Capital Gains Tax Considerations on an Investment Account

Using a partner’s lower tax status is now less attractive than it used to be for capital gains tax planning.   However there are still two personal tax allowances that can be used.  Note the 2016/17 changes are examinable by the CII from 1 September 2016.

Written by Mark Underdown

Here’s the new situation:

The Basic rate taxpayer rules require a little more attention. 

Capital Gains Tax for Basic Rate Taxpayers

The process to follow for calculating capital gains tax for basic rate taxpayers is as follows:

1. Calculate taxable income – This is your income, less your personal allowance, less income tax reliefs.
   E.g. If you earn £30,000, you deduct your personal income tax allowance of £11,000 to give you £19,000 in taxable income.
2. Work out taxable gains – basically realised gains (caused by disposals) less any losses.
   E.g. You invested £100,000 into a fund and sold it for £130,000, realising £30,000 in capital gains.
3. Deduct the tax-free allowance – The personal tax-free allowance for 2016-17-tax year is £11,100.
   So using the above example you deduct £11,100 from £30,000, leaving you with £18,900 that will be liable for capital gains tax.
4. Add this figure to your taxable income (calculated in step one).
   Using the figures outlined above, you add £18,900 in gains to £19,000 in taxable income to give you a total figure of £37,900.
5. Refer to the basic rate tax band – The basic rate tax band is £32,000 in the 2016/17-tax year (£11,000 – £43,000).
   Any gains within this band are taxable at 10%. Any gains above this are taxed at 20%.
   So in my example, £5,900 would be taxable at 20% (£37,900 less £32,000). The remaining £14,000 will be taxable at 10%.
6. Calculate tax to pay.
   So the total tax paid on the £30,000 realised gain would be calculated as follows:
   £11,100 at nil rates
   £14,000 at 10% equals £1,400
   £5,900 at 20% equals £1,180
   Total tax equals £2,580 (or an effective capital gains tax rate of 8.6%) 

Beyond the Numbers

So I’ve covered off the math behind the capital gains tax rules, but there are other more subjective factors, when considering tax planning for our clients. If it were as simple as putting numbers into a calculator, we’d probably be all out of a job!

Here are some factors that should be considered when setting up an investment account (by investment account, I mean a platform which holds Unit Trusts/OEICs – usually called General or Collective Investment Account etc).

Double Up Personal Allowance

It’s now really important to use up both personal allowances, meaning that £22,200 becomes free from capital gains.

Bed & ISA

Common tax planning of investments would be to gradually move these funds into ISAs each year, using up the available ISA allowances.

With the ISA wrapper from 2017/18-tax year being £20,000 per person, the amount that can be gradually moved into these tax efficient vehicles is becoming more attractive.

Remember that if you do this, you could realise a capital gain. If you invest in joint names, however, you get double the personal allowance and therefore reduce the likelihood of having to pay any capital gains tax if you Bed & ISA.

You’d actually need a gain of over 55.5% in one year for this to become a CGT issue, but it would be 27.5% if only one single personal allowance was used for the original investment.

Future Access/Encashment

In the future, are there going to be gradual withdrawals or is it likely to be a one off encashment? At the very least, you can usually rely on staggering across two tax years to scoop up extra personal allowances, but a future lump sum encashment is a very different tax scenario to making gradual withdrawals.

If you are making gradual withdrawals, you can use the personal allowance each year, but if you are realising a one-off gain, it becomes much more likely that capital gains tax will need to be paid (bring back taper anyone?).

Fund/Portfolio Structure

Are you naturally realising gains along the way, or are they being essentially stored up for the future? By this, I mean, are you investing in a discretionary portfolio where funds will be bought and sold continuously, or are you investing into funds that will be held for a long time? With a discretionary-style approach, even re-balancing can cause tax issues on very large sums.

Other Assets and Investments

Don’t forget other gains realised elsewhere, particularly ones that aren’t under your advice. For example, it’s not unheard of for some clients to also have their own investment account they manage directly. 

Expected Growth Rates and Time

If you are arranging an investment for say 7 years with a low risk profile, the likely gains will be moderate, however if you are setting up an investment for 20 years with a high risk profile, the likely capital gains will be far higher.

Other Tax Wrappers

Whilst I won’t go into other tax wrappers in this article, a consideration of other tax wrappers, both now and in the future, is important. For example, a client may wish to use something like a General Investment Account today, but in 10 years’ time start putting the funds into a pension.

With any decisions we make, our interaction with the future ensures our pro-active planning will never be 100% accurate, however it’s important to think about all of the different factors and scenarios in a balanced way, so we can provide good tax planning advice as part of our service.

Grab the resources you need!

If you’re studying for your CII R03 exam, and you’re wanting an edge on exam day, grab our free taster to try out one of Brand Financial Training’s resources for yourself.  Click the link to download the R03 mock paper taster now!

Alternatively, you can download taster resources for AF4 if you’re revising for that exam.

Over to You…

If you’re planning to sit a taxation or investment-related CII exam in the near future, what areas do you think will pose the greatest challenge to you?

Mark Underdown is The Nomad Paraplanner.  He works remotely and can assist with investment research and financial planning reports. Visit www.nomadparaplanner.com to find out more.