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An example of defusing capital gains

Image of a wires being cut to defuse.

The end of the tax year is April 5th. For many people, the weeks beforehand are a rush to put money into an ISA before the year’s annual ISA allowance is lost – despite them having already had 11 months to open or add to an ISA to earn interest, dividends, and capital gains tax-free, forever.

People, eh?

But what about those of us who do dutifully max out our ISAs at the start of every tax year – and who are lucky enough to still have cash leftover, even after pension contributions?

Or those who inherit a fat wodge and haven’t been able to ISA-size it all yet?

Or those of us (*whistles* *looks at feet*) who many years ago were dumb enough to invest outside of ISAs for no good reason?1

After a few years and a strong market, such investments made outside of tax wrappers can be carrying significant capital gains.

Keep on top of growing capital gains

High-rollers / reformed muppets with this high-class problem should be sure to use their annual capital gains tax allowance2 every year.

In the 2017/2018 tax year, you can realise £11,300 in capital gains tax-free, across all your CGT chargeable investments.

Remember, CGT is only liable when you realize the capital gain – that is, when you sell (in most cases) sufficient assets to generate more than £11,300 worth of gains (aka profits).

Until you sell, you can let capital gains roll up unmolested by tax. Deferring gains like this is better for your finances than paying taxes every year. But best of all is to pay no tax.

The trick then is to sell just enough assets to use your CGT allowance to trim back the long-term tax liabilities you’re building up, but not enough to trigger a tax charge.

You may also want to realize some capital losses to enhance the operation.

I call this process defusing capital gains.

Remember, taxes can significantly reduce your returns over the long-term.

Yet taxes are also a bit like high fees, in that being vigilant over your lifetime of investing can significantly lessen their impact.

Let’s consider an example to see.

Brief rant on Tax Justice Warriors

Before we begin, a quick interlude – necessary because some people always moan whenever I talk about mitigating taxes on investments.

We’re not fat cats around here. We’re ordinary people trying to achieve financial freedom on our own terms in a tough world.

I don’t want to hear (at least not on this post) how we should be handing the State a huge chunk of the gains we make by risking our own money out of some moral responsibility that most of the moaners would not feel if they were in our shoes.

I know how hard it is to compound stock market returns on an unspectacular middle-class income, because I’ve been doing it for the past 20 years.

It’s at least as hard as sitting in your million pound house in a London suburb that you bought in the late 1990s with a 95% mortgage – a house that has quintupled over two decades, multiplying your initial deposit 80-fold, entirely tax-free to you – and looking up from the Guardian to complain about share ‘speculators’.

Tax mitigation is legal and sensible. People can use the money they save on taxes however they choose. We admire those who give it to good causes or otherwise invest it in noble pursuits. But simply handing it over to the State because you weren’t paying attention hardly seems like intentional living.

If I roughly tot up the taxes I’ve paid over the past five or six years, I find that despite my best efforts I’m still paying plenty (not least thanks to a Stamp Duty Land Tax wealth amputation) and doing my bit.

There’s a time and a place to discuss the appropriate level of taxation, but I’m decreeing this isn’t it.

(I’m ready to delete rogue Citizen Smiths to keep the comments below on-topic.)

Deter-rant over. Thank you!

An example of defusing capital gains

I’ve written before how you can defuse gains by using your CGT allowance to curb the growth of your CGT liability over the years. I’d suggest you read that article before continuing with this one.

A good use for money raised from defusing, by the way, is to fund your next ISA! (Reminder: You can do so every year from April 6th.)

Let’s work through an example to see how you go about defusing a gain.

It’s not that bad! Defusing is usually not as complicated as this example is about to sound, because your broker, software, or record keeping spreadsheet can help you keep track of the ongoing gains on each of your holdings. I’m just showing the underlying calculations here for clarity. Make sure you keep great records if you invest outside of tax shelters! The paperwork can be painful, but it is necessary.

