FOOL'S EYE VIEW
The Dogs of Tax

By Stephen Bland (TMFPyad)
April 23, 2001

No, this is not an article on the tax treatment of canine pets, although the idea of having your mutt trade shares and thus escape capital gains tax has already been tried, and failed. Cats or budgies, though, now that's a different matter. Nor is it an article on the tax treatment of those shares in your portfolio which are doing seriously badly.

It is more a reference to the cliché of allowing the tax tail to wag the dog, or in my view not allowing it. By this is meant permitting tax considerations to override investment ones, a situation which is fairly common particularly with capital gains tax situations and personal pension schemes. The new version of the personal pension known as Stakeholder has been introduced from 6 April and, as with any personal pension, tax relief is a major factor in the investor's decision to purchase these products. The reason is that personal pensions/stakeholders are the only investment schemes that grant tax relief on the amounts contributed, in return for a series of powerful restrictions in withdrawing the money. All the details are in our Pensions Centre.

Investors will have to decide whether the tax relief available on their money is a fair trade-off for the restrictions on accessing it. There is however a strong trend within the industry to promote pension products on the back of tax relief. I have to admit they have a point, for the above reason -- that there is no other investment product that allows tax relief on contributions. But before plunging into pension plans because of tax relief I urge investors to consider the potential performance of the product, which has historically been so poor in a large number of cases, and whether the restrictions on getting at their money that comes with the territory are a fair trade-off against the tax relief.

Pension plans apart, a typical potentially tax-driven situation can arise where someone has made a sizeable capital gain on some shares, wishes to sell, and is wondering whether to spread the gain into two or more tax years by disposing of tranches each year. This may be beneficial for tax purposes because of the existence of the annual exemption and a possible mitigation of higher rate tax on the gain. But this has to be compared with the risks of continuing to hold the balance of the shares for further years. Impossible, perhaps, to quantify, but we all know what happened to holders of techs who may have been massively pregnant with taxable gain around the height of the boom. If they held off selling purely for tax reasons, they may well have been creamed and would have been many times better off selling the lot at a fat profit and paying the tax.

Easy to say now, of course, but during it one never knows when a boom has topped. In the earlier days of that boom, large gains were being made yet there was still plenty more to come. If you want to play fadstocks, then when the first doom mongers start to ply their wares about it all going wrong go in heavily; the earliest calls are always wrong, as equally and in the opposite direction are the earliest calls of the end of a bear slump.

But my point is that the decision to sell or hold should be made on investment grounds, not tax ones. If you are lucky or skilful enough to hold shares that are obviously very volatile, perhaps because they have little or no profits, and have done well, your decision on when to dump them should be based only on investment judgement, in my view. Holding on for tax reasons may be a disaster. It may also prove successful if the boom runs on, but if so it won't have been for tax reasons that you will continue to have done well: just the luck of the game.

Far better, nearly always, to make a profit and pay tax on it, than to risk loss and save tax. But that's me, I am notoriously risk-averse and will take on situations only where I perceive the odds to be as much in my favour as I can twist them. And tax definitely does not figure in my calculations in a share play, despite my background in dealing with peoples' tax affairs: or maybe because of it.

More: Pension Centre | Taxes discussion board