portfolio until death will avoid CGT, such an approach may not be beneficial where the value of the portfolio is high in relation to the amount of chargeable gains. For example, a person has a share portfolio valued at £200,000 with potential chargeable gains of £50,000. Retaining the portfolio until death will result in a maximum CGT saving of £14,000 (£50,000 at 28%), but the inheritance tax cost could be £80,000 (£200,000 at 40%).
It is also possible to avoid CGT by becoming non-UK resident, although it is necessary to be non-resident for at least five tax years. Obviously, such tax planning is not appropriate for people with the modest share portfolios being discussed here, but if someone is already planning to retire overseas it would make sense to delay disposals until after they have left the UK - this assumes that the gains will not be taxed in the new country of residence.
Deferring gains
The only relief that is likely to be available is reinvestment relief as a result of investing in shares that qualify for the enterprise investment scheme. Such an investment is probably too risky for the type of investor being considered here, but it might be appropriate where an investor is investing in their own company (for reinvestment relief, it does not matter if the investor is connected with the company). It is not particularly difficult for a company to become an enterprise investment scheme company (simply complete form EIS1), and the main restriction will be that certain types of trade are excluded.
The investment must be made within a period starting one year before and ending three years after the date of the disposal. It is only necessary to reinvest the amount of chargeable gains in order to obtain full deferral, and there is no upper limit to the amount of gains that can be deferred. Gains are only deferred until the enterprise investment scheme shares are disposed of, but if the shares are held until death the deferred gains will then be exempt.
Basic tax planning
There are three main aspects to basic CGT planning.
Firstly, maximise the benefit of the annual exempt amount - currently £10,600. This can be achieved by making sufficient disposals each tax year so that chargeable gains are at least £10,600.
Secondly, where CGT will be payable, then (all other things being equal) delay a disposal until the start of the following tax year, since the due date will then be one year later. For example, for a disposal made on 4 April 2012 the due date will be 31 January 2013, but for a disposal made on 6 April 2012 it will be 31 January 2014.
And lastly, minimise the rate of CGT by making disposals during a tax year when an investor has some of his or her basic rate tax band available. Chargeable gains are taxed at the lower rate of 18% where they fall within the basic rate tax band (currently £35,000), and at the higher rate of 28% where they exceed this threshold. There are several relevant points here:
- Where an investor’s taxable income is consistently below £35,000 then disposals could be spread over several years so that CGT is at 18% instead of 28%. This strategy also fits in with utilising the annual exempt amount.
- The basic rate band is extended if a person makes personal pension contributions. Therefore matching disposals and pension contributions to the same tax year could reduce the rate of CGT payable.
- Some investors may have fluctuating taxable income. It could be because a self-employed person makes a loss, or because an employee is posted overseas for a year (with their earnings being outside the UK tax net). In such a year all or most of a person's basic rate tax band might be available, so it will be a good time to make disposals. Directors of owner-managed companies that withdraw profits mainly by way of dividends could forego dividends for one year to achieve the same result.
- Similarly, a self-employed person could aim to make disposals in the same year that they incur expenditure qualifying for the 100% annual investment allowance - thus reducing their taxable profits.
Table 1
Spreading the disposals over this and the next tax years will reduce the total CGT to £7,864 and delay the payment of some of the liability by one year.
Table 2
Married couples and civil partners
For married couples and civil partners the basic tax planning outlined above can be extended further. Prior to their disposal, shareholdings can be transferred to a spouse or civil partner if that person has some of their annual exempt amount or basic rate tax band available. Alternatively, shareholdings could be in joint names.
If one spouse (or civil partner) is a higher rate taxpayer, and the other has little or no income, the potential CGT saving each tax year is £6,468 ((£10,600 at 28%) + (£35,000 at 10% (28% - 18%))).
Bed and breakfasting
Bed and breakfasting is the simple procedure of selling (bedding) shares at the close of business one day and then buying (breakfasting) them back at the opening of business the following day. Such a practice means that a chargeable gain can be realised in order to make use of the annual exempt amount, or a capital loss can be established. Although bed and breakfasting is prevented by matching disposals with shares purchased within the following 30 days, there are still ways in which a similar result can be achieved:
- Shares can be sold and bought, but the two transactions must be at least 30 days apart - the investor will therefore be exposed to real price movements.
- By making use of an ISA - shares are sold as normal, but the matching acquisition is then made within an ISA. Given the ISA investment limits this approach obviously has limited scope.
- The matching rules only apply where the same class of share in the same company is being sold and then reacquired. An investor is quite free to sell shares in one company and then to immediately acquire shares in another, similar, company. For example, if a shareholding in Lloyds TSB was sold it could be replaced by a similar value holding in Barclays, thus maintaining a broadly similar portfolio. If desired, the position could be reversed after 31 days so that the investor again holds shares in the original company.
- Spouses or civil partners can jointly undertake a bed and breakfasting arrangement. For example, a wife could sell shares with the husband acquiring an equal number of shares in the same company. Overall the couple have maintained exactly the same share portfolio. Of course the shares must actually be sold and acquired - it is not sufficient to simply make a transfer between spouses as this would be ineffective for CGT purposes (being at no gain, no loss). If desired, the position could be reversed after 31 days by making a transfer of the shares back to the spouse or civil partner that originally held them. A similar type of strategy could be followed by an unmarried couple living together.
Capital losses
Capital losses can only be set off against gains made in the same tax year or carried forward against future gains. Careful planning is necessary in order to make the best use of capital losses. The main problem is that capital losses of the same year have to be set against gains in full, with the result that the annual exempt amount may be wasted. In contrast, where capital losses are brought forward it is only necessary to offset sufficient losses to bring gains down to the level of the annual exempt amount.
For example, for 2011-12 an investor has chargeable gains of £10,000 and capital losses of £12,000. Although the gains are covered by the annual exempt amount, it is still necessary to offset £10,000 of the capital losses, leaving just £2,000 of losses to carry forward to 2012-13. The investor could have taken any of the following approaches to avoid this problem:
- Further disposals could have been made during 2011-12 so that chargeable gains totalled at least £22,600. This would leave gains of £10,600 after offsetting the capital losses.
- Postpone the disposals that resulted in the chargeable gains until 2012-13. The losses would then be carried forward in full to future tax years - unless further gains are made in 2012-13. Alternatively, the chargeable gains could have been incurred by a spouse or civil partner.
- Postpone the disposals that resulted in the capital losses until 2012-13. The losses would then be carried forward in full. Alternatively, the capital losses could have been incurred by a spouse or civil partner.
Tax planning with quoted shares will often involve incurring transactions costs now in order to save CGT in the future. A broker's fees will start from around £10 per transaction, and there will also be stamp duty at the rate of 0.5% on the cost of shares purchased. These costs could easily mount up if dealing with a number of small shareholdings. However, the higher CGT rate of 28% is still relatively low compared to the higher and additional income rates of income tax of 40% and 50%, so it would not be surprisingly if the 28% rate increased in the future.
David Harrowven is an ACCA tax examiner