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Utilising the CGT exemption

The annual exemption allows chargeable gains up to £3,000 from 6 April 2024 (£6,000 2023/24) to be taken free of tax. This has the effect of taking many individuals with relatively modest gains out of the need to report or pay tax on them.

But it's also a very effective way of limiting the gains payable on an investment portfolio by ensuring sufficient gains are realised each year to utilise the allowance. It's currently worth up to £600 for a higher rate taxpayer. And if the exercise is repeated each tax year, the tax savings can have a significant impact on the net investment return.

This guide explains how to calculate how much of client’s portfolio may need to sold to keep gains within the exemption, including adjustments which may need to be accounted for where income has been reinvested and how to avoid being caught by the share matching rules.

How much exemption is available?

The annual CGT exemption for 2024/25 is £3,000. But it's important to check if the client has made any other disposals in the tax year which may have resulted in a capital gain, as these will reduce the amount of exemption available. This could include any fund switches as part of rebalancing a portfolio. Additionally, share reorganisation can also lead to a capital gain - for example, where the existing shares are replaced with cash plus shares in the new company or fund.

However, there are some disposals which don't result in a capital gain. Switching between income and accumulation units within the same fund won't trigger a chargeable gain. Where a client’s assets are moved between investment platforms as part of a re-registration, this won't result in a CGT liability provided the exact same funds are selected on the new platform.

Calculating how much of the portfolio needs to be sold

• Step 1 – calculate the acquisition cost of the shares/units
  
  Gains are calculated by deducting the acquisition cost from the disposal proceeds.
  
  The acquisition cost for is determined by adding together all the purchase costs (also referred to as a ‘section104’ holding, or ‘pooled’ cost) and dividing this by the total holding to arrive at an average cost per unit/share.
  
  This pooled acquisition cost is then deducted from each unit/share sold to determine the amount of gain or loss.
  
  
  Example - Dan has 25,000 shares in ABC UK equity OEIC (income shares). He purchased 15,000 shares in April 2009 at £2.00 a share. He purchased a further a 5,000 shares in May 2012 at £2.20 a share and finally 5,000 shares in January 2015 for £3.00 a share.
  
  The average acquisition price for the holding is:
  
  15,000 x £2.00 = £30,000
   5,000 x £2.20  = £11,000
   5,000 x £3.00 = £15,000
  Total = £56,000
  
  Acquisition price per share £56,000/25,000 = £2.24
• Step 2 – Determine the gain per share
  
  Once you have the acquisition cost per share it's easy to calculate the gain for each individual share unit by deducting it from the quoted unit/share price on the date of the disposal.
  
  
  Example (continued) - The current unit price for the ABC UK Equity OEIC is £4.74 a share. The gain per share if Dan sells part of his holding is £4.74 - £2.24 = £2.50 per share
• Step 3 – Calculate the number of shares to be sold
  
  Once you have the gain per share it's simply a case of dividing the available exemption by the gain per share to determine the number of shares to be sold.
  
  
  Example (continued) - Dan hasn’t made any other disposals in the current tax year and has the full annual exemption available of £3,000. To make full use of his annual exemption this year he will need to sell:
  
  £3,000 /£2.50 = 1,200
  
  1,200 shares at the current market price of £4.74 a share will mean he will surrender £5,688 of his portfolio with a gain £3,000. 
  
  Dan's remaining holding will be 23,800 shares (25,000- 1,200) and his base cost for those shares will be adjusted to £56,000 - (1,200 x 2.24) = £53,312.
  
  His average acquisition cost remains £2.24 per share (£53,313/23,800).

Adjustments to the acquisition cost

The acquisition cost may need to be adjusted in certain circumstances - for example, where income distributions are reinvested. 

Accumulation units/shares

Investors in accumulation shares/units don't receive income distributions from their fund. The income is automatically reinvested within the fund, inflating the share/unit price. But the reinvested amounts are also added to the pooled cost, reducing the gain when shares/ units are sold.

Income shares/units

Income shares/units distribute income as either interest or dividends. There’s no adjustment needed for CGT if the income is paid to the investor and not rolled up within the fund.