A worked example of CGT defusing

Let’s say you invest £100,000 in Monevator Ltd – a small cap share that pays no dividend, but whose share price proceeds to grow at a very rapid 30% a year rate for three years.

After this period you decide to sell up and use the money to buy an ice cream van and become a self-made mogul like Duncan Bannatyne.

Is it a good idea to defuse or not to defuse along the way?

Here are two scenarios to help us answer that question (rounding numbers throughout for simplicity).

Scenario 1: You don’t sell any shares for three years

What if you don’t defuse? In this case your initial £100,000 of shares in Monevator Ltd compounds at 30% a year for three years.

At the end of the third year / beginning of the fourth year your shareholding is worth £219,700 and you sell the lot. You have thus realized a taxable gain of £119,700. (That is: £219,700 minus £100,000).

Assuming the annual capital gains tax free allowance is £11,300 in four years time – and assuming this is the only chargeable asset you sell that year, so there are no other gains or losses to complicate things – you will be taxed on a gain of £108,4003.

The tax rate depends on your income tax bracket. You are taxed on capital gains on shares at a basic 10% rate, with higher rate tax payers paying 20% on their gains.

From my previous article, you’ll know the taxable capital gain itself is added to your taxable income to determine your income tax bracket.

The basic income tax band is currently £33,500, so clearly most or all of the £108,400 in gains is going be taxed at a rate of 20% in this example.

Let’s presume you’re already a higher-rate tax payer from your job – a fair assumption for most people who pay capital gains taxes on shares.

At a tax rate of 20%, then, that £108,400 taxable gain will result in a CGT tax bill of £21,680.

You pay your tax and are left with £198,0204 for your next venture.

Remember: To keep things simple I’m presuming you don’t have any capital losses that you can offset against this gain to reduce your liability.

Scenario 2: You defuse your gains over the years

What if instead you’d sold enough assets to use up your capital gains tax allowance every year?

In the first year the holding in Monevator Ltd grows 30% to £130,000 for a capital gain of £30,000.

Remember: It’s not a taxable gain until you actually sell the shares.

You’re allowed to make £11,300 a year in taxable capital gains before capital gains tax becomes liable.

So what we need to do is to sell enough shares to realize a £11,300 taxable gain, which we are allowed to take tax-free. (i.e. We CANNOT just sell £11,300 worth of shares).

First we need to work out what value of shares produced a £11,300 gain.

A quick bit of algebra:

x*1.3 = x+11300
1.3x-x=11300
0.3x=11300
x=37,667

So £37,667 growing at 30% results in an £11,300 gain, which we can take tax-free under our CGT allowance.

We need to sell £37,667+£11,300 = £48,967 of the £130,000 shareholding.

Note: You could reinvest this money into the same asset after 30 days have passed, according to the Capital Gains Tax rules, or into a different asset altogether.

In the second year, we start with an ongoing holding of £81,033.5 Again it grows by 30%, so we end the year with £105,343.

But remember, this ongoing shareholding had already grown 30% in the previous year!

So the maths is:

x*1.3*1.3 = x+11,300
1.69x-x=11,300
0.69x=11,300
x=16,377

So £16,377 has grown by 30% per year for two years to produce the £11,300 tax-free gain we want to use up our allowance.

We need to sell £16,377+£11,300=£27,677 of the £105,343 shareholding.

In the third / final year, we are down to a shareholding of £77,666, which grows by 30% once more to £100,966

x*1.3*1.3*1.3 = x+11,300
2.197x-x=11,300
1.197x=11,300
x=9,440

Over the three years, £9,440 has grown by 30% every year to produce an £11,300 gain. We must sell £9,440+£11,300 to realize this gain and use up our CGT tax-free allowance.

i.e. We need to sell £20,740.

This leaves us carrying a holding of £80,226.

In total over the three years we have sold £97,384 worth of shares, and realized £33,900 in capital gains entirely free of tax.

Let’s once again assume we still need all our money as cash for the ice cream van business at the start of year four, as in scenario one.

The fourth year is a new year, so we’ve a new £11,300 capital gains allowance to use.

