With an annual Capital Gains Tax (CGT) free allowance of £10,100 available to every UK taxpayer, Fidelity International is urging the nation to take a closer look at this important tax break, as it believes that investors could be losing hundreds or even thousands of pounds a year.
Fidelity's research shows that just 9 per cent of Britons claim they fully understand CGT with 91 per cent either they do not fully understand it or believe it relevant. Even some of this 9 per cent were deluded because only a minuscule 6 per cent of the nation was able to name the correct £10,100 limit for the current CGT tax-free allowance, leaving a worrying 94 per cent of the nation ‘CGT confused'.
CGT – The Facts
CGT is a tax, currently at 18 per cent, on the profit or gain you make when you sell or ‘dispose of' an asset. This could be in form of selling it, exchanging it for something else, or transferring it or gifting it to someone else, other than your spouse.
CGT applies to a variety of assets such as many investments for example, stocks and shares, a second home or property that isn't your main residence, high value personal possessions such as paintings, jewellery and antiques and business assets.
However, before any tax becomes payable, all taxpayers are entitled to make £10,100 worth of capital gains from investing completely free of UK CGT. Despite this valuable tax break being available to every UK taxpayer, almost one in three (27 per cent) people don't consider CGT relevant to them. Like with ISA tax breaks, if a year's tax-free allowance remains unused it will be lost and cannot be transferred into the next tax year.
“It is clear from our research that CGT is a widely misunderstood and ignored tax,” Paul Kennedy, Head of Tax and Trust Planning at Fidelity International.
“For those who pay income tax at 40 per cent or higher the rate of capital gains tax at 18 per cent may look attractive but the key for most people is wherever possible to use their tax free allowance. Don't confuse these two issues - the rate of tax applies only where a gain exceeds the annual allowance. The annual allowance provides tax-free return whatever the rate of CGT and currently that's up to £10,100 of tax-free gains per person per year which is £20,200 for a married couple"
Using the tax-free CGT annual allowance
Because the annual CGT allowance does not accumulate you cannot just sit back over the years and use all your previous allowances in one go. To use their annual tax-free allowance investors must realise a gain in that tax-year. This means selling-out of the investment.
Previously, many investors used to realise a gain equivalent to the tax-free allowance on the last day of the tax year and then buy exactly the same investment back again at the start of the next tax year. This so-called “bed and breakfasting” loophole was closed in 1998, which now effectively means that to use your annual allowance you must wait at least 30 days before re-buying the same investment.
However, whilst you cannot buy exactly the same investment within 30-days, you can re-invest immediately in a different investment or fund and with many thousands of funds now on offer this strategy is undoubtedly used by some.
There are still two remaining strategies that do allow you to realise a tax-free gain within the annual allowance and then immediately re-purchase the same investment.
The first and most common is known as “bed & ISA”. Here the investor realises a gain by selling the shares or fund and then immediately buys them back within an
ISA wrapper (the 30-day rules does not apply where the re-purchase is through an ISA).
The second - over which some caution should be exercised - has the rather unfortunate term of “bed & spousing”. In essence, one spouse sells investments to realise a gain within the tax-free allowance and the other spouse then re-purchases an identical investment.
"Capital gains tax doesn't have to be taxing and there are ways that help make this tax work for you. However, it is important not to let the ‘tax-tail' wag sensible investment decisions,” concludes Paul Kennedy.
“Investments that are subject to CGT can often carry higher risk so use them only if they are suitable for you. Similarly, when it comes to the annual tax-free allowance, don't cash-in investments unless this makes sense within your investment plans.
“Generally, use your ISA allowance first and then, where your
investments fit, look to see if CGT offers the possibility of some more tax-free return and/or an otherwise relatively low rate of tax. All of which can help us further ensure that we are not unnecessarily gifting away our savings and investment returns to the taxman."
