Techzone

CGT planning & collectives – making the most of the annual exemption

Hello

Helping clients make good use of their tax allowances lies at the heart of effective tax planning and can make a real difference to their financial health. And helping clients save tax is tangible evidence of the value of your advice.

It’s easy to overlook the CGT annual exemption. But, as it’s one of the larger mainstream tax allowances, this could be a costly mistake.

To put this into context, let’s consider what the exemption is worth.

In tax year 2019/20, the annual exempt amount is £12,000. Gains above this are taxed at 20% for higher or additional rate taxpayers or 10% for basic rate taxpayers.

This means that using the CGT exemption every year could be worth up to £2,400 a year for clients who pay higher or additional rate income tax (that’s 20% of £12,000) or £1,200 a year for basic rate taxpayers (that’s 10% of £12,000).

To put this another way, for a client with a portfolio worth £240,000, this equates to a charge cut of 1.0% a year for a higher (or additional) rate taxpayer or 0.5% a year for a basic rate taxpayer.

This helps show the added value that using the exemption effectively can deliver for clients – making a real difference to their eventual financial outcome. Or the true cost of not using it.

And the exemption works on a ‘use it or lose it basis’, so it makes sense to use it every year as part of your annual tax planning.

Of course, before planning a strategy to use any unused CGT exemption you need to know how much is still available.

This means checking how much, if any, has already been used up by previous gains in the tax year. When doing this, it’s important not to overlook the CGT impact of any portfolio rebalancing during the tax year.

Indeed, it’s best practice to check the potential CGT impact before proceeding with a rebalancing exercise. Especially for larger portfolios, the tax implications might outweigh the risk implications of straying from the model allocation for a period.

Let’s look at a quick example of the impact rebalancing can have.

In our example, the client invested £300,000 into a portfolio with a model allocation of 60% equities and 40% bonds.

This is now worth £330,000. The equities have significantly outperformed the bonds over the period invested, meaning the asset allocation has moved to 67% equities and 33% bonds.

To rebalance to the model allocation, you need to sell £22,000 of the equity holding and reinvest it in bonds.

This realises a capital gain of £4,000, which means there’s only £8,000 left of the annual exemption to be used as part of the client’s yearly tax planning.

Having sold funds to create a capital gain and use the annual exemption, you now need to think about where to reinvest the proceeds. If the client wants to stay invested in the same fund, there’s another planning hurdle to negotiate.

There are anti-avoidance rules – known as the ‘share identification rules’ – to stop funds being sold and repurchased again very quickly simply to use the CGT annual exemption. These work by matching the funds sold with any repurchase of the same fund within 30 days.

This means that, if funds are rebought within 30 days, there won’t normally be much, if any, gain realised. So your planning to utilise the annual exemption will fail.

So, how can you plan around this to make effective use of the annual exemption – without being out of the market for a month?

There are four mainstream planning options that allow clients to use the annual exemption and stay invested in the same funds.

1. Firstly, there’s what’s known as ‘bed and SIPP’. Under this approach the client uses the disposal proceeds to fund a contribution to their SIPP. The SIPP contribution is boosted by tax relief, adding 25% more to their SIPP pot. And the client may be able to claim further higher or additional rate tax relief using self-assessment.
   
   The client can then reinvest in the same fund under their SIPP – potentially buying a larger holding, owing to the added tax relief. Once inside the SIPP, the funds can grow free of income tax or CGT. And they’ll normally be sheltered from IHT.
   
   Of course, the amount that can be paid into the SIPP may be limited by the client’s earnings or pension annual allowance. And there’s normally tax to pay when benefits are taken from the SIPP. But this can be a very effective way of using the CGT annual exemption without being out of the market.
   
   
2. Another approach is what’s known as ‘bed and ISA’. This is similar to ‘bed and SIPP’, but the sale proceeds are used to fund the client’s annual ISA subscription.
   
   The client can then reinvest in the same fund via their ISA. And, like the SIPP, the funds can grow free of income tax or CGT inside the ISA.
   
   The amount that can be paid into the ISA is limited by the annual ISA allowance. And, unlike the ‘bed and SIPP’ option, there’s no tax relief or IHT protection. But it’s another effective way to use the CGT annual exemption effectively and stay invested in the same fund.
   
   
3. A third planning option is ‘bed and proxy’. This involves using the sale proceeds to invest in a different, but similar, fund to plan around the ‘30 day’ issue.
   
