Capital Gains Tax (CGT), like its cousin Inheritance Tax (IHT), is a wealth tax which is applied to assets which have usually been acquired from post-tax income unless you have been fortunate enough to have inherited wealth. Even if you are the beneficiary of an estate it is highly likely that the donor created their wealth from their own post-tax income. Therefore, understandably capital taxes such as Capital Gains Tax are unpopular. When you consider how little taxation Capital Gains Tax raises for the government annually (approximately 2% of total tax receipts), taking into account the enormous cost of legislating for it and collecting it, it begs the question why bother with it?
Fortunately, there remain numerous ways to mitigate CGT. In many ways, Capital Gains Tax is a voluntary tax. Here are seven easy ways to reduce its impact on your investments.
Maximise yours and your family’s annual CGT exemptions
The annual CGT exemption is £12,300 per annum per person so a married couple can realise capital gains of up to £24,600 before paying CGT. Children including minors (aged under 18) are entitled to the full CGT exemption too.
Practise tax-loss harvesting
Tax-loss harvesting isn’t a term you hear about much in the UK. It’s a practice much more associated with US investors who appear to use this technique more than UK investors. Basically, it involves offsetting your CGT losses against your gains and maximising your CGT exemptions annually. This strategy has the potential to reduce your taxable gains significantly. Most investors do not plan their investment disposals CGT efficiently on an annual basis.
Use yours and your family’s pension schemes as tax shelters
Most adults can invest up to £40,000 a year into a pension scheme up until age 75 apart from individuals who do not qualify to pay maximum contributions. For example, some people, usually very high earners, are limited to pension contributions as low as £4,000 a year. Interestingly even if you have no earned income at all you may still pay up to £3,600 a year into a personal pension. Surprisingly minor children are entitled to receive pension contributions of up to £3,600 a year into Junior Pensions. You can also make third party contributions into your adult children’s pensions! Such contributions cannot exceed your adult children’s permitted Annual Allowance and all tax reliefs are claimed by them. Even if you do not have spare cash to invest in your pension do consider “in specie” contributions into a pension scheme whereby you transfer a qualifying asset into a pension scheme without selling it. However, only a few specialist “pure SIPP (Self Invested Personal Pension)” providers will allow it.
Invest in tax-advantaged investments such as pensions, EIS, SEIS and VCTs
A simple way to avoid CGT is to invest in tax-sheltered investments such as pensions and investments like the Enterprise Investment Scheme (EIS), SEED EIS (SEIS) and Venture Capital Trust (VCT). Not only are these investments free of Capital Gains Tax if you follow the qualifying rules but you also benefit from Income Tax relief on your investment ranging from 20%-50% and 100% Inheritance Tax relief if held for 2 years and it is still held at the time of death on transfer. The amounts you may invest in EIS, SEIS and VCT range from £100,000 to £2m each per annum too.
Maximise yours and your family’s annual ISA allowances
Adults are entitled to an annual ISA allowance of £20,000 each. Minor children have a Junior ISA allowance of £9,000 each too. This allowance is all too easily ignored. Even if you don’t have the spare cash to invest in an ISA remember you can always “Bed and ISA.” In other words, you can sell an investment to maximise your CGT exemption for the tax year and then buy back the same investment in an ISA from the proceeds. The beauty of this approach is that you avoid being caught by the 30 day CGT buyback anti-avoidance rule. This rule is designed to prevent you from making “artificial” capital gains by selling an investment and buying it back the next day in order to use up your CGT exemption of £12,300. The gain/loss between the sale and re-purchase is assessed for CGT with the shares retaining their original acquisition cost meaning you do not get the benefit of using up your CGT exemption and paying less CGT on a future gain from the same investment. The term Bed and ISA is associated with the term Bed and Breakfast because it is typically an overnight break!
Gift investments to your family
Gifting investments to other family members can be very tax-efficient too. For example, spouses may gift investments to each other without incurring a capital gain. The donee (the gift recipient) simply inherits the cost history of the donor (the giver). Gifts to other family members without incurring a CGT liability are possible too by using the holdover relief rules.
Use holdover reliefs (business assets, shares in certain trading companies, agricultural property not used in a business and transfers in and out of trusts)
The general rule is that where there is a gift of business assets, shares in certain trading companies and agricultural property not used in a business then as long as all qualifying conditions are met a gift may be made without triggering a CGT charge on the donor. Instead, the donee acquires the donor’s cost history. It is effectively a game of “pass the parcel” where the donee foots the eventual CGT bill.
Where a gift gives rise both to a capital gain and to a chargeable transfer for IHT purposes, CGT holdover relief can be claimed. This is the case even where no IHT is actually payable because the transfer, although technically chargeable, is covered by the IHT annual exemption, Nil Rate Band (NRB), Agricultural Relief (AR) or Business Relief (BR).
The most common circumstance in which this is relevant is where an asset is transferred into or out of a trust – but take care: not all such transfers are chargeable. In particular, there is no IHT “chargeable transfer” when an asset is transferred out of a trust within three months of being transferred in or of being subjected to the ten year “periodic charge”: it follows that no CGT holdover relief is available in those circumstances.
This is the only circumstance in which holdover relief is available regardless of the nature of the asset. Accordingly, by passing an asset between individuals via the intermediation of a trust, it may with care be possible to some extent to replicate the effect of the old general holdover relief on a gift between two individuals.
If the holdover reliefs do not apply then you will become liable to Capital Gains Tax when gifting an asset to somebody or when selling an asset at an undervalued price compared to its true market value.
Do take advantage of these CGT mitigation techniques. Tax saving strategies such as these are often overlooked by investors who all too often focus their attention on one aspect of investing and that is charges. However, by maximising the tax-saving opportunities by taking advice from a professional wealth manager, far greater wealth may be created than small fractional savings on charges on your investments. Be prepared to pay higher fees in order to get great tax saving advice as it will far outweigh the relatively marginal increase in fees. You know it makes sense.*
*The Financial Conduct Authority does not regulate tax advice. The value of your investment can fall as well as rise and is not guaranteed. The contents of this blog are for information purposes only and do not constitute individual advice. You should always seek professional advice from a specialist. All information contained in this article is based on our current understanding of taxation, legislation and regulations in the current tax year. Any levels and bases of and reliefs from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future.