Understanding a complex world

Like any area of taxation, it has had a number of changes with the most fundamental in 2008; when indexation and taper relief were withdrawn and the marginal rates of tax paid were changed.

There were further changes in June 2010 where we now have the position of gains subject to higher rate tax (HRT) at 28 per cent tax and those in the basic rate band (BRT) taxed at 18 per cent.

At this time of year, thoughts naturally turn to the impact of the chancellor’s Budget speech on March 19 and the end-of-year tax planning that many would benefit from undertaking.

It is customary to get a list of ‘things to do’ before the end of the tax year and one that is always quoted is to ‘use your CGT annual exemption’.

For the 2013/14 tax year this exemption is set at £10,900 and is available to nearly every UK resident investor.

It is set to rise modestly to £11,000 for 2014/15 and by another £100 the year after. Many commentators lament the lack of use of this valuable exemption.

This is where it is worth stepping back and considering that every investor is in a unique situation and should at least question this ‘perceived wisdom’.

The concept of using the full annual CGT exemption is correct, but how does it really look in reality for many? One of the key aspects when considering any action in this area is to think about the individual’s attitude to risk, a key fundamental of investing.

There are many ways to categorise a client’s attitude to risk, but for simplicity, a core number fall into the 3 to 7 range of a 10- point scale.

This leaves a few who will not take much, if any, risk and some who are very comfortable at the high end of the scale.

Against this background let’s look at some numbers:

An initial investment of £181,667 will need to return 6 per cent growth over the year (net of charges) to show a gain of £10,900, equal to the current annual CGT exemption.

As every client is unique, it is worth considering a wider set of levels of return (net of charges) to show what level of initial investment would be needed to produce the same gain: £10,900 of growth.

Someone targeting a 4 per cent return would need to invest approximately £272,500. A further factor to consider is how the investment growth is actually achieved.

To have the growth subject to CGT, then it needs to be 100 per cent capital growth, not a combination of growth and reinvested income. There are very few funds available that return growth only.

If the client had £181,667 as a total portfolio and is a cautious investor does selling and repurchasing the whole investment fit in with this position?

Would selling the whole portfolio to realise a potential tax benefit be correct advice? If they are more of a buy and hold investor then this strategy may not sit well with them.

The complex CGT matching rules on sales and repurchases may need a change of fund even though that may be in the same sector.

It’s also important to consider if there is a potential market timing issue with being in cash for even a day or two, as any tax saved needs to cover any costs associated with the sale and repurchase undertaken.

To put this into context, a higher rate tax payer would save tax of £3,052 by fully utilising their annual CGT exemption (£10,900 x 28 per cent).

There may be a switching fee involved and they would also need to factor in the cost of any advice given. £3,052 is 1.59 per cent of the £192,567 the investment realised, so if the fees/charges exceed this level then it may not be the right thing to do.

There is no doubt that the issue of CGT is a complex one. The key is to remember the unique nature of every situation and not to be afraid to question any ‘perceived wisdom’ in that area.

Andy Zanelli is head of retirement planning, AXA Wealth

CGT EXEMPTION

IS IT RIGHT FOR EVERYONE?

Andy Zanelli, head of retirement planning at Axa Wealth, points out there are a number of questions that need to be asked when considering whether to utilise a CGT exemption and any selling and repurchasing that this involves. These can include:

• What is the size of the portfolio and the attitude to risk?

• In reality, does the client tend to invest in a favoured fund(s) for a number of years?

• Will a switch of funds fit with the client’s investment strategy?

• Will the client be happy to invest in a different fund(s)?

• How long will the investment be held in cash before it is reinvested?

• What will the charges be for purchasing any new funds?