But now we are going to pay some capital gains tax.

The £80,226 holding we are still carrying was originally worth £36,516, before it grew at 30% every year for three years.6

We pay tax on the gain only, which is:

£80,226-36,516 = £43,710

We have that personal allowance of £11,300:

£43,710-11,300 = £32,410

The final (and only) tax bill on selling up the remaining £80,226 stake is therefore:

(£32,410) x 0.2

= £6,482

Compared to scenario one, we’ve saved £15,198 in taxes.

After tax we have £73,744 left from our final share sale, plus the £97,384 we sold along the way to give us total proceeds of £171,128.

(Before you start to type something in response to that, please read on!)

Is it worth defusing capital gains?

I can think of plenty of things I’d rather do with £15,198 than give it to the Government, so I vote ‘yes’, defusing is worthwhile.

Your mileage may vary.

But note that this is a very over-simplified example.

A 30% a year gain for three years in a row is very unlikely, even with winning shares – in reality even with the best performing companies or funds you’ll get up years and down years, likely spread over many more than three years.

You’ll probably also have more than one investment, so you’ll need to consider your gains and losses across the portfolio.7

I also completely ignored the issue of what you’d do with the money you liberate if you do defuse your gains along the way.

In fact, I’ve ignored overall returns altogether! I just wanted to show the tax consequences.

The eagle-eyed have probably already spotted that Scenario 1 leaves you with more money than Scenario 2, despite the higher tax bill.

This is a consequence of the money being left idle in Scenario 2 after annual defusing. In the first ‘pay it all out at the end’ strategy, all the money grows at 30% for three years – clearly a great investment.

In practice, cash released from defusing capital gains can of course be reinvested (though I wouldn’t bank on 30% returns each time if I were you!)

  • £20,000 a year of the proceeds could go into an ISA and be free of future CGT on gains. You could rebuy the same asset there (or in a SIPP, for that matter).
  • You could also sit on the money for more than 30 days before re-buying the same asset outside of an ISA.
  • Or you could immediately buy something different outside of an ISA, or just keep it in a cash savings account.

In Scenario two, the cash released could have been reinvested at the end of years one and two for (hopefully) further gains.

And just to complete the circle, if we do assume the proceeds of defusing in my example were reinvested at the same (crazy high for illustration’s sake) rate then you’d have a total final pot of £213,2188, which is of course £15,198 more than you were left with in Scenario 1. (i.e. Exactly what we saved in taxes!)

You might also argue I didn’t give the non-defusing strategy the very best shake. We could have sold one chunk on the last day of the third tax year, and then the rest on the first day of fourth year, to use up two lots of CGT allowance. This would have slightly reduced the tax bill.

But selling over two years like that is defusing gains, too! So the example is good enough I think.

As I say, it is just a fanciful illustration anyway. (I choose an unrealistically annual return number because the alternative was to illustrate a much more realistic 30-year defusing schedule – fine in a spreadsheet but even more boring to work through!)

The bottom line is taxes will reduce your returns, but there are things you can do to reduce how much you pay, from investing in tax shelters like ISAs and SIPPs, to exploiting your personal CGT allowance and offsetting with capital losses, as well as taking into account any spouse’s tax situation.

If you’re lucky enough to have capital gains, use all these techniques in combination to keep as much the gains as you can.

  1. Note: Laziness, trying to save a few pennies in charges, thinking “taxes won’t affect me” because you only look at one or two years expected returns, and not doing your research on the impact of taxes on investing returns are NOT good reasons. []
  2. Also known as your ‘Annual Exempt Amount’, if only by HMRC. []
  3. £119,700-£11,300. []
  4. £219,700 – £21,680. []
  5. £130,000-£48,967. []
  6. x*2.197=£80,226, so x=£36,516. []
  7. Are you a millionaire investing outside of tax wrappers? Then this is one reason not to use an all-in-one-fund, if you want to be as tax efficient as possible. If you buy and manage a portfolio of separate funds for yourself, you may be able to defuse the growing CGT liability by using the likely losses, as well as your personal allowance every year. []
  8. £82,754+£35,980+£20,740+£73,744. []

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{ 68 comments… add one }
  • 1 Wolfie Smith March 28, 2018, 7:21 pm

    You’ll be first up against the wall when the revolution comes.

