CGT hikes: should you act now?
Since the coalition government announced it would be looking at capital gains tax (CGT) rates and aligning them with income tax bands, there has been some panic selling by investors.
The latest figures from financial technology company, 1st Exchange, suggest as many as two out of three independent financial advisers are taking steps to sell their clients' investments that attract the tax, but is this the right course of action to take?
At the moment, a flat rate of 18% CGT is paid on income from assets above a personal exemption of £10,100. If CGT is aligned with income tax bands, however, higher-rate taxpayers will pay 40%, while basic-rate taxpayers will pay 20%.
Those earning over £150,000 per year, could be slammed with a 50% CGT on their assets, in line with the highest income tax band introduced by the previous government in April this year.
Many advisers are urging investors to act now, to avoid the coming increases, but it shouldn’t be considered a black and white process of selling – or gifting – assets to lock in the 18% rate.
Simon Leney, partner responsible for personal tax services at law firm Cripps Harries Hall, says: “Do not make investment decisions based on a possible cash saving. You shouldn’t let it blind you to more important matters such as, ‘is this a good investment and do I want to sell it?’”
So, before you act in haste, here are a number of issues to consider:
When will the CGT rise be implemented?
While some people have suggested the new rates will be implemented straight after the emergency Budget on 22 June, the likelihood is they will come into effect from April 2011.
This is because introducing new rates for CGT part way through the tax year would be tricky from a revenue perspective, so the most practical solution would be to bring them in from the start of the new tax year.
The problem with this is that the majority of revenue would not be collected until January 2013, says Leney, because there is a time lag between filling in tax returns and the deadline for paying the tax. This means the move will not achieve much in terms of cutting the deficit in the short-term.
How could the government address this problem?
Leney says another possibility would be for the government to change the way the tax is calculated. One way of doing this would be to double the amount of taxable income expressed on an individual’s tax return and continue to tax it at 18%. This would achieve the same as taxing it at 36% and could be used as a temporary measure until HM Revenue & Customs can implement a long-term change to the system.
Should I be worried about a lowering of the annual exemption?
Another possible move by the government could be to decrease or scrap the annual exemption of £10,100 from CGT. This has been a policy the Lib Dems have backed, suggesting a new exemption threshold of £2,000 per year.
“This would have a disproportionate effect on the less wealthy,” says Leney, “That's why my thought is it won’t be one the government will want to go for, politically it doesn’t look like a good idea.”
Is it worth acting to lock in the 18% rate as soon as I can?
The first thing to do is work out what the potential gain is. If the income you receive from your assets won’t exceed the current threshold you have no reason to act.
If you are married, think about splitting assets with your spouse to get the benefit of two annual exemptions. For example, if you had £100,000 worth of investment and were set to make £50,000 in profit, after the use of your annual exemption you would be liable to pay CGT on £39,900 of your gain – if you are a higher-rate taxpayer (40%) this would amount to £15,960.
If the asset was split with your partner, on the other hand, £25,000 of the profit would be in each of your names. This would mean after each of your annual exemptions were applied, you would both be liable to pay CGT on £14,900, which at 40% would amount to £5,960 each - £11,920 in total. The total tax saving in this instance would be £4,040.
Another thing to consider is the tax bands you fall into. If one of you is a basic-rate taxpayer and the other is higher rate, you might want to make the most of the 20% saving the basic-rate partner would make.
Leney says, “Do the sums and make sure there is a worthwhile saving to be had before you start taking decisions.”
Is gifting assets away an effective way to avoid the impending increases?
Gifting assets away will not make any difference from a CGT perspective, but can help in terms of avoiding inheritance tax liability.
A parent should not automatically think it’s a great idea to give assets away to their children – CGT will still have to be paid on the imagined gain.
“What people have to be reminded of is they have to pay the 18% and have no actual gain from the gift, as they would from a sale,” says Leney.
“From a cashflow perspective, you may not have that kind of cash when it comes to paying your tax and if you die within seven years of giving the gift and it comes into the inheritance tax bracket, the income will effectively be taxed twice.”
What alternative is there?
Instead of gifting to a family member you could consider putting your assets into a trust. This would still trigger the current 18% CGT rate, but the difference is you can get the assets back.
For example, if you have a buy-to-let property, which has increased significantly in value since you first bought it, by putting it into a trust you can ensure you still get income from the rent and later down the line if you want the property back you can get it.
If the property has increased in value by this point the trust can use what is known as a holdover, this means you would get the property back at the value you gifted it and therefore would have no CGT liability at that point. Eventually, if you sold it, you would trigger CGT on the income made.
Leney explains: “The overall exercise is slightly complex and it would require specialist advice, which comes with a cost. So it’s probably not worth it unless you are saving something like £25,000 on tax, which equates to an approximate gain (or imagined gain) of £100,000 from the sale or gift of the asset.”
Trusts are complicated to set up, so you need to seek expert advice.
What else can I do?
The argument for investing through an individual savings account will now be even stronger because income within an ISA is sheltered from CGT, so if you have not used your ISA allowance this tax year, now is a good time to do so.
Rebecca O'Keefe, head of investment at our sister site Interactive Investor, suggests if you have up to £10,200 (the same amount as your annual stock and shares ISA allowance) in investments you could bed and ISA. This means you sell the investment you have outside an ISA then buy it back again within the ISA wrapper.
The advantage of this is you do not have to come up with extra capital because you simply make existing investments tax efficient. Also, you don't have to worry about market timing risk because it is literally happening all at the same time.
O'Keefe says: "We are seeing a dramatic rise in the number of people who are doing this in advance of the Budget from fear that the CGT changes will come into effect more quickly than expected.
"Regardless of when the changes come in. Investors would do well to take a step back and think about what they are best off using in terms of tax wrappers – they will seriously come into play now."
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.