Simple Ways To Minimise CGT
The Individual Savings Account (ISA) is the only way by which an individual can totally avoid capital gains tax on direct investment whilst retaining full control.
If you are investing outside of an ISA then there are three main methods of reducing CGT.
1. 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 boasting 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.
2. 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 way back 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.
One final but very important point on the methods that rely on a spouse or other party. The suggestions here are 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.
3. 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.