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Six tricks to avoid the Capital Gains Tax hike

One of the very first proposals is for Capital Gains Tax (CGT) to be ‘increased significantly’ for non-business assets. Currently, CGT is charged at 18% above an annual tax-free allowance, which is £10,100 for the 20010/11 tax year (but only £5,050 for trustees).

It’s expected that the coalition government will bring CGT in line with income-tax rates. In other words, people making profits above the annual allowance could see their tax rate rise from 18% to, say, 40%, in line with higher-rate tax. What’s more, the 1% of workers who earn over £150,000 a year could see their CGT almost triple to 50%, but this isn’t likely just yet.

The money raised by higher CGT collection will be used to raise, over time, the yearly personal allowance for income tax above its current level of £6,475 to as much as £10,000. This will take effect from April 2011, and could completely free 3.6 million people from the tax net.

The good news for owners of small businesses is that they should not lose the CGT break they currently enjoy. This gives entrepreneurs a concessionary CGT rate of just 10% on the first £2 million of lifetime gains (increased from £1 million on 1 April 2010). Although this ‘entrepreneurs’ relief’ may well be reshaped, it is likely to remain on broadly similar terms.

To me, this seems like a sound idea, as taxing business owners too heavily would discourage entrepreneurs from wording harder and taking more risks in order to make higher profits and hire more staff

However, for investors in shares and property (including owners of second, holiday and overseas homes), CGT could leap from 18% to as much as 40-50%.

This will make investing in listed businesses and buy-to-let property far less attractive.

What’s more, it will hit the housing market, as property owners rush to sell before the new CGT rate takes effect.

While small-time property entrepreneurs across the UK are crying into their cornflakes, early sellers should get the best prices if this year’s “spring bounce” appears.

Nevertheless, higher rates of CGT will alter the investment equation for BTL landlords, making it much harder to generate sufficient profits to compensate for low or negative rental yields after paying expenses and mortgage interest.

How you can dodge this tax

There is an obvious knock-on effect from this announcement: owners who are sitting on large capital gains will rush to sell their assets — particularly property and shares — before the CGT rate rise takes effect. Thus, in the days ahead, I expect to see a flood of sales of shares and investment properties going on the market.

Without further ado, here are six ways that you can avoid paying higher rates of CGT:

1.     Take profits now

There may be just weeks before the new CGT rate is introduced; it could happen in a proposed Budget on 24 June. Thus, it makes sense to ‘crystallise’ some capital gains now, in order to minimise your tax liability.

Therefore, root through your portfolio to find gains that could be realised now via asset sales that minimise your exposure to CGT. Don’t forget that gains totalling £10,100 or less this tax year are not subject to CGT (which means that hardly anyone pays much CGT these days).

2.     Exploit your spouse

By this, I don’t mean treating him or her badly!

What you should do is make full use of your spouse’s yearly CGT allowance. Transferring assets between spouses (or same-sex Civil Partners) does not attract CGT, so you can gift some assets to your partner, who can then use his/her allowance to avoid CGT on a further £10,100 of gains. Simples!

3.     The ‘Bed and ISA’ trick

One neat trick is to crystallise some gains now by selling assets (such as shares, investment funds, bonds, etc.) and then buying them back inside a tax shelter known as an Individual Savings Account (ISA).

You can invest up to £10,200 this tax year inside an ISA.

However, you can do this by selling existing holdings, rather than putting new cash inside this tax shelter.

Here’s an example:

You buy 1,000 shares in Great Company plc for £5 each, a total of £5,000.
Great Company plc lives up to its name, doubling its share price to £10.
You decide to crystallise your profit of £5,000 by selling your 1,000 shares for £10,000.
You then immediately buy back your 1,000 shares for £10,000 inside your ISA.
In summary, you have made a gain of £5,000 and repurchased your entire holding of £10,000 inside an ISA, safe from future tax grabs. Do bear in mind that ‘Bed and ISAing’ means paying selling and buying commissions and, possibly, stamp duty at 0.5% of the purchase price.

4.     The ‘Bed and SIPP’ trick

Another variation on the ‘Bed and ISA’ trick is the ‘Bed and SIPP’ method. Instead of selling assets and then buying them back inside an ISA, you buy them back inside a Self-Invested Personal Pension. The end result is the same: you crystallise a gain and, safely inside your SIPP, future profits become tax free.

5.     Offset losses against gains

Capital losses offset capital gains, so a gain of £20,000 combined with a loss of £10,000 gives you a net gain of £10,000 — which is below the CGT threshold. Therefore, by crystallising losses alongside gains, you can minimise your total exposure to CGT.

6.     Grab income-tax relief

By investing in special tax-efficient schemes which provide capital to small businesses, you can claim back much of the income tax and CGT which you have previously paid. These schemes, known as Venture Capital Trusts (VCTs) and Enterprise Investment Schemes (EISs) can be extremely risky, so they are best left to the most experienced and wealthiest investors.

Finally, it would make most sense for the new CGT rate to come into force on 6 April 2011. However, the ConDem government could be sneaky by backdating any increase in CGT to today or the beginning of this tax year on 6 April 2010. However, this would be most unfair on investors who have sold before this announcement, so I hope the ConDems don’t get greedy and go for this ‘retrospective’ clawback.

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