The reform of capital gains tax (CGT), which took effect from 6 April 2008, now looks to have been somewhat academic, given the falls in investment values since then. With UK share prices still languishing at levels last seen in 2003, there are few gains around on which to pay 18% flat rate CGT.

This year the Chancellor has done the bare minimum to capital gains tax, increasing the annual exemption for individual investors by £500 to £10,100.

18% is better than 20%, 40% or 50%

Unless you are one of those lucky few who are able to benefit from the 10% savings rate band, 18% is the lowest tax rate that you will pay on your investment returns. It looks even better if you consider that in 2010/11, the highest rate of tax (on taxable incomes over £150,000) will be 50%.

Although the tax tail should never wag the investment dog, there is now a stronger case for favouring growth over income when setting your investment goals. There are many anti-avoidance rules which prevent income being transformed into capital gains, but it remains the case that some financial product structures provide income returns while others produce capital gains even though the underlying investments are the same. Selecting the right structure could therefore halve your tax bill.

Use your annual exemption

Would you waste a tax exemption worth up to £1,818 a year?

That is what your full annual capital gains tax exemption is worth in terms of tax saving. As far as possible it is important to use the exemption each year (and for your spouse/partner to do the same) because, if unused, it cannot be carried forward.

If you do not systematically use your annual exemption, you are more likely to reach a point where some of your gains are subject to tax, especially now taper relief has disappeared. Unfortunately you cannot simply crystallise a gain by selling and then repurchasing an investment - so called bed-and-breakfasting. However, there are other ways of achieving similar results:

•  Bed-and-ISA You can sell an investment, eg shares in an open-ended investment company, and buy it back immediately within an ISA. For 2009/10 the maximum ISA investment is currently £7,200, but the limit will rise to £10,200 from 6 October 2009 if you were born before 6 April 1960.

•  Bed-and-SIPP This is a similar process to bed-and-ISA, but the cash realised is used to make a contribution to a self-invested personal pension (SIPP). The reinvestment is then made within the SIPP. This approach has the added benefit of income tax relief on the contribution and may also offer a higher reinvestment ceiling than an ISA, depending on your earned income and other pension contributions. However, if you have income of £150,000 or over, the new rules on pension tax relief must be borne in mind (see below).

•  Bed-and spouse You can sell an investment and your spouse can buy the same investment without falling foul of the rules against bed-and-breakfasting. However, you cannot sell your investment to your spouse – the two transactions must be separate.

Keeping down your CGT bill

There is a variety of tactics that can be used to limit your exposure to capital gains tax, including:

•  Maximise the use of ISAs, where there is no capital gains tax. Do not forget that from 6 April 2008, all existing PEPs became stocks and shares ISAs.

•  Use funds of funds rather than individual fund holdings. Fund changes made within a fund of funds do not create any immediate gain for the investor. This is one of the reasons why private client portfolio managers have increasingly adopted fund of funds instead of individual portfolios.

•  Share your gains. Transfers between spouses living together are on a no gain/no loss basis, so if your spouse has not fully used their annual capital gains tax exemption and you have, together you could save tax.

•  Take advantage of venture capital trusts (VCTs) and enterprise investment schemes (EISs). These are high risk investments, but they are generally free of capital gains tax.

Replace 40% CGT with 18% CGT

If you paid CGT at a rate of more than 18% on gains made in 2006/07 or 2007/08, you could consider using an EIS investment now to claw back the tax you have paid and bring the gains into the 18% tax world.

An investment in an EIS allows you to claim reinvestment relief for any capital gain ( before taper relief) that you have made in the previous three years. This allows you to reclaim any tax you have paid on the gain or defer tax that is due. When you sell the EIS shares, the gain you have reinvested is crystallised and becomes chargeable, but at current tax rates. So you might be able to turn a former 40% tax liability into an immediate tax repayment and an 18% deferred tax liability. The maximum amount of EIS investment that qualifies for income tax relief is £500,000 in 2009/10, but there is no limit to investment where the claim is only for CGT reinvestment relief.

Mind your losses

In current market conditions, the rules on the treatment of capital losses are arguably more important than those which apply to capital gains. These contain a trap which could mean your losses are wasted if you realise losses and gains in the same tax year. The example below highlights the situation.

A Wasted Loss? In December 2008 Jill finally decided to sell her RBS shares, having watched their value evaporate over the previous year. What had originally cost her £10,000 was eventually worth just £1,000 – a £9,000 loss. Three months later, in late March 2009, Jill had thoughts about selling another long-term shareholding (in Astra Zeneca), which would realise a profit of £5,000. •  If Jill had sold her Astra Zeneca shares before 6 April 2009, the RBS loss would have been set against the gain, leaving £4,000 of loss to be carried forward to 2009/10 and beyond. If Jill had sold her Astra Zeneca shares on or after 6 April 2009, ie in the 2009/10 tax year, the calculation would be rather different. The RBS loss would now be a carried forward loss. Such losses are only used after the annual exemption is exhausted. So in 2009/10 the Astra Zeneca gain would be set against Jill's annual exemption. If Jill does not make further gains of over £5,100 in 2009/10, she will then be able to carry forward the whole £9,000 RBS loss to future tax years.

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The contents of this Bulletin are based on the proposals put forward by the Chancellor in his Budget speech and explained in documents subsequently published by HMRC and the Treasury.
All Budget proposals may be subject to change before the Finance Act is passed. References to spouse, husband and wife and married couples include references to registered civil partners and civil partnerships.
This Bulletin is provided for general consideration only and no action should be taken or refrained from based on its contents alone. Accordingly, no responsibility can be accepted for any loss occasioned as a result of any such action or inaction.
Professional advice must always be taken.

This news item is provided strictly for general consideration only and is based on our understanding of law and HM Revenue & Customs practice as at July 2008. No action must be taken or refrained from based on its contents alone. Accordingly no responsibility can be assumed for any loss occasioned in connection with the content hereof and any such action or inaction. Professional advice is necessary for every case.

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