    Power to the people!

  • 2 Brod March 28, 2018, 9:24 pm

    Sadly I don’t have this problem. Just investing porn for me.

  • 3 The Rhino March 28, 2018, 9:27 pm

    Very timely post

    I’m struggling to think of a use-case where you’d wait 30 days before buying back the same thing, i.e. you’re probably going to lose out in terms of time out of market
    So what you need is a few products to cycle through which are sort of equivalent so you can sell and buy as quickly as possible.
    Anyone have such a strategy in place?
    Is anyone doing this with VLS products?
    Say you wanted a 60:40 split you could buy 50% VLS40 and 50% VLS80 and just flip flop between the 2 every late March mitigating CGT as you go?
    Does that sound sensible? Have I got that right..

  • 4 YoungFIGuy March 28, 2018, 10:44 pm

    @The Rhino – that’s exactly why the 30 day rule is there – to make, what used to be called, ‘bed and breakfasting’ less desirable.

    Great post TI although it’s made me come over in cold sweats thinking about calculating the s104 pool (both recalling my ACA exams and, god forbid, if I ever have to do it on my investments).

  • 5 dearieme March 28, 2018, 11:32 pm

    “Anyone have such a strategy in place?”

    There was a time when one might have sold shares in Alliance Trust and bought shares in Second Alliance Trust. Then the bloody things merged. But maybe it would be close enough to trade between two investment trusts in the same categories and with similar investment policies. Or how about trading between two ETFs tracking the same market? I sell Vanguard and buy L & G; that sort of thing.

  • 6 hosimpson March 29, 2018, 8:03 am

    @rhino – A nice problem to have. Sounds like a good idea though, sell 50 of VLS40 and and 50 of VLS80, buy 100 of VLS60. I recon outside of the VLS funds, anything that tracks the same index should be a reasonable substitute.
    @TI – is there a resource out there that groups ETFs by the index they track? I thought I had seen something like that on the Morningstar page, but I can’t find it now. Must’ve imagined it.

  • 7 Kris Wragg March 29, 2018, 8:30 am

    Interesting article! I have been trying to wrap my head around things like this lately as I luckily bought some Bitcoins when they were quite cheap and now plan to start trying to cash out sensibly.

    I’ve slightly exceeded my CGT allowance for this year so will need to do a self assessment tax return.

    I’d never heard of this 30 day Bed and Breakfast rule before, reading up on it a bit more I don’t think I’ve accidentally broken the rule as I sold Bitcoin and put the cash into my S&S ISA into a Vanguard Lifestrategy fund, as they are completely different asset classes I don’t think that’s an issue?

    As you mentioned in the article, paying taxes isn’t an issue to me, I just want to be smart about what I do pay. I’m already in the higher tax bracket anyway so CGT charged at the higher rate unfortunately 🙁

  • 8 Neverland March 29, 2018, 8:52 am

    Just a few weeks of home ownership has obviously been enough to turn you into the Daily Telegraph Money section made flesh

    Actually the best way to not pay CGT is simply to be married; no CGT on transfers; and two annual CGT allowances

    GBP 22,600 of tax free capital gains each year is going to be enough for most people

  • 9 The Rhino March 29, 2018, 9:20 am

    Whether its enough depends on what you need to do with it

    My thinking revolves around the possibility of having to cash everything in all of a sudden to fund a house purchase. In which case judicious defusing over the preceding years could be very valuable.

    But if you’re just selling to fund living costs then I would agree that the allowances are plenty

    Its dawning on me that maybe my record keeping may be sub-optimal as I haven’t recorded the dividends paid within each accumulation type fund and I don’t want to be calculating CGT on dividends that I’ve already paid income tax on. I’m thinking going forward – acc units only in tax-free wrappers, inc. everywhere else just for ease of accounting?

