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With quoted shares and securities (and 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 percent higher rate of CGT from 2010 means that there are now more tax planning possibilities than was previously the case with just a flat rate of 18 percent. 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 GBP50,000 to GBP250,000 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 GBP11,520), 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, whilst many other investors prefer to actively trade shares rather than just retaining 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 GBP200,000 with potential chargeable gains of GBP50,000. Retaining the portfolio until death will result in a maximum CGT saving of GBP14,000 (GBP50,000 at 28 percent), but the inheritance tax cost could be GBP80,000 (GBP200,000 at 40 percent).
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.
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 our investor, 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.
There is also the option of investing up to GBP100,000 per year in shares that qualify for the seed enterprise investment scheme, although this is not appropriate for someone investing in their own company. For 2013-14, an investment provides 50 percent exemption for reinvested chargeable gains plus income tax relief at the rate of 50 percent.
The total potential tax relief of 64 percent (50 percent + (half of the higher CGT rate of 28 percent) might therefore make such an investment attractive despite the risk of investing in very small companies. An investment can be treated as being made in the previous tax year, so it's still possible to exempt gains made during 2012-13. In this case, 100 percent of the reinvested gains will be exempt - the total tax relief is then 78 percent (50 percent + 28 percent).
Basic tax planning
There are three main aspects to basic CGT planning.
Firstly, maximise the benefit of the annual exempt amount - currently GBP10,900. This can be achieved by making sufficient disposals each tax year so that chargeable gains are at least GBP10,900.
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 2014 the due date will be 31 January 2015, but for a disposal made on 6 April 2014 it will be 31 January 2016.
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 percent where they fall within the basic rate tax band (currently GBP32,010), and at the higher rate of 28 percent where they exceed this threshold. There are several relevant points here:
- Where an investor's taxable income is consistently below GBP32,010 then disposals could be spread over several years so that CGT is at 18 percent instead of 28 percent. 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 percent annual investment allowance - thus reducing their taxable profits.
For example, over the next 12 months an investor wishes to make disposals of shares which will result in chargeable gains totally GBP60,000. The investor's annual taxable income is GBP17,500. If the disposals are made entirely in the current tax year then the CGT liability will be as follows: