How to reduce your Capital Gains Tax liability
Receipts from Capital Gains Tax (CGT) are expected to reach £9.1 billion in 2019-20. This compares with just £2.5 billion 10 years ago, highlighting the hefty tax bills that investors could face when cashing in on their investments.
CGT is charged on the profits made when certain assets, especially investments, are sold or transferred. In practice, share sales make up the majority of capital gains, followed by residential property.
Everyone, including children, has an annual CGT exemption, which amounts to £12,300 in the 2020-21 tax year. This means that any gains realised within that amount incur no tax. Gains over the annual exemption are charged at 10% (basic rate taxpayers) or 20% (higher and additional rate taxpayers) depending on your other income except for residential property’s gains which are taxed at 18% or 28% depending on your tax rate.
There is a further 10% rate of CGT known as entrepreneur’s relief, otherwise known as business asset disposal relief. This relief was reduced from £10 million to £1 million of qualifying capital gains by the Chancellor, Rishi Sunak, in the Budget on 11 March this year.
Use your allowance
The £12,300 is a “use it or lose it” allowance, meaning you can’t carry it forward to future years. But remember that each individual has their own allowance, so a married couple can potentially realise gains of £24,600 this tax year without incurring any tax liability.
In most cases, you can also transfer assets between spouses and civil partners tax-free, so it might make sense to consider transferring holdings to a spouse in a lower tax bracket or one who hasn’t used their allowance.
Offset any losses against gains
Gains and losses realised in the same tax year have to be offset against each other, and this will reduce the amount of gain that is subject to tax. If your losses exceed your gains, you can carry them forward to offset against gains in the future, provided you have registered those losses with HMRC.
Capital gains in a fund
Investors in funds on wrap platforms such as Parmenion or Standard Life or the CCM Intelligent Wealth Fund are not liable to CGT on any gains made when the fund itself sells holdings, because this is the fund trading rather than you. There may be tax costs in other countries, which are paid out of the fund’s ongoing charges figure or OCF.
However, you may be liable to CGT on any gains when you sell or otherwise dispose of your shares in the fund, after taking your annual allowance into account.
Another thing to think about is the possibility that you may build up a large capital gain in excess of the annual CGT exemption over time. To reduce this risk you can use your annual allowance to sell at least part of the holding at the end of each tax year and then buy it back. By doing this, you reset the cost of your holding at a higher level and so reduce the potential profit against which your future CGT liabilities will be calculated.
Tax rules mean that you have to wait 30 days before you can buy the same holding back. So if you’re not comfortable with this out-of-market risk, you could also consider investing in an exchange-traded fund (ETF) offering similar exposure in the interim.
Other strategies include realising a gain in a general investment account and using the proceeds to fund unused pension or ISA allowances. These are also known as ‘Bed and SIPP’ or ‘Bed and ISA’ and are a potential way of moving your investments to a more tax- advantageous position. The term refers to a practice known as “bed and breakfasting” your capital gains. This is because in the past you could literally sell your shares and buy the same ones back the very next day. The timescale was so short, overnight, what it was the same length of time as staying in bed and breakfast accommodation for one night.
Manage your taxable income levels
Since the rate of CGT you pay is dependent on your income tax band, reducing your Income Tax rate can have a knock-on benefit on your CGT. A couple of simple ways to reduce your taxable income is through pension contributions or charitable donations such as Gift Aid, for example.
Don’t pay twice
Another thing to bear in mind is that capital gains are wiped out on death, so your estate will pay Inheritance Tax rather than CGT. Incurring CGT by selling assets later in life can effectively mean you pay tax on the same asset twice. The proverbial own goal in tax terms.
Use your annual ISA allowance
It never ceases to amaze me how many high-net-worth investors I meet for the first time who don’t use their ISA allowances. Some don’t realise that the current allowance is £20,000 per person and that all personal capital gains are tax-free on ISA investments. Others simply don’t get round to it. However, we have many clients with ISA portfolios of £500,000 or more, who have effectively removed all concerns about CGT. That’s because we remind them to use up their annual £20,000 ISA allowance every year.
EIS and SEIS
Investments such as the Enterprise Investment Scheme (EIS) and the Seed EIS allow you to re-invest the proceeds of assets subject to CGT and defer the taxation on those capital gains potentially indefinitely with good tax planning. These investments offer Income Tax relief at rates of 30% (EIS) or 50% (SEIS) too. However, such investments are high risk and illiquid. Also unless you have a high enough income to cover the reinvested proceeds of the capital gain, you won’t get the full Income Tax relief. So they are not right for everyone.
For an individual to avoid Capital Gains Tax it is usually necessary to remain non-resident for more than five complete tax years where you leave the UK after 5 April 2013. This way you can avoid CGT completely. It’s a pretty extreme strategy but if you have a large potential Capital Gains Tax liability, and you were thinking of emigrating anyway, then this could be the strategy for you. However, do make sure that you will not become liable to CGT in your new country. Do your research and look for tax havens which have no capital taxation by which I mean CGT and Inheritance Tax. Two such tax jurisdictions are on your doorstep – the Isle of Man and the Channel Islands. Otherwise you will have scored an own goal.
If you’re liable to Capital Gains Tax, you can’t choose whether to pay it or not. However, with careful planning there are sensible ways to make the best use of the available reliefs and allowances to reduce your bill or even wipe it out altogether. As ever it is always important to take advice from a professional before you take any action to save CGT. You know it makes sense.*
*The value of investments and the income derived from them may fall as well as rise. You may not get back what you invest. This communication is for general information only and is not intended to be individual advice. You are recommended to seek competent professional advice before taking any action. All statements concerning the tax treatment of products and their benefits are based on our understanding of current tax law and HM Revenue and Customs’ practice. Levels and bases of tax relief are subject to change.