David Prosser reviews what possible Capital Gains Tax reform could mean for investors’ portfolios.
The history of financial planning is littered with examples of tax scares that never came to pass; for example, the run-up to every Budget sees dire warnings that tax relief on private pension contributions is about to be scrapped, but it has not happened yet. Still, one area where change does seem to be on the way is capital gains tax. Not only has the Office for Tax Simplification recommended a string of reforms that would see many people paying more CGT, but also, the Chancellor has promised to review these ideas.
With the Treasury so desperate to shore up the public finances in the wake of the Covid-19 crisis, the writing is on the wall. A shake up of CGT is coming and the government is likely to look to raise significant sums from this tax.
For investors in investment companies, there are several implications. First, if and when you cash in investment company holdings at a profit, there is a good chance you may be asked to pay more CGT than in the past. Currently, on profits above your CGT allowance for a given tax year - £12,300 in 2020-21 – you pay the tax at 10% if you are a basic-rate income taxpayer or 20% if you are on the higher or additional rate of income tax. One very likely reform is an alignment of CGT rates with those that apply on income tax; that would see CGT rates rise to 20% and 40% for basic- and higher-rate taxpayer respectively, and possibly the introduction of a new rate of 45% for additional-rate taxpayers.
How best to mitigate this risk, particularly if you are sitting on substantial profits from investment companies that have delivered such strong returns in recent years? Well, the most obvious solution is to make the best possible use of individual savings accounts (Isas), since there is no tax to pay on profits realised on investments held inside these wrappers.
Everyone gets an Isa allowance of £20,000 each tax year, so as well as considering new investments to make use of this tax relief, it is worth looking at moving existing unprotected investments inside of the wrapper to secure immunity against CGT (as well as income tax). A “bed and Isa” process will enable you to do exactly that with investment company shares.
The second thing to think about is that when the tax system becomes tougher, demand for vehicles and products that offer some respite naturally rises. Venture capital trusts are one obvious beneficiary of CGT reforms, since profits on VCT shares are not subject to CGT.
Investors worried about paying higher rates of CGT may want to think about adding move VCT exposure to their portfolios, particularly where they have used their Isa allowances in full. The maximum annual investment in VCTs is currently £200,000 – so while it never makes sense to make investment decisions purely for tax reasons, there is clearly plenty of opportunity here.
One final word of warning on CGT. Investment companies benefit from an important concession; in most circumstances they pay no CGT on profits made inside their portfolios even above the annual allowance. Ministers have always recognised that it would not be fair for investors to be liable for CGT on an investment where CGT has already been paid. While there is no suggestion that the chancellor intends to abandon this approach, it is something to watch out for – and to lobby hard against if there is any suggestion of a change of heart.