Tom Green had the pleasure of chatting with Kenny Russell and Mark Fairburn on their Stock Box media platform this week about Capital Gains Tax and specific implications for investors. You can listen to the podcast here and also check out some of our summary notes below.
Again please remember the details are just general guidance, and everyone's specific circumstance will vary, so you should always seek specific professional advice from before taking any action.
CAPITAL GAINS TAX (CGT)
HMRC define Capital Gains Tax as a "tax on the profit when you sell (or 'dispose of') something (an 'asset') that's increased in value. It's the gain you make that's taxed, not the amount of money you receive".
These assets include but are not limited to, personal property worth more than £6,000, second homes, buy to let or investment properties, business assets, and the sale of shares and securities in both listed and unlisted companies.
Focus on shares & investing
To better understand CGT, we used a very simple example.
Mr A invests £20,000 in listed PLC, "company X", through a standard investment account. The share increases in value over several years, such that the initial investment is now worth £100,000. Mr A sells the shares for £100,000. What are his CGT implications (assuming no other gains and losses in the year)?
First of all the gain is worked out be deducting the cost of the shares from the proceeds (£100,000-£20,000 = £80,000).
Once this is done, the next step is to deduct the Capital Gains Tax Allowance for the year. This is the amount of overall capital gain (across the total of all annual capital gains) each taxpayer is allowed to make before paying CGT (think of it as a Personal Tax Free Allowance specifically for Capital Gains, and separate to your income tax allowance).
For the 2020/21 Tax Year this allowance is £12,300. So £80,000-£12,300 = £67,700 Taxable gain.
This is taxed in relation to your personal income tax band such that
a) Basic rate tax pay 10%**(see note)
b) Higher rate tax pay 20%
**Note: This is taxed in relation to your personal income tax band such that total income up to the higher rate Tax limit - the rest of the gain would then be taxed at 20%
(also note, CGT rates for property are higher at 18% basic rate and 28% higher rate)
So assuming Mr A is already a higher rate tax payer his CGT bill would be 20% of £67,700, £13,540.
Note 1. if Mr A had other capital losses, it may have been possible to offset these against the gain.
Note 2. Your CGT allowance is annual and across all capital gains and losses combined (i.e you don't get a separate allowance for each chargeable gain/loss in the year). You can NOT carry your CGT allowance forward.
Could Mr A have prevented this CGT Bill through better planning?
Possibly yes. Consider the following investment options -
He could have invested through an stocks and shares ISA (Individual Savings Account). These are classed as a separate tax wrapper for CGT purposes, so any capital gains made on investments within the ISA (as well as dividends paid by companies to shares held in the ISA) are tax free.
You are allowed to contribute £20,000 into an ISA each year. So in this instance if Mr A had put his initial £20,000 investment into his ISA, and bought the shares in company X through his ISA wrapper, the gain upon selling the shares would have been entirely tax free. He could have reinvested the funds (again through his ISA), or withdrawn the money.
Note: ISA's will not let you trade in things like options and warranties.
Alternatively he could have invested through a SIPP, or Self Invested Personal Pension.
These allow you to pay into a pension pot, which you can then direct into certain investments, including stocks and shares. Again gains made on investments through a SIPP are free from Capital Gains Tax. Plus they have the added benefit of 20% Tax Relief for basic rate tax payers and a further 20% for higher rate payers. For example if for every 80p paid you pay into your SIPP, your SIPP provider will claim and additional 20P from HMRC by way of relief, such that you're getting £1 worth of investment for an 80p contribution. If Higher Rate you can then claim an additional 20 percent Tax relief at the year end through your Tax Return, such that effectively a 60p SIPP contirbution is getting you £1 of investment.
You can contribute up to a maximum of your annual salary, capped at £40,000 per year into a SIPP (although this cap limit tapers down for additional rate payers, and can actually end up as low as £4,000 depending on how high your annual salary is).
However the SIPP is a pension and only suitable for investors happy to put their money away - you generally cannot make a withdrawl until age 55. At this age you can withdraw up to 25% of the SIPP as a tax free lump some, while the remainder can be used as an ongoing income and subject to income tax as per standard income depending on relevant tax bands.
