Capital gains tax planning
Clients with unrealised or potential future gains need to consider capital gains tax (CGT) and the use of annual exemptions and reliefs. This is likely to require consideration of capital gains before a fund is sold in full or in part and an end of year CGT planning exercise.
Facts and analysis
At 10%* for basic rate taxpayers and 20%* for higher rate taxpayers the rate of CGT, (compared with the highest rates of income tax 40% and 45%) looks relatively low. Bearing this in mind, what should potential CGT payers be considering?
In the context of year-end planning the following should be considered:
- The annual exemption for individuals is £12,300 for 2021/22 and £6,150 for most trustees. The annual exemption cannot be carried forward. If an individual has investments with inherent gains he/she should consider making disposals to realise any gains within the annual exemption. To ensure gains are properly realised the disposer must not personally reacquire the same shares within 30 days of disposal.
- The annual exemption is available to both a husband and wife and so between them capital gains of up to £24,600 in tax year 2021/22 can be realised without any CGT liability.
- With two rates of CGT (10%* for gains that, when added to the taxable income of the investor, fall below the higher rate tax threshold and 20%* for gains that are in excess of the threshold) there is a potential tax benefit to be secured from a 'pre-disposal' no gain/no loss transfer of an asset from a higher rate or additional rate tax paying spouse to a non or basic rate paying spouse. The saving that could be made will be 10% of the gain (20% - 10%).
- Consideration could be given to realising losses on investment to offset against capital gains. However, this should not cause net capital gains to fall below £12,300 because then part of the annual exemption will be wasted. Carried-forward losses can be offset to the extent they reduce current year capital gains to £12,300 with any balance losses being carried forward.
For example, the position would be as follows where there are both current year losses and losses brought forward from previous years.
|Capital gain (2019/20)||=||£17,000|
|Losses (2019/20)||=||£ 4,000|
|Net gain (2019/20)||=||£13,000|
|Gain after exemption||=||£ 1000|
|Brought forward losses||=||£10,000|
|Losses carried forward to 2020/21||=||£ 9,000|
It should be noted that the annual exemption is set against the net gains for 2021/22 before any of the brought forward losses are used. Therefore, only £1,000 of the £10,000 losses brought forward are used leaving £9,000 to carry forward to the next tax year and beyond.
- If a person is contemplating making a disposal in the near future which will trigger a capital gain in excess of £12,300 it may be worthwhile, if possible, spreading the disposal across two tax years to enable use of two annual exemptions to be made.
Alternatively, if the disposal cannot be spread or the gain is very substantial, the disposal could be delayed until after 5 April 2022 to defer payment of CGT until 31 January 2024. However, careful thought would need to be given to the possibility that the rate of CGT may increase in the year 2022/23.
CGT anti-avoidance rules
A transfer of an asset showing a loss to a spouse with assets showing a gain can be considered but care should be taken over the CGT anti-avoidance rules that apply.
When introducing CGT targeted anti-avoidance legislation in 2007 HMRC stated:
- "The rule does not apply to a simple sale at arm’s length of an investment standing at a loss and the setting of that loss against gains, utilising the statutory relief for losses. Such a transaction does not constitute arrangements whose main purpose is to secure a tax advantage, as the main purpose is the disposal of the unprofitable investment.
- The legislation is intended to have effect where a person enters deliberately and knowingly into arrangements to gain a tax advantage.
- The effect of the legislation will be to restrict the use of capital losses resulting from the arrangements where the gaining of a tax advantage is the main purpose or one of the main purposes of the arrangements.”
So, for this anti-avoidance legislation to apply, there must first be an “arrangement” and a “tax advantage”.
HMRC goes on to state that the intention of the legislation is to prevent people making artificial capital losses where there is no genuine economic loss or no genuine economic disposal. Frequently this will be achieved via a scheme.
CGT planning using losses is still very possible but where a client is intending to transfer assets showing a loss to a spouse on the basis that the transferee spouse realises the loss and offsets it against his or her capital gains, care needs to be exercised. In such cases it would be appropriate to consider the full details of the HMRC commentary on the extent of the anti- avoidance rule before taking action.
It seems clear that in cases of transactions in the same class of share being undertaken by husband and wife, whether the new rule will apply to neutralise capital losses will depend on the economics of the circumstances. In cases where there is a genuine transfer of shares to which the donor spouse loses access then a subsequent loss arising to the donee spouse on disposal will not be disallowed by the application of the anti-avoidance legislation.
However, in cases where transactions are entered whereby the spouse owning the shares at outset ends up with the same shares and an allowable loss, there is a strong likelihood of that loss being disallowed for offset against other chargeable gains arising then or in the future. In deciding whether the anti-avoidance rule will apply in any particular case it is essential to remember that HMRC will look first to see if there has been an arrangement and then look at what the main purpose of the arrangement was. It will be essential that securing a tax advantage was not the main purpose. In determining this, sustaining a real economic loss and also losing (and not reacquiring) the asset that generated the loss will be helpful as will the absence of the use of any marketed scheme.
Investment wrapper choice:
The disparity in income tax and CGT rates is something that investors and their advisers need to carefully consider in making wrapper choices for particular portfolios.
For those advisers using Platforms for managing client investments there is the opportunity to take a holistic view of investment and tax planning. For some, a spread of product wrappers for different portfolios or parts of a single portfolio may represent the most tax efficient way forward.
On the face of it 10% or 20% CGT rates and the annual exemption of £12,300 would appear to make collectives the overwhelming choice for capital growth/gains in the portfolio. Obviously, the current and potential future tax rates and the annual exemption available to the investor will also play a part. The bigger the investment the more “tax important” wrapper choice will be.
*Except for carried interest and gains on residential property which are taxed at 18% up to the basic rate limit and 28% on anything above the basic rate limit
- Discuss with clients the key CGT rules and planning opportunities.
- Organise a year-end capital gains tax audit for your clients.
- Factor in the possibility of an increase in the rate of CGT.
- Carefully consider the relative impact of income tax and CGT in making platform- based investment wrapper decisions.
This information has not been approved for use with customers and is based on Aviva’s interpretation of current law and legislation, and our understanding of HM Revenue & Customs (HMRC) practice as at 6 April 2021. It is provided for general information purposes only and should not be relied upon in place of legal or other professional advice. Both the law and HMRC practice will change from time to time and our interpretation may be subject to challenge by HMRC or other regulatory body. Aviva cannot act as legal adviser for you or your clients. You should always seek appropriate legal or other professional advice.