The 18% CGT rate means investors must look at the structure of their investments to minimise tax constraints.
Until April 2008, an individual paid capital gains tax (CGT) as though the gain (after deducting various reliefs) was the top slice of taxable income. This meant that CGT was effectively chargeable at various rates up to a maximum of 40%.
From 6 April, CGT is chargeable at the fixed rate of 18% for all taxpayers (apart from corporate entities), which is a wide disparity between this and the higher rate of income tax of 40%. Therefore, in recent months there has been much interest in investments whose gains give rise to CGT rather than an income tax charge.
Tax Treatment Of Some Mainstream Investments
Most conventional investments yield dividend or interest subject to income tax, plus there can be a CGT charge at 18% when the investment is disposed of.
However, some investments pay no dividends and all the income rolls up within the fund until it is either wound up or the investor disposes of his/her holding.
Many such funds are based offshore and those that do not distribute 85% or more of their annual income are classified as 'non-distributor funds'. Under current legislation, when you make a disposal of units in such a fund, the gain will be subject to income tax at the investor's marginal rate of tax.
Other historically popular investments are the offshore bond or non-qualifying insurance policy. They roll up income and gains until withdrawals or disposals are made in excess of a specified maximum, equivalent to 5% of the original capital invested for each year the bond has been in existence, at which time (unless the individual is not UK resident), an income tax charge will arise. Care must be taken to ensure one does not invest in a personal portfolio bond as the tax regime for such investments is less favourable.
Certain investment structures are only subject to CGT. A good example is the zero dividend preference share class of split capital investment trusts, often referred to as 'zero prefs'. Zero prefs provide no income, so no income tax charge is incurred, and on disposal are only subject to CGT. The value is rolled up within the investment, so the tax suffered on the total investment is limited to 18%, unlike most conventional investments. Zero prefs are medium-risk, cautious investments with the objective of long-term capital growth.
A portfolio of zero prefs further reduces the exposure to risk, of which the Smith & Williamson's Cautious Growth Fund is a good example. While past performance is no guide to the future, it is interesting to note that this fund achieved a cumulative performance of 32% over the past five years to July 2008.
It is also important to consider how investment decisions can be implemented without tax constraints. Pension funds, notably Self-Invested Personal Pensions (SIPPs), are perfect for this.
Those with substantial portfolios may want to consider a private unit trust. There are various regulatory and tax issues to consider but, in the right circumstances, these can be a tax efficient investment vehicle for high-net-worth individuals.
CGT-Free On Disposal
Provided qualifying conditions are met, some investments do not give rise to CGT on disposal. Venture Capital Trusts holdings and Enterprise Investment Scheme shares are the two most obvious examples, both of which, if the conditions are met, come with a range of other tax benefits.
British government stocks and gilts, which also do not incur CGT, are often overlooked. Returns are at the low end of the scale, but with the current market depression, they may be worth considering.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.