   The holding will be different, but this approach can help maintain exposure to the same asset class or sector for example. The client can always switch back to the original fund after 30 days.
   
   
4. Finally, there’s the ‘bed and spouse’ approach. This involves the client gifting the disposal proceeds to their spouse, who can immediately invest in the same fund.
   
   The spouse may be able to buy the fund using their SIPP or ISA, to use their allowances and shelter future growth from tax. And, because the gift is between spouses, it has no IHT implications.

So, there are a range of mainstream planning options to use the CGT annual exemption.

That’s the tax planning theory. Let’s look at a case study to help bring this to life and show how it could work effectively in practice.

In our case study, the client – Lucy – invested £200,000 into an OEIC. As tax year end approaches, you’re reviewing this to see if she should realise gains to use her CGT annual exemption to rebase her acquisition cost for future disposals.

Firstly, you need to quantify the gain. Her OEIC is currently worth £250,000 – creating an unrealised gain of £50,000. The client has no other gains in the tax year, so can use part of her unrealised OEIC gain to use her CGT annual exemption.

Next, you need to work out how much to realise to use the £12,000 exemption.  The total gain on the OEIC is £50,000 – so you need to sell 12/50ths of the holding to realise a £12,000 gain. This means disposing of £60,000 of the holding (that’s 12/50 times £250,000).

You’ve now ensured Lucy has made effective use of her CGT annual exemption. But how can you plan to avoid her being out of the market for the next 30 days?

You can use a combination of approaches to plan around the ‘30 day’ issue.

Firstly, ‘bed and SIPP’. Lucy still has her full £40,000 pension annual allowance available, and sufficient earnings to support a £40,000 pension contribution, so she can use £32,000 of the sale proceeds to pay a contribution to her SIPP.

This is grossed-up to £40,000 inside the SIPP with basic rate tax relief. Lucy may be able to claim further higher rate tax relief via self-assessment.

This means Lucy can repurchase a £40,000 OEIC holding under her SIPP, which can grow free of future income tax or CGT. And the fund should normally be IHT-free on death too.

Lucy may be able to pay more to her SIPP if she has unused annual allowance to carry forward from earlier years and enough earnings. But, if not, she can still use the ‘bed and ISA’ approach to repurchase more of the OEIC holding.

Lucy hasn’t yet used her ISA allowance this tax year, so can pay £20,000 of the sale proceeds into her ISA to immediately reinvest in the same OEIC.

This restores her full £60,000 holding. And, like the SIPP, the fund can grow free of future income tax or CGT under the ISA.

Because of the tax relief on her SIPP contribution, Lucy still has £8,000 of the disposal proceeds left to invest.

She could use a ‘bed and proxy’ approach to invest this in a similar fund. Or she could gift it to her spouse so they can invest in the fund (potentially using their SIPP or ISA).

You’ve now ensured that your client has both used their CGT annual exemption effectively and navigated the ‘30 day’ issue to retain – or even increase – the OEIC holding they so value.

Great financial planning and a happy client.

So, to sum-up our key messages:

1. The CGT annual exemption is a valuable part of the tax planning toolkit. It’s provided on a strict ‘use it or lose it’ basis each tax year, so it makes sense to use it every year if you can.
   
   
2. It’s important to pin down how much, if any, of the annual exemption has already been used-up – to work out how much can still be used.
   
   Don’t forget to take account of the CGT implications of any portfolio rebalancing during the year. Indeed, it’s best practice to check the potential CGT impact before proceeding with a rebalancing exercise.
   
   
3. Planning using ‘bed and SIPP’, ‘bed and ISA’, ‘bed and proxy’ or ‘bed and spouse’ can help navigate the ‘30 day’ issue - to make good use of the CGT annual exemption without being out of the market.

It’s all about applying effective tax planning to deliver better client outcomes – and reinforce the value of your advice.

I’m Lauren Hanlon. Thank you for listening.

This presentation is based upon Standard Life's understanding of UK law and HM Revenue & Customs practice in the UK at the date of recording.

Tax and legislation are likely to change.

This presentation is designed as educational support for authorised advisers and should not be relied upon by anyone else.

Tax treatment depends on individual circumstances.

No guarantees are given regarding the effectiveness of any arrangements entered into on the basis of this presentation.

This content provides a suggested approach only – other approaches may be equally suitable. Every client's circumstances will be different and require advice.

Standard Life accepts no responsibility for advice which may be formulated on the basis of this presentation. Any advice you give is your responsibility.