As the name might imply, Capital Gains Tax (CGT) is paid on the gain on the sale of an asset that has risen in value. In other words, the tax only becomes due if that asset has risen in value and realised a profit.
While very few individuals delight in paying tax, in the case of CGT there should be some cause for congratulation, as this means you will have made money on an investment, which is never a bad thing
For the 2020/2021 tax year, each individual is allowed to realise gains of up to £12,300 before any tax become due. Any gain over that amount is taxed at what appears to be particularly favourable rates, with basic rate taxpayers paying tax at 10% (or 18% on residential property) and high or higher rate taxpayers only incurring tax at 20% (28% on your gains from residential property). This compares very favourably with the current higher rate of Income Tax at 45% and would be appear to be an obvious anomaly in the current tax system.
The annual CGT exemption of £12,300 is one of the most underutilised allowances in the UK tax system, quite often due to a lack of awareness which leads to an inability to plan.
As the economic cost of the COVID-19 pandemic racks up and the government continues to borrow to support the UK economy, the spotlight has turned to how taxes might rise in the not so distant future to repay this debt and support the economy.
While we don’t know what plans Chancellor Rishi Sunak has in mind, one obvious way to potentially raise tax revenues would be to bring the rates of CGT more in-line with Income Tax. The government will need to strike a balance between raising taxes and stimulating growth but it would not be too surprising if we were to see an increase in the current tax rates on capital gains.
Although we don’t yet know how CGT rates may change, it seems unlikely that CGT rates will get any lower than they are currently. This could present an opportunity for investors to reset the bar and to think about their current investment strategy.
Quite often we will come across investors who will be sitting on investments they made several years ago, safe in the comfort that they have performed very well and are showing a healthy paper profit. However, these investments don’t necessarily have a role to play to within the wider context of a financial plan and sometimes the fear of paying tax on these profits can lead to inertia when it comes to making sensible decisions.
We recently worked with a client who had identified an opportunity after the banking crisis of 2007/2008 and had chosen to make investments into two unit trusts, one a UK equity tracker and the other a US equity tracker. Both investments would be categorised as medium to high risk and had performed exceptionally well, as global equities had rebounded strongly since the big sell off in 2008.
However, 11 years had elapsed since those investments were made and the world has moved on, as had our client’s objectives. Our clients were contemplating retirement from 2021 and needed to change their focus from targeting capital growth to generating a sustainable and tax efficient income.
While we could only admire the wisdom of the decision taken back in 2009, the reality was that these investments had performed exceptionally well and delivered growth way beyond expectations. However, neither investment fund could distribute an income and, arguably, both were quite high risk for someone venturing into retirement.
Taking a step back, the client was able to recognise that this was a positive situation to be in, where an exponential profit could be taken and proceeds realised to support the financial plan.
This was not a case of trying to time the market and be clever, more a situation where profit could be raised and where the subsequent tax liabilities, which were going to have to be paid at some stage in the future either on realising gains and/or on death, seemed comparatively favourable.
There is a lot to be said for converting a paper profit and banking it. The investments could continue to grow and the profit become bigger but the value could also fall and tax rates could rise. For this client, the conclusion was that a tax of 20% on a sizeable surplus gain over the £12,300 allowance was a price worth paying and so they have ‘banked’ a very healthy profit which they are unlikely to regret.
These proceeds will now be reinvested in a wider portfolio of diversified assets within sensible tax efficient structures, allowing the client to reduce their exposure to investment risk and to generate a tax efficient income towards their retirement objectives.
The starting point for investment and future growth has also been reset, although now we will monitor these investments annually and, where appropriate, seek to realise gains year-on-year to take advantage of the £12,300 allowance (at least for as long as it remains).
The message here is simple - don’t let a fear of paying some tax dissuade you from making a sensible decision as, whichever way you look at it, a realised profit is a good profit.
It is certainly worth reviewing your investments to check their appropriateness and gains position, to see whether opportunities arise to reset your investment strategy and bank away those gains at what look like favourable rates of tax.
For more information on the issues raised in this article or to discuss your individual circumstances speak to your financial advisor or one of our financial planning consultants.
The views, information, or opinions expressed within this publication are solely those of the individual authors involved and do not necessarily represent those of Crowe Financial Planning Ltd.
Crowe Financial Planning UK Limited is authorised and regulated by the Financial Conduct Authority (‘FCA’) to provide independent financial advice.
The information set out in this publication is for information purposes only and does not constitute advice to undertake a particular transaction. Appropriate professional advice should be taken on specific issues before any course of action is pursued. Any advice provided by a Crowe Consultant will follow only after consideration of all aspects of our internal advice guidance.
Past performance is not a guide to future performance, nor a reliable indicator of future results or performance. The value of investments, and the income or capital entitlement which may derive from them, if any, may go down as well as up and is not guaranteed; therefore investors may not get back the amount originally invested.
The Financial Conduct Authority does not regulate Tax and Estate Planning.