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11th January 2017
Understanding Capital Gains Tax

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It is approaching that time of the fiscal year when we think about year-end tax planning and the utilisation of your annual Capital Gains Tax allowance. For the 2016/17 tax year, your tax-free allowance – called the Annual Exempt Amount – is £11,100 (£5,550 for Trusts), with tax paid on your overall gains above this amount. 

You are allowed to use losses, including losses from earlier years that have been registered with HMRC, to reduce your taxable gain in the current tax year. Losses can be carried forward indefinitely, but only those that have been registered no later than 4 years after the end of the tax year in which you disposed of the asset.

Capital Gains Tax is a tax on the profit when you sell (or ‘dispose of’) something (an ‘asset’) that’s increased in value. It’s the gain you make that’s taxed, not the amount of money you receive. For individuals, tax paid will be at a rate of 10%, 20% or a combination depending on the individual’s personal rate of taxation.* It is important to note that any gains chargeable to tax are added to one’s gross income in order to determine the rate at which tax is paid. Trustees and personal representatives pay tax at a flat rate of 20% (28% on residential property).

The general view of the Annual Exempt Amount is that, whilst welcome, it is not overly generous; and for a portfolio with an initial value of £220,000, growth of just over 5 per cent in the first year creates a notional gain close to the £11,100 threshold. Please note, if you do not fully use your Annual Exempt Amount it does not carry forward, hence the expression ‘use it or lose it’ applies. So, if the inherent gains in your portfolio are significantly in excess of the Annual Exempt Amount, not only should you ensure you fully utilise your personal exemption, it would also make sense to consider transferring assets to your spouse or civil partner so they too can fully utilise their personal exemption.

Such activity helps to ensure portfolios remain, as far as possible, unconstrained by Capital Gains Tax. However, with regard to larger portfolios we often question whether the payment of Capital Gains Tax should be considered an acceptable cost within the context of efficient portfolio management. Or, to put it another way: should we not view the tax paid as a percentage of the overall gain rather than of just the chargeable gain? In other words, the effective rate of tax. For higher rate taxpayers especially, understanding the effective tax rate may make the task of planning for regular external commitments, or for future capital expenditure, less burdensome.

*Gains on residential property are payable at 18% or 28% depending on your personal rate of taxation. Sole traders or partnerships may qualify for Entrepreneurs relief on which gains are taxed at 10%.