How do I reduce Capital Gains Tax (CGT) on listed shares
There are a series of simple techniques that can be used to avoid or minimise Capital Gains Tax (CGT) with regards to listed shares.
1. Investing With No CGT
The Individual Savings Account (ISA) is the only way by which an individual can be certain, as certain as anything can be in taxation, of avoiding totally the tax on direct investment whilst retaining full control.
One often hears about people “getting an ISA” as though an ISA is an investment. It is not at all, it is merely a tax shelter within which investments of the individual’s choosing can be held, subject to restrictions on some types of shares or funds. This misunderstanding arises from marketing hype by some institutions who sell the plans in this way.
A person cannot set up an ISA alone, they can only be obtained through authorised organisations, which are usually banks, insurance companies, brokers and so on. Some are self select, allowing any investments within the rules to be held, others are only for the institution’s own products, usually some type of unit trust.
If you are investing outside of an ISA then there are three main methods of reducing CGT.
2. Shared Ownership
Everyone has an annual CGT exemption. If, therefore, you are investing enough to be likely to produce this sort of gain, it makes sense, purely from a tax point of view, to share ownership with another by holding jointly. This is most commonly with a spouse or partner, but it doesn’t have to be. It could be anyone. In this way all gains and losses are automatically assumed to be due 50% to each of the joint holders.
Even where you wish to sell and the shares are already pregnant with a large taxable gain, but only one holder exists, all may not be lost, particularly if you are married. Although gifting assets is generally treated as a disposal for CGT, exactly as though it was a sale at market value, with spouses, gifts are made at cost. Hence in such a transfer, contrasting with general gifts, there is no gain or loss.
Thus solely-owned shares showing taxable gains that you wish to sell can first be put into joint names with your husband or wife, thereby effectively gifting half to that spouse at cost. Upon selling the now jointly-owned holding two benefits accrue. Firstly the gain is split into two, and secondly two exemptions are available, each against half the gain.
Variations on this include considering the marginal income tax situations of the spouses or other joint owners. Since CGT is calculated by reference to total income in the tax year, where one owner is in a much higher tax bracket than the other, then it could pay to split the holdings to be sold in such a way as to optimise the CGT due, putting more or all of it on the lower marginally rated taxpayer. This works with spouses because of the ability to transfer at cost, so that the holdings would be unequal, the exact inequality desired to be decided once the potential gain is known. It might not work with unmarried joint holders, because any shift in the holding would cause a disposal, so you would need to examine this carefully before proceeding.
3. Offset losses against your gains
If you sell an investment and make a loss, the loss can be offset against any gains you have made in the same tax year. If your losses exceed your gains, you can register the losses on your tax return to offset against future gains.
4. Sell when you pay tax at a lower rate
The rate of capital gains tax is based on the rate of income tax you pay so your CGT bill will be lower if you realise gains when your income is lower. If you know your taxable income will fall in the future, perhaps due to retirement, you could consider delaying selling until then. However you should always look at your investment objectives and merits first and look at the tax benefits as an added bonus.
5. Reduce your taxable income
Because the rate of capital gains tax you pay is linked again to the rate of income tax you pay, reducing your taxable income could reduce the amount of capital gains tax you pay. The easiest way to do this is through tax shelters such as ISAs – income from an ISA is free from further tax.
In some cases you might be able to reduce your taxable income for a particular year – perhaps by transferring income-bearing assets such as cash deposits, to your spouse.
6. Use your pension to reduce capital gains tax
A pension contribution can also be used to reduce capital gains tax liability for many investors by taking advantage of the tax relief on the contribution. Effectively your basic rate tax band is increased by the amount of the pension contribution, meaning larger gains might be realised before the higher rate of capital gains tax is payable. For example, a pension contribution of £3,600 will extend your basic rate tax band from £42,475 to £46,075. Providing your taxable income and gains are less than £46,075 in this tax year, you will pay capital gains tax at 18% and none at 28%.
7. Sale and Repurchase
The purpose of these ideas is to realise a gain or loss on shares by selling, but retaining ownership where you wish so to do. The object is to raise the base cost of the shares by utilising the annual exemption in order to mitigate the CGT on ultimate disposal, or possibly to create a loss to set off against other realised gains in year.
This process used to be called bed & breakfast prior to the change in the law in 1998. Bed & breakfasting was used to sell a share and repurchase it the next day, with only a small risk of the market going against you.
The 30-day rule ended this practice. Now, over 30 days has to elapse between the sale and purchase in order to have the desired effect. Otherwise, you’re treated as though you never sold them. Selling shares and buying them back 30 days later is less desirable since the shares could move significantly against you while you’re waiting.
Not surprisingly, new techniques have evolved to get around the rules. The most obvious is to make use of that most useful taxation tool — the spouse. You own the shares solely, sell them in the market (creating the gain), your spouse simultaneously repurchases in the market to avoid price movement and later transfers the shares back to you (if that’s desirable), which can be done in effect at the repurchase price remember.
Thus neither of you make a gain or loss plus you wind up still owning the shares as before. It could be done with an unmarried partner or any other person but with a slight additional problem. After the simultaneous repurchase in the market, the person, upon transferring back to the original holder, has to do so at market value because of the gifts rule. No problem if the market price is the roughly the same, but if it has moved substantially, then our second person will create a gain or loss on themselves upon transferring back to the original holder.
8. Different, But Similar Sale and Repurchase
This version requires only one person, and is restricted really to certain types of investment. The identification rules for matching sales and purchases of shares refer to those of the same class, which means in practice the identical shares.
However there are many types of investment that are in fact nearly identical yet are different classes for CGT purposes.
A good example is the ubiquitous index tracker. One tracker, for CGT purposes, is not the same as another from a different fund manager, even though technically they may be pretty similar. Thus if you are showing gains on one, and wish to utilise your annual exemption, you could sell enough to use the exemption, and use the proceeds to invest in a different tracker with similar specification. You end up owning a similar investment, but at the current market price, in consequence raising the base cost and reducing any future CGT. You would do this each tax year when gains exist, continually uprating the cost.
The same principle would apply to any two investments which are closely correlated, yet not the same for CGT identification purposes. This is most likely to be the case with unit or investment trusts as it would be hard to find shares other than these investments that are so closely correlated.
And that’s it for this article on a few tips for avoiding or reducing this tax.
One final point on the methods that rely on a spouse or other party. The advice here is given purely from a tax mitigation point of view. However there may well be personal considerations that have priority over tax matters before entering into any such arrangements.