Q & A 1 - Tax implications of investing in listed shares
Updated: Aug 14, 2020
We'll periodically be posting questions we've received into the office that we believe may be of wider interest.
This weeks question
Q: During Lockdown I have taken the opportunity and some spare cash to invest in the stock markets. How am I taxed on any gains I am fortunate enough to hopefully make?
A: There has been a small boom in the numbers of amateur private investors during the Cornoavirus pandemic, spurred into life by the perfect storm of market volatility and people having disposable cash while their other leisure activities are curtailed during the enforced lock down. However investing without knowing the tax ramifications could leave you facing an unexpected tax bill, meaning your gains were not quite as impressive as you thought.
There a several aspects to this, but we'll focus on the straight forward shares traded on the stock market (we can advise on tax implications of other investments on a case by case basis).
An investment in a listed PLC can yield two types of positive return. A Capital Gain, where you sell the shares for more than you paid for them, and Dividends, which is a distribution made out of company profits at the time you are currently holding that company's shares - your reward ffrom the company for investing in them.
Let's take a real life example of a share that has experienced significant price volatility where potentially a large gain on investment could have been made.
Our new investor has some spare cash, and so opens a standard investment account on one of the many online platforms.
He sees the price of Aston Martin Lagonda Global Holdings PLC (AML) shares, crashed to 30.7p on 14 May. So lets say our novice investor timed his purchase perfectly (beginners luck!) at the bottom of the market, perhaps hoping to make enough money on a recovery to buy his own Aston Martin. So, on 14 May he buys 32,573 AML shares, costing roughly £10,000. By 8th June the price reached a peak of 80.7p. Not believing his luck, our investor decides the time is right to cash out and receives £26,286 in return for his shares.
He has made £16,286 profit. However he has not considered the tax implications.
The gain is therefore subject to capital gains tax given he invested using a standard account. Assuming no other losses or gains in the tax year, the first £12,300 falls within the annual capital gains allowance and therefore is tax free. However the remaining £3,986 is subject to capital gains tax. So for gains which when added to taxable income fall in the UK basic rate tax band, the CGT rate is 10%, or £398.6, or for gains which when added to taxable income fall in the UK higher or UK additional rate tax band, the CGT rate is 20% or £797.20.
Any other gains he makes on shares throughout the year would also be subject to same CGT rules, although the £12,300 is an annual allowance not per transaction. So assume he makes another £10,000 on his next trade in the same tax year, his CGT will be an additional £1,000, or even £2,000 if paying at the higher CGT rate.
In summary therefore, at the end of the year, all the capital gains are added together, all the capital losses are deducted (shares sold for less than paid for) as well as the annual capital gains allowance and the total profit is how the CGT is calculated.
In addition to tax on capital gains, our investor would also be subject to tax on any dividends he receives from investments made through his standard investment accounts, should they exceed the annual dividend allowance in he year of £2,000. Dividends are taxed at 7.5% up to 50K total income and then 32.5% after.
If our investor has stopped to consider the tax implications before invested he would have realised that he would have been better off investing through an INVESTMENT ISA, rather than a standard investment account. That's because any capital gains or dividend income made on investments through an investment ISA are deemed tax free. They work in the same way as standard investment accounts, with the only restriction being you can only put £20,000 into your ISA in a tax year - however you are free to use and reinvest the gains from that investment which are also tax free if made within the ISA.
In this instance, our investor funds his ISA with £10,000. He buys and sells his AML shares as above, meaning there is now £26,286 sat in his ISA. He reinvests the lot the following week in another share he thinks could take off. As luck has it this investment also doubles a week later and he cashes out again. He now has £52,572 in his investment ISA, or £42,572 profit from his initial stake. His Capital Gains tax would be as much as £5,940 assuming he was already a higher rate tax payer (it would be lower if a basic rate rate payer)....however as the money was invested through his investment ISA, his tax is zero.
The same goes for dividends. There is no tax on dividends paid on shares owned in an investment ISA.
So the benefits of investing through a an ISA are clear, and your only restriction is that you are limited to putting £20,000 of your own funds into an ISA in a tax year (again profits generated from within the ISA do not count towards this limit and can be freely reinvested through the ISA)
There are other efficient ways of investing and this just scratches the surface, but a fundamental point of consideration for anyone new to the markets.
A FINAL THOUGHT ON THE PRIVATE INVESTING BUBBLE
As accountants, we can not give financial advice with regards to specific investments and this should be sought through an approved independent IFA (we can recommend a suitable one). However, if you choose to invest in the markets without professional guidance, we would urge people to be very wary and to educate themselves as to how the markets work as well as to undertake their own detailed research into the company they are looking into.
This should involve detailed analysis of the latest financial reports as published by law by all PLC's and by considering quantitative factors such as their solvency, liquidity, assets, earnings per share, and market cap alongside other more qualitative measures. More small amateur investors lose money in the stock market than make it, and a large part of this is due to not understanding how to interpret the fundamentals of company accounts and not doing their own research - just following people on bulletin boards and social media into shares often does not end too well. If you don't understand the financials of what you are investing in, it becomes little more than a gamble.