The 18% flat rate for capital gains tax (CGT), introduced in April 2008, always looked doomed once Alistair Darling announced an increase in the top rate of income tax. That it survived his final Budget probably had much to do with the way it was announced in the October 2007 Pre-Budget Report. Mr Darling was forced into an embarrassing climb down on his original proposals, so would not have wanted to bury the flat rate just two years later.

The Liberal-Democrat election manifesto proposed taxing capital gains as income to counter the obvious incentive to convert income into gains. At the same time (but not in the manifesto), the LibDems suggested that the annual exemption (currently £10,100) should fall to £2,000. The inclusion in the Coalition Agreement of a promise to bring the CGT rate close to income tax rates was one of the first surprises delivered by the new government.

In the event the Budget changes to CGT were less draconian than expected:

• Gains are to be taxed as the top slice of income, as they were before 6 April 2008.
• Gains falling within the basic rate band are taxable at 18%.
• Gains falling in the higher and/or additional rate bands are taxed at 28%.
• There is no indexation allowance and no taper relief, so the simplicity of Mr Darling's regime remains.
• The annual exemption stays at £10,100 and will be indexed in line with the RPI next year, as usual.
• Entrepreneurs' relief becomes a flat 10% tax rate on eligible gains, with the lifetime limit increased to £5m from £2m.

All these changes take effect from 23 June 2010 – two and a half months into the tax year. This should make for an interesting 2010/11 tax return, but only if you need to report your gains and losses. Gains realised before 23 June are subject to the old rules and are ignored when looking at any post-Budget gain calculations. The taxpayer can choose which gains should benefit from their 2010/11 annual exemption or any losses, to minimise their tax bill.

CGT Old and New Mervyn is a basic rate taxpayer with taxable income of £32,400 in 2010/11. He bought 10,000 shares in Barclays in January 2009, for which he paid £5,000. As at 22 June 2010 they were worth £31,000. He could have sold them then, but he was unable to get through to his stockbroker, so he is now thinking of selling them under the new CGT rules. The busy line cost him £1,090, assuming the share price has not moved since (which it has – downwards!):
	22 June 2010	23 June 2010 or later
	£	£
Gain: £31,000 - £5,000	26,000	26,000
Less annual exemption	( 10,100 )	( 10,100 )
Taxable gain	15,900	15,900
Tax on gain	£15,900 @ 18% = 2,862	5,000 @ 18% = 900 10,900 @ 28% = 3,052 3,952

PLANNING POINTS

Keeping the CGT rate down

The revised CGT rules represent a partial return to the regime that existed before April 2008. Thus a number of strategies which had been consigned to history are now set to reappear while some of the bright ideas of the last two years warrant re-examination.

• Tax deferred is tax saved. Capital gains tax can only normally arise on the disposal of an asset or investment. Thus structures and strategies which allow you to avoid disposals have become more valuable. For example, investment made via collective funds allows active investment management to take place without changes to the underlying portfolios giving you a personal CGT liability.
• Maximise the use of ISAs ISAs are free of capital gains tax. Now that gains and income are taxed at much the same rates, the CGT shelter offered by ISAs has become more valuable. If you hold cash ISAs, earning interest of perhaps 1% or less, you should at least review whether it would now make sense to make the irrevocable switch to a stocks and shares ISA. You would lose the capital security of a deposit investment, but your potential tax savings could be much greater.
• Remember the spouse In the 18% world, it did not matter whether you or your spouse realised gains - if they were subject to CGT, the rate was the same. Now a link between the rates of capital gains tax and income tax has been restored, once again the logic is to put taxable gains into the hands of the lower (basic or less) taxed spouse, as far as practically possible. Even if you are both taxed at the same rates, there is still the opportunity to use two annual exemptions rather than one and limit the scope for a part of any gain to be pushed into the 28% band.
• Income tax plan for CGT With gains once again taxed as the top slice of income, reducing your taxable income could mean a lower capital gains tax bill, if you can bring the total of your taxable income and gains into the basic rate band. So, for example, a pension contribution could reduce your CGT bill.
• Life assurance based investments The introduction of 18% CGT reduced the relative tax efficiency of investment bonds, whether onshore or offshore. As the rate of tax charged within life companies has not been changed, for 28% CGT payers the tax balance has now moved back in the direction of investment bonds and away from collective funds. However, the calculations are complex and there is no substitute for an individual assessment of any planned investment using specialist software.
  
