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Investment insights

Balancing tax and investment performance threats

Charles Calkin, Partner, Financial Planning Consultant
Charles Calkin, partner and financial planning consultant

Charles Calkin, partner and financial planning consultant

For investors with significant assets outside a tax-friendly pension or ISA wrapper, a big threat is Capital Gains Tax – CGT. It is often regarded as a voluntary tax because you only pay it when you realise a chargeable gain on disposal. Keep the assets and you are fine. Except, of course, that might mean you are sitting on assets that have stagnated or are vulnerable to a correction after years of growth.

Do you take the tax hit or carry the investment risk?

The announcement that the government is committing £20bn a year of extra cash to the NHS by 2023 might influence the decision. Perhaps there will actually be a “Brexit dividend” to contribute towards this investment in the NHS, but it is also clear that there will have to be what Jeremy Hunt describes as “more resourcing through the taxation system”. We should probably assume that we are now in a position where both parties are committed to raising taxes – including the incumbent government.

Bear in mind that there is now only one Budget a year and the next comes quite soon – this autumn.

Regarded by Labour as a tax on the rich, CGT could easily be one tax to rise. As our history panel below shows, few Chancellors have been able to resist making changes to this tax and it is now at historically low rates. Many fear it could be brought more in line with income tax – for higher-rate and additional-rate taxpayers that could mean a rise from 20% to at least 40%.

This is a good time to at least review your portfolios. Here we have offered some suggestions of steps you might take to mitigate the pain of CGT if you are looking to sell some assets you may have held for some time that are not really appropriate or in line with your current investment strategy. Be aware that you cannot just slide these assets into a pension or ISA wrapper as part of your annual allowance. Such a move will trigger CGT. Sorry! There are some things you can do though:

  1. Share your assets with your spouse prior to disposal

It is possible to give your assets to your spouse or a civil partner without triggering a tax event. We each have a CGT allowance, called the Annual Exempt Amount, of £11,700. By sharing assets that you want to dispose of between you and your partner you can enjoy £23,400 of gain before you incur CGT. If your spouse or partner is a lower-rate taxpayer you may want to give him or her more to dispose of. If trying to minimise CGT be careful not to sell so much that your partner breaks into the higher-rate bracket. The way to calculate this is to work out how much taxable income they have (income minus their personal allowance of £11,850 and any other income tax reliefs they are entitled to). Add to this estimated total taxable gains from the disposal of assets (less the £11,700 Annual Exempt Amount). If this figure falls under £34,500, they should pay just 10% on their gains.

  1. Give the shares to charity

It is possible to give HMRC qualifying shares to charity without selling them. The charity then makes the disposal and because charities are exempt from CGT there will be no tax to pay. You and the charity both actually end up benefiting.

The market value of the shares on the day they are given can be deducted from your total taxable income.

So if you are a 45% taxpayer giving £10,000 in shares to a charity (and have at least £10,000 of income subject to tax at 45%), you can claim back £4,500 via your self assessment tax return.

It means a £10,000 donation has actually cost you just £5,500 and also saved you any built in CGT liability on the gifted shares.

For those who give significant amounts to charity, holding shares with built in gains, this might be an option in lieu of cash donations they might have otherwise made from their income.

  1. Wait for a market downturn

From a CGT perspective, the optimum time to sell assets pregnant with gains is when they have lost a lot of those gains during a market correction or recession. However, the question you have to ask yourself is: would I lose as much if I sell these assets before a downturn and invest in something better? Unfortunately, we can only know the answer to that question when it is too late.

  1. Stagger the disposal

Many people will struggle with taking a big CGT hit voluntarily but they will also recognise that the tax rates could be much higher in future and there might also be a significant cost in holding assets that are no longer appropriate. The answer may be a compromise strategy of gradual disposal. A number of our clients faced with this dilemma have opted to sell enough assets to incur a tax hit of £5,000 this year and the same again for the next few years until the problem is resolved. In some cases they have opted to pay the tax from the disposal of assets within their portfolio rather than from income or cash balances.

It is understandable if clients prefer to sit on historic assets pregnant with gains rather than dispose of them and trigger a tax event. But I will end with the warning I give all clients: it is dangerous to let tax avoidance dominate your investment strategy.

A brief history of CGT

1965: CGT was first introduced by the then Chancellor James Callaghan and charged at 30% to stop people switching income to capital to avoid paying income tax. The threshold was £9,500. (It was subsequently reduced before climbing again. Today it is just £11,700, so it has not gone up much in five decades.)

1982: With inflation hitting 21%, Geoffrey Howe introduced indexation allowing people to strip out the effects of inflation when calculating the gain for tax purposes.

1988: Nigel Lawson taxed gains at the taxpayer’s marginal income tax rate – 40% for higher-rate taxpayers.

1998: In his first Budget Gordon Brown replaced indexation with taper relief – the longer you held the asset the lower the rate of tax you paid.

2007: Alistair Darling simplified everything by scrapping taper relief and creating a flat rate of 18% (and introducing entrepreneurs’ relief).

2010: The Liberal Democrats campaigned to lift CGT in line with income tax. George Osborne lifted the tax for higher-rate taxpayers to 28%.

2016: Osborne cut the higher rate from 28% to 20% and the basic rate from 18% to 10%. However, gains made on residential property were maintained at 18%/28%.

Posted 21 June 2018

You should not act on the content of this market commentary without taking professional advice. Opinions and views expressed are personal and subject to change. No representation or warranty, express or implied, is made of given by or on behalf of the Firm or its partners or any other person as to the accuracy, completeness or fairness of the information or opinions contained in this document, and no responsibility or liability is accepted for any such information or opinions.

The value of an investment and the income from it can go down as well as up and investors may not get back the amount invested. This may be partly the result of exchange rate fluctuations in investments which have an exposure to foreign currencies. Fluctuations in interest rates may affect the value of your investment. The levels of taxation and tax reliefs depend on individual circumstances and may change. You should be aware that past performance is no guarantee of future performance.

 Image: iStock

© Copyright James Hambro & Partners LLP 2015