Forecasts from the Office for Budget Responsibility show capital gains tax (CGT) receipts are set to surge to £9.1 billion this year, despite already rising substantially for a decade. CGT receipts were £8.7 billion in 2016/17 up 23 per cent on a year earlier, following increases of 27 per cent in 2015/16 and 42 per cent in 2014/15, so altogether the Treasury’s take has doubled since 2013.
CGT is charged on profits from the sale of assets including shares, funds, second homes or buy-to-let properties, business premises, paintings and antiques worth over £6,000, with the rate dependent on the individual’s income and the type of asset sold.
Basic-rate income taxpayers typically pay lower CGT rates of 10 per cent on gains from most assets and 18 per cent on residential property and carried interest, while trusts and higher-rate taxpayers pay 20 per cent for most assets and 28 per cent on residential property gains and carried interest.
The tax is payable on gains above a threshold (the annual exempt amount), which in 2017/18 is set at £11,300 for individuals and £5,650 for trusts. Sole traders and partners selling their business may qualify for the entrepreneurs’ relief rate of 10 per cent, up to a lifetime limit of £10 million.
At 28 per cent for higher-rate taxpayers, CGT is a big bite out of profits, but there are steps you can take to minimise your liability.
1) Use up your spouse’s CGT exemption
Many investors do not use their spouse’s capital gains exemption and so pay more tax than they need. Assets can be moved between partners without any tax charge, so it can often make sense to do this prior to an asset’s disposal, particularly where one person in a couple is a higher-rate taxpayer and their spouse pays little or no tax.
The transfer of investments is a relatively simple exercise, involving the completion and submission of a transfer form. In this way, a couple can realise up to £22,600 of capital gains in this financial year without any liability. Although both partners in a couple are entitled to their own allowance in a joint investment account, in practice it helps in the mechanics of tax planning for each spouse to have their own share account.
Stock transfer forms are available from your broker.
2) Use up your allowance every year
Where possible, you should crystallise gains up to the CGT limit each year in order to re-base their capital value. In volatile markets this can present problems, however, as you are not allowed to repurchase the same investment within 31 days if it’s outside a tax wrapper.
3) Crystallise losses
You can ameliorate the pain of a poor investment by ‘crystallising losses’ in shares or funds that have fallen in value, as capital losses can be carried forward to set against future gains. If, for example, you have lost patience with a fund or share and sell it at a loss, you can boost your future tax-free gains by the equivalent sum. Capital losses will need to be entered on your tax return, and can then be called upon as required over the next four years.
4) Bed and Isa ‘unwrapped’ investments
If you have not used up all your Isa allowance then you can move assets into an Isa and shelter them from HM Revenue & Custom’s grasp. Known as ‘bed and Isa’, this process works best when you sell just enough assets to realise gains up to the value of the CGT exemption and then buy them back within your Isa, or that of your spouse.
5) Max out your pension
A sensible step is to max out your contributions to your pension, as neither capital gains nor investment income in a pension wrapper is liable to tax.
Furthermore, contributing towards your pension provides income tax relief at your marginal rate, and with careful planning, some people can use a pension contribution to effectively lift their higher-rate threshold so that the tax they pay on capital gains is limited to a maximum 18 per cent.
6) Invest in your employer’s share option scheme
Company shares offered through an employer arrangement, such as company share option plans, share incentive plans, save as you earn or enterprise management incentives (EMI), do not attract income tax or national insurance. However, they are liable to CGT, with the gain calculated as the difference between the disposal proceeds and the price paid for the shares when the options were exercised.
The most attractive of these schemes from a CGT perspective is the enterprise management incentive for small and medium-sized enterprises, which offers entrepreneurs relief on the shares acquired, so slashing the CGT rate to 10 per cent. The proviso is that there must be a gap of at least one year between the grant of the option and the sale of the shares.
7) Invest into an Enterprise Investment Scheme
Enterprise investment schemes (EIS) offer a 30 per cent income tax credit to investors who buy shares in small, unlisted companies and hold them for three years. You can contribute up to £2 million per tax year, but any amount over £1 million must be invested in ‘knowledge intensive’ companies, defined as those where at least 15 per cent of operating costs relate to research and development, and where either the company is creating intellectual property or at least 20 per cent of its workforce has a higher education qualification and is engaged in R&D.