**DISCLAIMER - AGAIN, YOU NEED TO SPEAK TO A QUALIFIED FINANCIAL ADVISOR BEFORE TAKING OUT ANY FINANCIAL PRODUCT OF THIS AND THIS IS NOT A RECOMMENDATION **
So between the SIPP and the ISA theres potential to invest up to £60,000 a year sheltered from CGT. If you are married, then the same applies to your spouse so between the two of you you could invest £120,000 a year in tax wrappers away from CGT.
For shares already in standard investment accounts consider the following
You can transfer assets to your spouse with no capital gain. As such if you transfer some shares to your spouse, and they dispose of them, they can also use their capital gains tax allowance (£12,300) for the year against the gain.
Note - in transferring the asset you are relinquishing control so this is not always suitable for some partnerships!
2. Utilise CGT Allowances
You can no longer "Bed and Breakfast" shares to "rebase" the share cost - this is the practice of selling enough shares to generate a capital gain just within your allowance at the end of the tax year, and then buying them back the next day (eg. If Mr A sells enough shares that cost £1 each but are now worth £3 each, on 5th April, such that his capital gain is say £12,000, he pays no CGT as the gain is under the allowance. But he still wants to own the stock. So he buys them back the next day (new tax year) at a cost of £3 a share. It used to be that the new cost of shares in his portfolio would have been £3 each - i.e he'd rebased the cost per share upwards, such that when he eventually disposes of the shares for good, the total cost is reflected higher in his register - But HMRC introduced matching rules which determined the order in which shares are disposed with in order to prevent this practice, such that the first shares classed as sold in a disposal are and shares in that company that you acquired either on the same day of disposal, or 30 days AFTER...this means the original shares remain in the share pool at the original value.
3. CGT deferment through reinvestment in EIS
The Enterprise Investment Scheme is designed to encourage investment in new, unlisted companies, and offers generous tax incentives as well as the option to defer the capital gains tax owed on a capital gain made, should the proceed be reinvested in a qualifying EIS company. The CGT is still paid though when you exit that EIS investment at a later date - its a deferment rather than mitigation. There are a few criteria to this that need to be satisfied though, which we'll look at in more depth in a later article or will advise on a case specific request.
You can "Bed and ISA", or "Bed and SIPP" - i.e sell the shares one day (perhaps enough to keep under the CGT limit) and buy them back the next day through your ISA or SIPP provided you have enough funds in them, or enough annual allowance left to contribute the required funds into them to allow you to repurchase. Most major providers can assist you with this - AS EVER TAKE ADVICE
Bed & Spouse is also an option, whereby you would sell the shares and your spouse could buy them back - however the spouse then retains control of the security, and HMRC are likely to take a dim view should the spouse then transfer them back to you at a later date and may be challenged under anti-avoidance.
Bed and CFD is a slightly different approach. Again you could sell enough shares to realise you annual CGT allowance on the last day, and then rather than repurchase, take out a CFD (Contract for difference) in the share to hedge against any price movements for the next thirty days. When the thirty days is up, you are free to rebuy the shares again at the rebased price - so you close the CFD, and rebuy the shares. Any price movement up or down is covered by the gain on the CFD, or if the price went down the loss on the CFD is covered by the now lower share price. As CFD's are a position, they are not classed as owning the asset themselves.
Take professional advice regarding the tax position of your investments. HMRC can and will charge penalties for failure to report taxable gains, so a "buried head in the sand" approach is not advisable
Investigate tax efficient "Wrappers" like ISA & SIPP, (again proper advice required from IFA when setting up investment products)
Rishi Sunak has asked the office for Tax Simplification to take a look into Capital Gains Tax as a potential avenue to begin clawing back some of the spending on COVID relief. Proportionately most Capital Gains Tax payers are higher rate tax payers to begin with, and CGT raised only amounts to about 15% of Chargeable gains. As such some options being considered may be
Reduction or removal of the annual CGT allowance
Raising or potential raising of rates from 10% Basic Rate and 20% Higher Rate, (18% & 28% for property) more inline with income tax rate bands (perhaps 20% and 40%) respectively
Closer control and monitoring of reported gains
More than ever its important to make sure you have your tax affairs in order and an efficient plan in place so you are not left with any nasty shocks from your otherwise successful capital gains and would be happy to discuss further with anyone who has any questions around this subject.