    I’m hoping the info is there but I’m going to have to do a bit of digging..

  • 10 The Rhino March 29, 2018, 9:43 am

    Just to clarify, if you sell in a taxable account but then buy back in an ISA/SIPP, does that mean you can buy the same asset but without waiting 30 days?

  • 11 The Investor March 29, 2018, 9:46 am

    @YFG — Been there, done that. A major motivation for why I have got quite so vociferous over the years when people have turned up here saying they don’t bother with an ISA because of this or that spurious short term reason.

    @Neverland — I’ve been writing articles on tax mitigation as you know on this site for a decade, so your comment is wildly inaccurate. As for my preventative rant, needless to say I wrote it partly with you in mind. All that said you have made me give a sort of amused snort despite myself, so fair enough. 😉 Further off-topic stuff about what *should* be enough (politically speaking, not from an asset management point of view which is fine) will likely be deleted.

  • 12 Scott March 29, 2018, 9:56 am

    I’m about to do this.
    I’d like to sell non-sheltered funds on the final day of current tax year, and then buy within my new tax year ISA allowance the next day, to minimise time out of the market. Just not sure on what date I need to submit the sell instruction to ensure it is carried out within current tax year.
    I’m with Halifax Share Dealing – anyone know their time lag for selling funds, or if it’s based on the date the instruction is submitted?

  • 13 Scott March 29, 2018, 10:00 am

    @The Rhino – yes, it’s fine to immediately buy back within an ISA. Some brokers, e.g. ii, even offer a bed-and-ISA service (for individual shares, not funds, in their case).

  • 14 The Rhino March 29, 2018, 10:01 am

    @Scott – good question, I’ve found with funds the actual transaction takes at least a few days to get executed, but whether you can use the instruction submission date for tax purposes I would also very much like to know..

  • 15 The Rhino March 29, 2018, 10:04 am

    @Scott – cheers on the bed-and-isa question. I remember now that iweb also offer that service, but on the same terms, i.e. shares, ITs but not funds

  • 16 Vanguardfan March 29, 2018, 10:12 am

    @rhino (I’m not stalking you, honest). I mitigate CGT in this way every year. I’ve used the strategy you flag, changing LS80 for LS100 plus a bond fund. I’ve also tried to find alternatives to LS to swap into, but nothing is quite the same 😉 You do end up with a rather more messy portfolio, and it gets complex quite quickly.
    I do hope you haven’t been holding acc units in a taxable account – I discovered the pain of that the hard way. Inc in taxable always. There are also nuances to do with equalisation payments on some funds (including lifestrategy) even with the inc units. I confess that gets delegated to the accountant.
    Yes, you can buy back straight away in an ISA since that is invisible in tax terms.
    The other strategy I’ve used is to sell a security in my account, and buy it back in spouses account, and vice versa. I have since read that this might be considered dodgy by HMRC. And you need to be married, of course.
    Overall, it’s a pain. Between spouse and me we hold 6 different securities in taxable accounts, and that is more than enough to keep track of. No idea how people deal with portfolios of 20, 30 individual shares….This article also doesn’t mention the scenario where your holding has been bought in tranches over time, and you need to calculate average cost per unit…
    First world problems though, clearly.

  • 17 The Rhino March 29, 2018, 10:34 am

    @VF – where was the other blog I was talking to you about this? I’ve completely lost track!

    Yes – I re-read the MV articles that have attempted to find VLS alternatives but concluded there aren’t any, at least not on such good terms. I think a move into inc. ETFs is on the cards for me in taxable accounts.

    Yes – I have done exactly that and I now understand it will be painful. I think I can do it though. On the plus side I did have to extract the dividend income for prev tax returns so that may be half the battle.

    Good to get a 2nd vote that ISA buyback inside 30 days is fine

    Good to hear of someone implementing the VLS flip-flop approach. I think theres a nugget of a good idea in there.

