How to use CFDs to shield my gains from the taxman
CGT is payable on any gain of more than £10,600 (for the tax year 2011/12) made on asset disposals at the rate of 18 or 28% – depending on your tax band.The CGT exemption is a ‘use it or lose it’ relief that cannot be carried forward to cover future gains. A practice known as bed and breakfasting, whereby assets are sold and bought back the next day to make maximum use of the annual exemption, is no longer allowed. You are permitted to buy the same shares back after 30 full days, but that does not always appeal to asset holders who want to stay in the market.
An alternative strategy involves taking out a contract for difference (CFD) position to crystallise your gains, or losses for offsetting purposes. Essentially, a CFD is an agreement to exchange the difference in the value of a particular asset between the opening and closing price. To bed and breakfast using a CFD, you simply sell a share, buy a corresponding CFD exposure and, after 31 days have elapsed, sell the CFD contract and repurchase the original shares.
The CFD position keeps you in the market regardless of its direction. If the share price rises during the 31-day interval, profits from the CFD trade will offset the cost of repurchasing the shares at a higher price. If the share price falls in the period, the CFD loss is compensated for by the cheaper price of the repurchased shares.
You should be able to find a CFD spread that works for your portfolio, as thousands of underlying shares are represented, as well as foreign exchange, commodities and stock indices. Trades are conducted on a leveraged basis and the margin is based on a small percentage of the value of the trade, so you can open a position by putting up just 5 to 10% of its value.
If you sometimes spread bet, you may find your spread betting firm offers CFDs. One main benefit of spread trading is that profits are CGT exempt, but this means you cannot offset losses against capital gains for CGT purposes. The big attraction of CFDs over spread betting is that losses can be offset against your CGT liability.
The cost of financing CFDs is linked to Libor (the London interbank offered rate), and as Libor has been running at low levels in line with the Bank of England rate, the cost of holding CFDs for any length of time has fallen.
Chris Beauchamp, a market analyst at IG Group, says: “CFDs are the easiest to use as they are taxable – gains and losses can be offset in the same way as they can with normal shares. With spread bets, gains are not taxed, but it is not possible to offset losses against gains. From an individual’s perspective, it is easier to use CFDs because they are directly applicable in CGT calculations.”
Another advantage of a CFD is that you can use it to defer your capital gains liability to a subsequent tax year, when another annual exemption will apply or other losses may be available to offset a gain. A loss can also be deferred.