With the UK facing a £40bn “fiscal hole” in the public finances, the government is planning to lower a range of tax-free allowances to help ease pressure on the public purse. In particular, capital gains tax (CGT) is set for some important changes in the coming tax years. This makes it more likely that an investor may be taxed on the profits of asset “disposals” (e.g. selling shares which have risen in value). Below, our team at PS Aspire explains how capital gains tax works and offers four ideas to help avoid an unnecessary tax bill on your profits.
When you sell an asset (e.g. shares in a general investment account), the amount you receive from a sale is not taxed - but the gain might be. For instance, if you bought shares for £5,000 but later “dispose” of them for £7,000, the £2,000 profit may be subject to CGT (but not the full £7,000). The rates are currently 10% or 20% for individuals, or 18% and 28% tax rates for residential property and carried interest ("carried interest" - is a share of a private equity or hedge fund's profits that is paid to the fund's managers). Below, we offer four ideas to help investors mitigate a needless CGT liability.
In 2022-23, a UK resident is entitled to earn up to £12,300 in capital gains (outside of an ISA) without facing CGT. Many people do not make maximum use of this allowance to protect their profits. One strategy is to “spread out” your asset disposals across two tax years if you risk exceeding your CGT allowance within a single year. However, you need to be confident that the assets in question will not fall significantly in value while waiting to sell them. It is also important to recognise that this Annual Exempt Amount is set to fall to £6,000 in April 2023 and, later, to £3,000 in 2024. Therefore, this tactic may not be as effective as in previous tax years.
Bear in mind that you cannot “carry forward” unused CGT allowance into the following tax years. If you do not use your £12,300 allowance in 2022-23, for instance, then it will be lost in 2023-24. The CGT allowance can often be useful for assets that cannot be held inside of an ISA, such as buy to let investments and personal possessions worth over £6,000.
On top of your yearly CGT allowance, each UK tax resident (age 16+, or 18+ for a stocks and shares ISA) can place up to £20,000 inside of ISAs and release capital gains without tax. However, most British people do not use their ISA allowance. Only 48% of people with over £50,000 of investable assets maximised their allowance in 2020-21, whilst for those with £50,000 and £100,000 the figure was 33%.
One reason for this may be that people do not plan ahead for the tax year. Committing a lump sum of £20,000 to an ISA before the 5 April deadline is often not feasible, but committing about £1,666 per month might be more within reach. Even moving an existing portfolio (in a general investment account, or GIA) to an ISA can be achieved using the “bed and ISA” approach.
This involves selling investments in a portfolio and then immediately buying them back in an ISA. It can be an option for saving capital gains tax over multiple tax years. However, consider speaking with a financial adviser first. Some investments in your GIA may be worth selling, for instance, but not re-purchasing in an ISA (e.g. shares that have run out of “growth potential” or which are resting on poor fundamentals). Instead, the capital could be used to buy other assets within an ISA that better reflect your goals and strategy.*
If you give or sell assets to a spouse or civil partner, then no capital gains tax (CGT) is due, unless certain exceptions are met (e.g. you separated and did not live together at all in that tax year). This can be useful for reducing the overall CGT bill within a household, since each person has their own CGT allowance and can organise their assets accordingly. For instance, if a wife has used her full £12,300 allowance in 2022-23 but her husband has not, then she could give the other shares she wanted to sell to him. He can then sell them for a profit within his own CGT allowance. In effect, this can allow a married couple or civil partnership to expand their collective CGT allowance to £24,600 per year and their joint ISA allowance to £40,000.
Certain schemes exist in the UK which allow investors to save on CGT, also encouraging investment into the economy. For instance, the Enterprise Investment Scheme (EIS) allows investors to generate tax-free capital gains on EIS shares which have been held for at least three years. In addition, EIS offers “deferral relief” - i.e. deferring the tax liability of a capital gain (from a non-EIS investment) by investing this gain into an EIS-qualifying company or fund. Investors can use deferral relief for previous capital gains made over the past 36 months or for expected gains over the next 12 months.
For instance, suppose you sell a buy to let property for a £50,000 profit and use your £12,300 CGT allowance towards it in 2022-23. This would leave £37,700 potentially subject to 28% CGT if you are a Higher Rate taxpayer (producing a £7,540 tax bill). However, suppose you invested £37,700 straight into an EIS fund and did not dispose of the shares until 3 years later. In this case, no CGT will be due on the capital.
However, bear in mind that EIS is targeted at early-stage companies that are more likely to fail or collapse. The growth potential can be significant, but EIS investments are classified as high risk investments by the FCA and are not suitable for all investors due to the risk involved. Speak with a financial planner if you are interested in tax-efficient investments like these to explore how they might integrate into your wider portfolio.*
*As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.
If you would like to discuss capital gains tax, contact your PS Aspire adviser.