    My gut feeling is that spouse thing would be OK, and if so then its a great idea. But happy for someone to tell me otherwise..

    I’ve got less than 6 holdings in taxable accounts so fully agree how anyone (without an accountant?) manages on anything more complex is a bit of a mystery

  • 18 The Rhino March 29, 2018, 10:41 am

    On a related note, I have the spectre of a house sale CGT bill hanging over me (but on the wifes tax side). Now that is also fully complicated, when its somewhere you’ve also lived in for several years.
    I think I have worked it out, but can’t know for sure until I submit the tax return in december to see if HMRC agree.
    I *believe* there is no taxable capital gain on it – so do I risk using up the wifes CGT allowance for this year on a bed and ISA?
    But what if I’ve got the calculation wrong and I effectively shoot myself in the foot?
    Ahh – more 1st world problems..

  • 19 The Rhino March 29, 2018, 10:44 am

    I should probably hire a tax accountant (but wheres the fun in that)?

  • 20 The Rhino March 29, 2018, 11:06 am

    Sorry to multi-post, but I’ve just found something interesting (in the loosest sense of the word)

    In the case of the wife, I have three tranches of VLS60 purchased over time, with the current gains on those purchases varying between +30% to -3%. Now if I make a sale, I can’t tell iweb which tranche I want them to sell from. So, effectively I can choose which tranche I notionally sold from at the point in time I submit my tax-return – giving me the option of posting a nice gain or a small loss. This is very attractive! Have I got it wrong? I think it makes the Bed and ISA option a no-brainer..

  • 21 Vanguardfan March 29, 2018, 11:12 am

    I’m only vanguardfan on Monevator.
    Spouse swaps can also be complicated if very different % gains. ETFs are good in taxable accounts.
    Accountants – I do the end of year CGT calcs myself, to inform trades, but delegate the actual tax submission. Sometimes I get it wrong (usually due to something like equalisation that I don’t properly understand) and I like to have a check on what I’ve done, not least because some of what I look after is not my money.

  • 22 Vanguardfan March 29, 2018, 11:17 am

    @rhino, sorry, you can’t do it like that. You have to calculate the average purchase price per unit for the entire holding, and then the gain per unit, and hence the number of units that can be sold.

  • 23 The Rhino March 29, 2018, 11:18 am

    @VF – haha yes I remembered that it was on the last article here! My memory is shot 😉

    when you say you get it wrong – who is spotting that? the accountant or HMRC?

    unless the accountants checking everything (I can see the value in that) then surely your doing the graft and delegating the easy bit?

  • 24 Vanguardfan March 29, 2018, 11:19 am

    I keep a running spreadsheet for each holding tracking sales and purchases, and average purchase price, to help calculate the current gain per unit.

  • 25 The Rhino March 29, 2018, 11:21 am

    @VF – ah brilliant – I had totally the wrong end of the stick there then..

  • 26 Kris Wragg March 29, 2018, 11:22 am

    I use a free piece of software called GNUcash for tracking all my spending and my investments, then I use their lots feature for tracking my gains/losses. I think it uses a basic FIFO (first in first out) system for calculating these values.

    Saves a lot of faffing with manual calculations.

  • 27 YoungFIGuy March 29, 2018, 11:34 am

    @Rhino

    Bed and ISA (as well as Bed and SIPP) are offered by most brokers. It’s fine as you aren’t trying to dodge capital gains, only making use of tax sheltered investment wrappers. Most brokers offer the service at a discount to regular trading, usually you pay only one lot of trading fees. Its what I’ll be doing on 6th April.

    On the spousal asset front – it’s a grey area. As long as there is no ‘strings attached’ it should be OK. But generally speaking you need to be married and living together. Hmrc take a dim view if you gift the assets but really you are still the beneficial owner and that you are doing all this purely for you to avoid cgt. There are a set of principles called the Ramsey Principles on this subject.