However, some investors may choose to have their income reinvested and this is achieved by purchasing additional shares/units in the fund. Each new purchase will be added to the section 104 pool and will affect the average cost used when shares are sold. This means that, to accurately calculate the gain, the number of shares purchased and their cost for each income distribution will need to be identified.

Equalisation payments

There are fixed dates on which income is distributed. A new investor who invests between distribution dates (but before the ex-dividend date) will still receive the full distribution for the period, even though they were only invested for part of the period for which it relates.

The investor is only assessable to income tax on the part of the payment which reflects their period of ownership. The balance is treated as a return of their original capital and is known as an ‘equalisation payment’. This amount is not taxable but has the effect of lowering the acquisition cost of the shares purchased.

There's no adjustment for ‘equalisation payments’ on the notional distributions from accumulation shares. That’s because the capital has not been returned to the investor and therefore does not alter the acquisition cost.

Details of equalisation payments will typically be included in the investors consolidated tax certificate.

Shares inherited on death

The date of death value is used as the acquisition cost for any assets transferred following the death of the original owner.

Jointly owned assets will have two acquisition costs following the death of one of the joint owners. Half the acquisition cost is based on the survivor’s ownership history and the other half will be rebased to the date of death.

What to do with the proceeds?

Crystallising gains within the annual exemption will realise capital which may need to be reinvested if the client doesn’t have a specific purpose for the money. Consideration may need to be given if there is a more tax efficient home for these funds and ensuring that immediate reinvestment into the same fund doesn’t undo the planning undertaken.

Share matching rules

There are rules which treat the sale and immediate buy back of shares, often referred to as ‘bed and breakfasting’, differently. This is to prevent investors benefiting from crystallising gains within the annual exemption when they have in reality never been without the shares for a significant period. These ‘share matching’ rules mean that, where the same shares are sold and repurchased within 30 days, the full gain built up over the total time that the shares were owned is not crystallised. Instead, the repurchase cost becomes the acquisition cost for the shares disposed of and the gain/loss is calculated using this figure.

There are several options which allow investors to crystallise gains to use their annual exemption and still remain invested in a particular fund without being out of the market for 30 days.

Bed and SIPP

Shares can be sold and the same shares immediately bought back in a pension, such as SIPP, which allows self-investment. This won't trigger share matching for capital gains tax as the shares are being purchased by the SIPP trustees/administrator and not personally by the investor.

Additionally, by making a pension contribution the investor will also benefit from tax relief. Also, holding the investments within a pension means that there will be no CGT on future gains and the value of the investment is generally outside the estate for IHT.

Of course, using the pension wrapper may not be suitable if the money is needed before age 55. And the amount that can contributed may be limited the individuals earned income and available annual allowance.

Bed and ISA

Another way to avoid being out of the market for 30 days is to sell funds and buy them back in an ISA. Shares held within an ISA are generally free of both income tax and CGT.

Bed and Spouse

This is where the shares are sold by an individual and bought back in the name of their spouse or partner. The disposal of shares crystallises the gain and allows the individual to make use of their CGT allowance. Of course, to buy back the shares, this may require a gift of the disposal proceeds to the spouse/partner.

Taking it a step further, if the spouse or partner hasn't maximised their pension funding or ISA allowances, they could use the proceeds to make a contribution to a SIPP or ISA and repurchase the shares within the tax wrapper to gain additional tax benefits.

Buy similar asset

Share matching rules mean that the gain won’t be crystallised in the normal way if the investor buys back into the same fund within 30 days. However, this can be overcome by buying assets in a similar fund and means the investor is not out of the market.

What if there are capital losses?

Where an asset falls in value, this may create a capital loss. Capital gains and losses incurred in the same tax year are offset against each other. This includes reducing gains down to zero, even though some of the gain would otherwise have been covered by the annual allowance (£3,000 in 2024/25).

Therefore, some or all of the current year's annual allowance could be wasted if there are losses in that year.

Any  loss not used in the year they arise can be carried forward indefinitely. An individual can choose how much loss to use against future gains. Typically a client will choose to use their loss against any gains in excess of their annual allowance, carrying forward any remaining loss to future years.