What impact will this week’s Budget have on your finances?
The answer – joked Douglas Scott, investment manager at Aegon Asset Management – depends on whether you are a “chain-smoking private equity fund manager who will be flying to their soon-to-be-purchased third home by private jet to catch up with the four kids on a break from boarding school”.
Yet many people with far less lavish lifestyles could be liable for a much larger tax bill.
Capital gains tax (CGT) was hiked in Wednesday’s Budget from 10% to 18% for basic rate taxpayers and from 20% to 24% for those on a higher rate. This follows the previous government’s decision to reduce the annual CGT allowance from £12,300 to £3,000.
However, investors have a few tricks up their sleeve to guard against the chancellor’s tax grab.
First and foremost, they should be making full use pension funds and ISAs to invest in equities and other asset classes tax free.
Second, a manoeuvre called ‘Bed and ISA’ or ‘Bed and SIPP’ involves selling assets that are outside of a tax wrapper and rebuying them within an ISA or self-invested personal pension (SIPP) so that any future gains are tax free.
Selling the assets could potentially incur a CGT liability now, said Laith Khalaf, head of investment analysis at AJ Bell, but “investors can mitigate this by judicious use of their annual £3,000 CGT allowance”.
“Investors who feel they might breach the £3,000 annual CGT allowance using this approach might consider pairing the sale of a profitable investment with a loss-making one. Losses can be used to offset gains, thereby reducing the capital gains tax liability, then either or both investments can be rebought within the ISA to avoid tax on future gains,” he explained.
People in a committed relationship who are happy to plan their finances jointly have even more tools at their disposal to avoid the ravages of higher taxes.
A couple has recourse to both partners’ annual £3,000 CGT allowance on profitable share sales.
“By doing a ‘Bed and Spouse and ISA’, it’s also possible to use two sets of the annual ISA allowance of £20,000 to shelter those assets from future capital gains,” Khalaf noted.
Furthermore, transferring assets to a spouse or civil partner can be done free of CGT and is especially useful if one person is a higher rate taxpayer and the other is not. Even when capital gains exceed the annual CGT allowance of £3,000, it is better to pay 18% than 24% tax.
Another option for wealthy, adventurous investors who have filled their pension and ISA allowances would be to invest in early stage, fast-growing businesses through venture capital trusts (VCTs) and enterprise investment schemes (EIS).
“Capital gains on investments held within both VCTs and EIS are free from tax and in addition, an EIS investment provides the opportunity to defer capital gains made elsewhere, whereas a seed enterprise investment scheme (SEIS) investment comes with a 50% exemption on gains made elsewhere,” Khalaf explained.
Nonetheless, “investors should ensure they don’t let the tax tail wag the investment dog”, he warned. “VCTs and EIS invest in small, early stage companies which might fail and have low levels of liquidity.”
Another move investors may wish to consider is shifting money into multi-asset funds or investment trusts because fund managers can buy and sell assets and rebalance their portfolios without incurring tax.
Investing in gilts is a further option because capital gains on government bonds are tax free. “A theoretical gilt yielding 4% entirely through capital gains is equivalent to a cash account yielding 6.7% in the hands of a higher rate taxpayer and 7.2% in the hands of an additional rate taxpayer,” he noted.
The increase in CGT was less than some experts had anticipated but was problematic for four reasons.
First, basic rate taxpayers face a far more severe CGT hike than for those on a higher rate, which seems unfair.
Second, CGT smacks of double taxation. “For most people, capital gains build up on assets purchased with money that has already gone through the income tax wringer, so capital gains tax represents a second wave of taxation,” Khalaf explained.
In addition, “both the complexity and rate of capital gains tax serves to discourage investment in the stock market”, he continued, although “this is mitigated to a large extent by the protection afforded by pensions and ISAs”.
Last but by no means least, hiking CGT is unlikely to bring in much money for the Treasury.
Rachael Griffin, tax and financial planning expert at Quilter, said: “While this move is aimed at boosting revenue, is likely to have the opposite effect, as it discourages investment and leads to reduced economic activity across key sectors.
“In statistics produced by the government which model the revenue impact of certain policies, this is laid bare. For example, it found that a 10 percentage point increase in the higher CGT rate shows a significant negative impact, reducing revenue by £400m in 2025-26, £985m in 2026-27, and £2.25bn in 2027-28.”
High tax rates discourage people from selling their assets, which “has the effect of locking wealth into certain asset classes, reducing the flow of capital into the economy”, she explained. “This behavioural shift could undermine the government’s revenue-raising objectives, as fewer transactions mean less CGT collected overall.”
This paradox makes the CGT increase all the more frustrating.