    @Vanguardfan is right – Acc funds outside of a tax wrapper are an absolute nightmare. If you are going to hold funds that are non tax sheltered I would strongly advise Inc funds.

    That said accountancy firms have fancy pants software that does most of the CGT calculations for them, so for them calculating the s104 pool isn’t too onerous.

    @Scott date of disposal for cgt purposes is the date of contract – i.e. when the transaction is not legally reversible – you’ll get the contract note from the broker shortly/immediately after you’ve hit execute on the transaction. The settlement date, when you actually get the money, doesn’t matter.

    @hosimpson – there is a great website called just etf.com which does exactly that. Actually, I think TI has written an article about it in the past.

  • 28 Kris Wragg March 29, 2018, 11:40 am

    @YoungFIGuy what are the implications of holding ACC funds outside of an ISA? I had a life insurance policy that paid out a couple years ago and I filled up my ISA and put the rest in a Vanguard Lifestategy ACC fund as my lazy passive investment.

    I wasn’t aware I had to do anything fancy for this other than just measure how much profit I’d made like any other fund / share? How do you even find out how much was from dividends getting reinvested?

    I’d assumed the whole point of those types of funds was to avoid all the hassle?

  • 29 The Investor March 29, 2018, 12:27 pm
  • 30 ianh March 29, 2018, 12:35 pm

    I’m dithering over this. I put a 6 figure sum into vanguard ftse global all cap find in October, and it has sunk by 5.4% since then. I’m considering selling the lot and switching into a similar product, as someone suggested doing with the LS funds, however there is only one directly comparable fund I can find (Halifax Fund of Investment Trusts A, which has the same morningstar category and similar performance, but quite a different composition e.g. about 45% UK vs 5% with the Vanguard fund – so not really what I want). The few others in the category are inaccessible as they are from dimensional fund advisors (institutional or via certain IFAs only I think). My aim in selling would be to crystallize the loss (about 7k) to carry forward on my tax return and offset against future gains. I think that this can provide a £700 (10% X 7k) tax saving at some time in the future. The downside is the risk of missing out on market moves while I’m doing the trades, that can take as much as a week in my experience, plus the increased product fee ( 0.5% vs. 0.25%), and having to invest in a fund I don’t like the look of. Alternatively I could buy units in a different category, such as vanguard global small cap fund (0.38%) – that seems more attractive. But changing the investment category seems to add extra risk again – for example I’d have to compare the performance of the two funds over the relevant period to make sure I wasn’t losing too much value. So on the one hand I’ve the feeling taking this course is too much unnecessary tinkering for a relatively small potential gain after a relatively short period in the market, but on the other hand maybe it would be a sensible course of action despite the effort and additional risks. I’d be interested to learn how others have weighed up these kind of issues.

  • 31 YoungFiGuy March 29, 2018, 12:48 pm

    @Kris Wragg – the issue with Accumulation funds is that it’s a pain to work out the cost of acquisition.

    Without rambling on for too long, to calculate the capital gain: Sales proceeds mins purchase cost.

    In respect of purchase costs, this is the average purchase price per unit of the investment sold multiplied by the number of units sold.

    The problem with Acc funds is twofold:
    1. You need to account for ‘notional dividends’ that you get. These are reflected by the value of the units going up, not receiving more units. But remember, each of these dividends was subject to income tax. So before summing them up, you can deduct the total income tax you paid on those dividends. The aggregate amount of these dividends is called the ‘net dividend’ and you subtract it from the sales proceeds.
    2. You also need to account for what’s called ‘equalisation’ this is the amount of accrued dividends, but not yet “released” before you bought into the fund when you make a purchase. This is equalisation is added to your first dividend, but is not subject to income tax (it’s treated as capital). Therefore, when you buy into the fund the purchase cost includes this equalisation amount, so to avoid double counting it is subtracted from the purchase cost.

    So the modified formula for capital gains on an Acc fund is: (sales proceeds – net dividends) – (purchase cost – equalisation).

    [You might realise that the net dividends includes the equalisation amount, so really, the equalisation on both sides cancels out.]

