Much to gain by taking advantage of low CGT

Budget failed to close gap between CGT and the highest level of income tax – but not for long

THE new higher rate of income tax came into force this week, but the door has been left open to exploit a low rate of capital gains tax (CGT) – for now at least. And investors have been urged to make the best of the opportunity by taking their returns as gains before the gap between CGT and income tax is narrowed.

The new 50 per cent income tax band means there is a 32 per cent gap between CGT at 18 per cent and the highest level of income tax, a discrepancy the government was expected to address in the Budget, but did not.

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There was also talk of a new CGT tier, distinguishing between short and long-term gains, with a higher rate on the disposal of assets held for less than, say, two years.

However, CGT is staying at a flat rate of 18 per cent until the next Budget statement – which could be as early as June should the Conservatives seize power and fulfil their pledge to hold a Budget in the first 50 days.

Should that happen, then CGT will come under the microscope. If not, then the rate is likely to increase next year.

Adrian Lowcock, a senior investment adviser at Bestinvest, said it would be only a matter of time before the next government addresses the gap between CGT and income tax.

"Investors should be wary of taking an aggressive approach to converting a portfolio to producing only capital gains, particularly where the investment is in Isas," he said.

"However, if you have an existing portfolio where there are significant gains, it is worth looking into realising these gains now before the rate goes up."

Up to 10,100 of gains can be realised each year without paying CGT, an allowance that will be sufficient for many people.

But above the allowance it remains more tax-efficient to take returns in the form of capital gains rather than income, particularly for those people who are paying income tax at the rate of 40 or 50 per cent.

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So how can you take advantage of this? Here are a few options:


To "smooth" out your gains means that by realising a large capital gain over two years or more, you can keep the year's gain within the allowance. Capital losses from previous tax years can also be used to offset gains for tax purposes. Similarly, those who have used their annual allowance can use a spouse's allowance by transferring assets into their name.


These include shares in growth companies that roll up profits rather than paying dividends, or unit trusts and investment trusts that focus on growth rather than income stocks. Investments focused on emerging markets and growth regions such as Asia tend to be particularly growth-focused.

Graeme Forbes, chartered financial planner at Intelligent Capital in Glasgow, commented: "There is often an unavoidable small element of income which is taxed at income tax rates as a by-product, but these are still worthy of consideration."

Lowcock warned investors targeting capital growth to bear in mind the likelihood of the CGT rules changing sooner rather than later. "It would be best to build a diversified portfolio where income is taken from investments inside an Isa wrapper, avoiding additional income tax, and where capital gains are locked in to ensure the portfolio doesn't become burdened with gains."


These preference shares, issued by split capital investment trusts, pay a fixed sum on a fixed date if the trust achieves a certain rate of return. With no income paid, only CGT is charged, but investors take the risk of the tax rules changing before the maturity date.


These plans are focused on growth and typically pay out on the performance of an index over a three or five-year period. Returns are pegged to a certain annual amount and usually qualify for CGT treatment on the first 10,100 of gains and 18 per cent on the remainder.

More growth-focused structured products are likely to be developed in the coming months as investment providers respond to demand for capital growth over income.


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These trusts, which can be set up by employers, hold company shares for a group of employees over a period.

When the shares are finally released they attract only CGT, rather than the income tax payable had the employer paid the money conventionally as income.


Those who sell their own businesses get a favourable 10 per cent CGT rate on the proceeds. The relief applies to gains of up to 2 million over a lifetime – the threshold was doubled in the Budget.


These are more about limiting income tax, as EISs are virtually the only investment vehicle in which capital gains can be sheltered, provided they are up to three years old. Income tax relief of 20 per cent is available on investments of up to 500,000 in a tax year and there is potential for investments to be exempt from inheritance tax. Forbes said: "This makes the EIS a very tax efficient investment across the three main taxes, although these investments tend to be higher risk."


Like EISs, these are more focused on restricting income tax than using the lower CGT rate. VCT investors can claim 30 per cent income tax relief on investments into a qualifying VCT up to an annual limit of 200,000 if they hold on to their shares for at least five years.

Dividends are tax-free if the investment is held for five years, and any increase in the value of the shares is tax-free when disposed of. Like EISs, however, VCTs are not for the faint of heart.