If you already have a CGT liability, you can postpone it by investing the equivalent amount in EIS shares, and any CGT due up to the amount invested will be deferred until the EIS is cashed in. Moreover, provided you subscribe for the EIS shares within one year before or three years after selling your assets, and hold the EIS for at least three years, there is no tax to pay on any capital gains when you dispose of them.
This mechanism can be used by higher-rate taxpayers to defer a CGT liability until they retire and become basic-rate taxpayers, and can even enable investors to continue rolling over the liability until death, when EIS shares would be exempt from inheritance tax and the CGT liability would dissolve. However, as young, unquoted companies, EIS are high-risk, and it may not be easy to realise your investment when you’d like to.
8) Invest into a Seed Enterprise Investment Scheme
Seed Enterprise Investment Schemes (SEIS) focus on the smallest start-up businesses, and to reflect this offer tax relief at a handsome 50 per cent. You can invest a maximum of £100,000 a year, and you pay no CGT on the sale of SEIS shares held for at least three years. The tax tail should not wag the investment dog, however, and these investments are only recommended for experienced investors with a diversified portfolio.
9) Invest in Venture Capital Trusts
Investment in a venture capital trust (VCT) provides 30 per cent income tax relief up to a maximum investment of £200,000 a year. These schemes invest into larger, more established businesses than EIS. To receive the tax break, investors must retain the VCT for at least five years, and any gains when they sell are tax-free.
CGT strategies: second property disposal
Many landlords are leaving the residential property investment market following the overhaul of the buy-to-let tax regime, which has seen mortgage interest relief reduced to a basic rate level of 20 per cent and the removal of the 10 per cent wear and tear allowance.
However, this is one of the most difficult areas for CGT mitigation, as large sums are involved and partial selling over more than one tax year is not possible. Like other assets, it may be advantageous to transfer the property to a lower-tax paying spouse, which can be achieved by a simple deed of trust drawn up by a solicitor for a few hundred pounds.
Many people are looking to pass on property to their children. HMRC monitors property transactions and has technology capable of tracking people who sell rental properties and holiday homes. Gifting to someone other than a spouse or civil partner is deemed a disposal and can result in a nasty CGT bill for parents who are trying to help their children financially.
The traditional strategy has been for the parents to sell the second property and hand the cash on to the next generation. Such disposals incur CGT, but if the parents survive seven years then they can avoid 40 per cent inheritance tax under the ‘potentially exempt transfer’ rule.
However, CGT liabilities die with you, and the new higher £1 million IHT threshold has opened up opportunities to push more assets through to your children free of tax.
Currently each individual has an IHT allowance, or ‘nil-rate band’, of £325,000 which is transferable between spouses and civil partners, amounting to a nil-rate band of £650,000 per couple. Since April, each partner also receives a £100,000 ‘residence nil-rate band’ (RNRB), to put towards their family home. This will increase to £125,000 in 2018/19, £150,000 in 2019/20 and £175,000 in 2020/21, lifting a couple’s overall IHT nil-rate band to £1 million.
To encourage empty-nesters to ‘downsize’ without feeling hard done-by, people who move to a smaller property can continue to claim up to £350,000 per couple. This means that when the second partner dies after 2020, both home and assets can be passed to beneficiaries free from CGT and from IHT up to £1 million.
The EIS can also be useful where a large asset such as a second property attracts a CGT liability. For example, a higher-rate taxpayer who sells a buy-to-let property with a taxable gain of £100,000 faces a CGT liability of £28,000. But by investing the £100,000 into an EIS they will receive 30 per cent income tax relief, effectively buying 30 per cent more investment than the net cost. They can also defer their £28,000 CGT liability while they are invested in the EIS shares.
Together these two tax breaks provide an upfront tax discount of 58 per cent (30 per cent income tax credit and 28 per cent CGT liability). When the EIS shares are sold after three years, the original capital gain of £28,000 is recrystallised, but this may be at a more convenient time financially, and meanwhile the cash has been put to good use.
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