Capital Gains Tax – the advantages of taking the allowance into consideration
- Author : Novia Financial
- Date : 24 Feb 2020
For those holding investments in a general investment account Capital Gains Tax (CGT) can sometimes feel like a punishment for good performance, but all the same there are definite advantages to taking CGT allowance into consideration. Utilising the allowances to the full helps improve returns and therefore factors into investment decisions, whether that be when crystallising profits or crystallising losses to reduce the year’s net capital gain. Capital losses are certainly worth reporting; with the natural focus being on gains, these are often overlooked, but they do have an upside: if reported, these losses can be used to offset future gains.
Calculating Gains & Losses
When crystallising investments the proceeds raised are matched against an acquisition cost to calculate the gain or loss. This acquisition cost is derived using three matching rules:
- Matched against units purchased on the same day
- 30 Day Rule
These matching methods are applied in the order shown above, and sometimes multiple matching methods will apply. For example, if 100 units are sold, 10 re-purchased on the same day and 10 purchased the following week, the sale would initially be matched against the 10 units purchased on the same day, followed by the 10 units purchased a week later, then finally the remaining 80 would be matched against historic purchases using the pooling method.
The purpose of the Same Day and 30 Day rules is to prevent artificial crystallisation of gains to maximise the annual CGT allowance whilst resetting acquisition cost so that future gains are decreased.
Distributions are treated as income for tax purposes, so if gains/losses were not adjusted for these then there would be a risk of double taxation:
Notional distributions occur when, rather than paying out income to investors, the distribution is automatically reinvested and the value is retained within the fund. To avoid paying tax on both the distribution and the added value via CGT, the notional distribution is treated as allowable expenditure for CGT purposes. The original acquisition cost is increased in line with the distribution, meaning the increased value arising from the distribution is not subject to CGT.
Units purchased between the ex-dividend date and the dividend payment date are purchased at an inflated price. This inflation is caused by the upcoming dividend payment, after which the price will drop as shown in the below graph:
This equalisation payment is treated as a return of capital for CGT purposes, and therefore is not subject to gain or loss. To facilitate this, the acquisition cost is lowered by the amount of the equalisation payment.
Allowances & Rates
The personal capital gain allowance is the net amount of capital gains an individual can make tax free. At the turn of the last decade this stood at £10,100 and has steadily increased to the current level of £12,000. The allowance for a trust has always been half that for an individual.
The rate at which CGT is calculated on gains over and above the allowance depends on an individual’s total taxable income, with basic rate tax payers paying 10% and higher rate taxpayers 20%. When selling property, the rates are slightly higher at 18% and 28% respectively.
Investor A earns £40,000 p.a. and made a £27,000 gain on their investments. The allowance of £12,000 brings the taxable gain down to £15,000.
Before taking the gains into account, Investor A has £10,000 before they reach the £50,000 higher rate bracket, therefore £10,000 is taxed at basic rate (10%) and the remaining £5,000 is taxed at the higher rate (20%).
£10,000 @ 10% = £1,000
£5,000 @ 20% = £1,000
Total CGT payable = £2,000
Why record losses?
Throughout the year all gains and losses made contribute to the final net position that is reported to HMRC. If the net position is an overall loss for the year, it might be assumed that there is no benefit in reporting. In fact, capital losses that are recorded within a tax year can be carried forward indefinitely to offset any gains in future tax years that are above the personal capital gain allowance.
As you can see in the above table, one year of poor performance can actually provide significant benefits and savings in future years. In this example, assuming this is a higher rate tax payer, they have saved £1,000 across two years (20% of £5,000) by reporting their losses.
Using the Novia CGT tool can help take the stress away from calculating all of the above. It lets you view gains and losses of each disposal over tax years or specified date ranges. It also allows you to drill into each disposal, providing a breakdown of the acquisitions it has been matched against and which matching method has been used. You can also drill into the Acquisitions to view any adjustments that have been made as a result of distributions.
Finally, you can run an unrealised gains report; this will show all the investments currently held and the original acquisition cost along with the potential gain/loss based on the latest available price. This report can be used as a guide when trying to determine how best to sell down to utilise the CGT allowance.
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