CGT has come under tax review scrutiny and may do so again. In any event, clients should make the most of the CGT allowance before tax year end, says Dave Downie, technical manager, abrdn.
Capital gains tax (CGT) annual exemption is an opportunity to take investment ‘profits’ tax free, and a higher rate taxpayer could miss out on £2,460 each year if they fail to take advantage.
The Office for Tax Simplification recommended a series of changes to CGT in 2020 which would have had a significant impact on traditional tax year end planning. However, the Government has confirmed that it doesn’t intend to implement these changes at this time.
This means, as far as planning for this tax year end is concerned, it’s business as usual. Here are four key areas to remember when using the CGT allowance.
Determine what gains can be taken tax free
The annual capital gains tax free allowance remains at £12,300 for this tax year and for 2022/23. How much of this remains available at the tax year end will depend on the net gains made during the tax year.
Gains and losses made on disposals in the same tax year must be netted off against each other before the annual allowance is deducted. This can mean that some or all of the allowance can be wasted if there are large losses, as any unused allowance cannot be carried forward to future years.
Example: Jade sells two funds. One has made a gain of £20,000 but the other has made a loss of £15,000. The net gain for the year is £5,000. While Jade will pay no tax, only £5,000 of the allowance has been used, and £7,300 will be wasted.
If Jade had sold enough of the Open Ended Investment Company (OEIC) shares to create a loss of £7,700, she would be able to use the allowance fully and still potentially be able to use the remaining losses to set against next year’s gains.
Double up with spouse or partner’s allowance
The amount of gains that can be taken tax free can be doubled if a spouse’s or civil partner’s allowance can also be used, provided each partner has enough gains in their own name to fully use the allowance.
If one partner does not have any assets showing gains in their own name, then a transfer of assets (and the related gain) may be made between partners without incurring a charge so that both have enough gains in their own names to use up their allowance.
Determining the rate of tax payable
When gains are taken in excess of the annual allowance and any losses, they are added to a client’s income to determine what rate is paid.
Gains falling in the basic rate band of £37,700 are taxed at 10%, with gains in excess of this amount taxed at 20%. These rates increase to 18% and 28% respectively if they relate to residential property.
Any unused part of the personal income tax allowance should be ignored when determining the rate paid on gains. So, a client with no income will still be taxed at the higher rate of 20% on any taxable gains made over £37,700 (after deducting the capital gains tax allowance and losses).
It should also be noted that for capital gains tax purposes, Scottish residents use the same basic rate band of £37,700 to set the rates, even though the income tax bands may be different.
Where gains are to be taken in excess of allowances, it therefore makes sense to ensure that they are only taxed at 10% where possible. This is another reason to consider transferring assets between higher and lower rate tax paying spouses and civil partners.
Similarly, if a client makes gains on both their investment portfolio and on residential property in the same year, they can apply their allowance and any losses to their own advantage. For example, it may be beneficial to use the annual allowance against gains from residential property to save tax at 18%, leaving other gains to be taxed at 10%.
Where gains do arise, it may be possible to defer the tax due until a later year if the proceeds are used to subscribe for shares in an Enterprise Investment Scheme (EIS). But it is worth remembering that the deferred gains will be taxed at the prevailing CGT rate when the EIS shares are sold.
Avoid ‘share matching’ rules when staying in the market
While there may be good tax reasons to take profits at the year end to use the CGT allowance, there may be no desire to ditch those investments completely. Unfortunately, buying them back immediately is not an option due to the ‘share matching’ rules.
Broadly, when shares are sold and bought back within 30 days, the gain on the disposal is not the sale value less what was originally paid for them. Instead, it will be the sale value less the price they have been subsequently bought back for, which may mean there is no gain at all.
Being out of the market for 30 days or more may not be acceptable for some clients. But solutions can be found by re-purchasing shares immediately via an ISA or SIPP. If there is no scope for this, then a ‘similar’ share could be purchased, but note that for this purpose switching between income and accumulation shares in the same fund do not count as a disposal.
Taking advantage of the CGT allowance can make a big difference to a client’s long-term savings. But, perhaps more importantly, failure to use it annually could lead to a larger tax bill on accumulated gains later down the line.
