Capital Gains Tax - Share Identification Rules

Here, we explain how the principle of LIFO (Last in, First Out) applies to share sales. This concept was introduced as a major change to the CGT rules on 6 April 1998. Prior to that shares were "pooled" - that is, multiple purchases of the same share, minus sales, were combined into an averaged holding, to which indexation was added. Indexation, which was introduced in March 1982, represented an allowance for inflation based upon the increase in the Retail Price Index over the period the shares were held.

To find the cost of a partial sale, for CGT purposes, was a simple matter of taking the relevant proportion of the pool. However, with the change in the law in 1998, any shares held at that date, together with indexation up to that date, were effectively frozen (creating a frozen pool). And since then we have had the LIFO method of matching a sale with a purchase in order to establish the CGT liability.

In general, the processes of matching a sale with a purchase in order to work out any gain or loss are known as the identification rules.

Up until 5 April 1998, a well-known procedure known as Bed & Breakfasting could be operated. The idea was that shares could be sold on one day then repurchased the next (hence the term "Bed and Breakfast"), thus establishing a gain or loss as desired while still, more or less, continuing to own the shares. The reason for doing this was to use up the annual CGT exemption and raise the base cost of the shares in order to reduce any future chargeable gain. Alternatively, it could have been to create a loss to set against other gains, where the taxpayer still wanted to hang on to the shares for some reason. The risk was minimal, since the price had only one day to move against the investor.

However, this was prevented by a change in the law. Here, then, is the order in which shares sold have to be identified with their purchase for CGT purposes:

1) Acquisitions on the same day as the disposal
2) Acquisitions within 30 days of the disposal - this is the anti Bed & Breakfast rule
3) Acquisitions after 5 April 1998 on a LIFO basis
4) Acquisitions after 5 April 1982 in the frozen pool as at 5 April 1998
5) Acquisitions prior to 6 April 1982
6) Acquisitions on or before 6 April 1965 on a LIFO basis

A little explanation of the above may help (although in complex cases you may need to refer to HM Revenue & Customs's full guide). Note that the list is chronological. So to identify the cost for CGT purposes of shares sold, you must work down the list until you come to the point which satisfies the conditions under which the shares were purchased.

Same Day Rule

The same day rule means that where more than one purchase of the same share is made on one day, these are treated as a single acquisition. The same applies to sales. A sale must be identified first with a purchase made on the same day. Few investors would buy and sell a share on the same day, except for day traders who will do this regularly. This is their identification rule, assuming they are taxed under CGT and not income tax as traders.

30-Day Rule

The 30-day rule applies only to a share sale followed by a purchase of the same share within that time. So if you bought some shares then sell them, after which you repurchase them within 30 days, the chargeable gain or loss is based on the selling price less the repurchase cost.

In other words, in effect, you still own the shares at the original purchase price. Note that this rule applies only where a sale is followed by a purchase of exactly the same shares within the 30 days, not the other way round. So, for example, if you bought, sold and repurchased all within 30 days, it is still the latter two transactions that would be identified to calculate any gain or loss, despite the fact that the sale was within 30 days of the first purchase.

LIFO Rule

Since 5 April 1998, where there have been multiple purchases of the same share, and then some are sold, that sale must be identified with the cost of shares on the Last In First Out (LIFO) basis.

Frozen Pool at 5 April 1998

For shares sold after this date - and having used up all the LIFO as above to the extent that any were purchased after this date - further sales are identified with the averaged cost of shares in the frozen pool as at that date, where they were acquired after 5 April 1982. This frozen pool includes indexation up to 5 April 1998.

1982 Holding

If the sale is still not identified with any cost under all the above conditions, the next step is to consider shares held at 5 April 1982. These are, in fact, treated as having been acquired on 31 March 1982, which is the date at which indexation commenced.

Holdings on or before 6 April 1965

In the very rare event these days that none of the above conditions identify the cost of the shares sold, the final condition is this one, back on to the LIFO basis. The date is the one upon which CGT itself was introduced.

And there you have it - the identification rules for discovering how to match shares sold with their appropriate cost for sales after 6 April 1998. It doesn't matter for a single purchase followed by total sale of those shares. In such a case there is only one cost to identify. It matters where there are multiple purchases and partial sales of a holding.

There is nothing voluntary in all this. It is mandatory for these rules to be followed, so you cannot simply choose, when making a partial sale of a holding that was built up at various times, which particular ones formed the cost for CGT purposes.

But there are various methods of circumventing some of the rules that, for the moment, do work. The most common is to get round the 30-day rule by taking advantage of a spouse. With this, you sell the shares to create the gain or loss desired, then your husband or wife repurchases them immediately in the market. Thus the shares remain in the family at the new re-based purchase cost. The spouse can then, if necessary, transfer the new holding back to the original holder, although this last step is more of an administrative matter. Since inter-spouse transfers are deemed to be at cost for CGT purposes, no gain or loss occurs.

Another method, which has the advantage of not involving other people, is to sell a share, and then immediately buy a similar, but not identical one. The identification rules will not apply because they are confined only to exactly the same shares. For example, tracker funds, although all technically similar, are legally different securities for this purpose. So if you sell one to realise a gain, then simultaneously buy a different one, they cannot be identified together for CGT purposes. Therefore the 30-day rule is defeated and you make the desired chargeable gain or loss. Costs will be involved, of course, so you must judge whether it is worth it. And this is of less use with straightforward shares because there are very few that are so similar that you see no difference between them from an investment point of view.