  One type of life policy - the maximum investment plan (MIP) - that was enjoying a new lease of life as a result of the restrictions on pension tax relief has become even more attractive for high earners willing to make long-term regular savings. Within a life company, MIP funds are subject to a maximum of 20% UK tax on income and post-inflation gains. There is no personal tax liability, provided the MIP runs and premiums are paid for at least seven and a half years.
• Venture capital trusts (VCTs) and enterprise investment schemes (EISs) VCTs and EISs can offer income tax relief on your initial investment. Both are also generally free of capital gains tax, a feature which has now become more valuable. EISs can also allow you to defer tax on capital gains. When you sell the EIS shares, the gain you have reinvested is crystallised and becomes chargeable, but at then current tax rates. These tax attractions are not given away lightly by the Treasury - VCTs and EISs involve high risk investments in small companies and are not appropriate for many investors.

Use your annual exemption

Would you waste a tax exemption worth up to £2,828 a year?

One corollary of the higher CGT rate for higher and additional rate taxpayers is that the annual exemption (£10,100 of gains in 2010/11) has potentially become more valuable. It could now save you £2,828 in tax.

As far as possible it is important to use the exemption each tax year (and for your spouse 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 the new, higher tax rate. 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 2010/11 the maximum ISA investment is £10,200.
• 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 'relevant income' of £130,000 or over, the rules restricting 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.
• Bed-and-something-similar There are plenty of funds that have similar investment objectives or, in the case of tracker funds, identical objectives. So, for example, if you sell the ABC UK Tracker fund and buy the XYZ UK Index fund, the nature of your investment and the underlying shareholdings may not change at all, but because the fund providers are different, you will not be caught by the rules against bed-and-breakfasting.

Mind your losses

The FTSE 100 index today is still about 1,500 points below the level of ten years ago. Many long-term holdings could thus still be standing at a loss. Combine this fact with a higher rate of tax on gains for some investors and the oft-forgotten rules on the tax treatment of capital losses assume a new importance. The combined rules, which were not changed in the June Budget, contain a trap for the unwary - see the box below.

Beware the Wasted Loss If you realise a gain and a loss in the same tax year : The loss will be set off against the gain, even if the gain is within your annual exemption. As a result you could end up wasting the loss which will now be more valuable because you now face 28% tax on future gains above your annual exemption. However, if you carry forward a loss from a previous tax year : The carried forward loss is only used up to the extent that is reduces your overall gains to the level of your annual exemption. The loss is therefore only used when necessary. Uniquely, in this tax year you can choose whether to offset the loss against pre-23 June gains or those made later in the tax year. The lesson is that you should always take care before realising gains and losses together in a single tax year.

Identification matters

When the flat rate of CGT was introduced in 2008/09, taper relief was scrapped and with it most of the complex identification rules for share/fund transactions. If you sell a holding in a single company or investment fund, for CGT purposes the disposal is matched:

1. First to acquisitions made on the same day;
2. Second to acquisitions made in the next thirty days (the rule which blocks bed-and-breakfasting); and
3. Thirdly all other acquisitions, taken together as one pool.

The pooling provision means that you no longer identify a sale with a recent purchase – the so-called last in-first out (LIFO) rule has disappeared. This can make quite a difference to the calculation, as the example below shows.

A Mis-engineered Pool Helen bought 15,000 shares in GKN in June 2006 for £40,500 – equivalent to 270p a share. In July 2009, she took up the GKN rights issue and bought another 18,000 shares at a cost of £9,000 (50p each - it was a deeply discounted issue!). With the GKN share price now around 120p, Helen is thinking of taking some profits on the shares she bought a year ago. She reckons that if she sells 14,428 shares, she will make enough gain to match her annual exemption, ie.: 14,428 x (120p – 50p) = £10,099.60 Helen's calculation ignores the changes introduced from April 2008. The correct calculation pools together her two share purchases: Total number of shares = 15,000 + 18,000 = 33,000 Total cost = £40,500 + £9,000 = £49,500 Average cost = £49,500 = 150p 33,000 So the reality is that any sale at 120p will be at a loss of 30p a share.

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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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