    This is why Acc funds are more of a pain outside a tax wrapper because you have to adjust for the ‘notional dividend’ and the tax you have paid.

  • 32 The Rhino March 29, 2018, 1:35 pm

    @YFIG – many thanks for detail. super useful. I fully concur that acc units in a taxable account are non too pleasant and I intend to correct the oversight of having naively gone down that road several years back.

    I think there is a case (which hopefully applies to me) where you don’t have to be super-accurate when trying to compute CGT. Thats when you have a good margin of safety that you are under the threshold. I.e. you make some assumptions that you know mean your overestimating your CG (like not correcting for dividends) and your still a few k under 11,300. On top of that if the amount sold is https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/505151/sa108-notes_2016.pdf

    Did you mention you may start freelancing ‘wealthy accountant’ style (https://wealthyaccountant.com/)? I am on the lookout for a good tax accountant..

  • 33 Doctor March 29, 2018, 1:39 pm

    To be clear, the sale transaction of Bed&ISA is liable to CGT.

    See “The Disadvantages” section of

    https://www.charles-stanley-direct.co.uk/News_Features_Research/how-tax-changes-have-increased-appeal-%E2%80%9Cbed-isa%E2%80%9D/

  • 34 The Rhino March 29, 2018, 1:39 pm

    @TI I think use of a less than sign trashed that last post

    meant to be:

    On top of that if the amount sold is less than 44.4k then I think you don’t have to declare anything to HMRC.

    I based this thought process partially on this document:

    https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/505151/sa108-notes_2016.pdf

  • 35 beeka March 29, 2018, 1:49 pm

    I echo the point about Acc funds outside of ISA being a PITA. I thought I might manage two birds with one stone by selling the Acc units and buying Inc ones… intending to diffuse the CGT and simplify the accounting. However the HMRC said that Acc and Inc probably don’t look enough like different funds (more like ways of interacting with the same underlying fund) and so would not be enough to trigger CGT calculations. I say ‘probably’ as nobody was willing to commit to giving legally-binding advice, even the HMRC.

  • 36 Matthew March 29, 2018, 1:49 pm

    I think it’s fair enough that during life we should have as little tax as possible because of the risks we’re taking, and also more practically I think it’s better for the global economy if investment builds tax free and remains in trust after death, better than charity I suspect, since handouts aren’t sustainable and get impeded by conflict, etc.

  • 37 Tyro March 29, 2018, 2:27 pm

    @Rhino: re your property sale, there’s a CGT calculator on the HMRC site which may be helpful. Whether it can cope with anything unusually complex I don’t know, but I found it quite easy to use when trying to work out what CGT would be due on my BTL if I sold now-ish.

  • 38 Naeclue March 29, 2018, 2:28 pm

    I try to utilise our CGT allowances by rotating between ETFs outside our ISAs and SIPPs, with ETFs/tracker funds inside ISAs/SIPPs. I look at this twice per year, once at the beginning of January when I rebalance and raise cash in our SIPPs for drawdown and once at the start of the tax year when I transfer assets in to our ISAs. The last few years this has been sufficient to use up the allowances.

    Always a bit of a balancing act as I also try to keep higher amounts of lower yielding ETFs (US and Japan) outside tax shelters to mitigate dividend income tax.

    Another perfectly legal tactic is to sell part of a ETF/index fund position and buy into a very similar ETF/fund from another fund manager, but I have not had to do that for a few years.

    Hopefully at some point we should end up with all investments tax sheltered and no longer have to concern ourselves with this faff, but I would not be surprised if the ISA tax relief was watered down in some way before it happened!

  • 39 John Nicholas March 29, 2018, 2:32 pm

    @bekoo HMRC CGT manual confirms what you have been told on transfer from acc to inc units:
    “Many unit trusts offer accumulation units and income units. These should be treated as different classes of unit. Any switch from one class to another within the same unit trust should be treated as a share reorganisation, see CG51700+”, ie it is treated as though no disposal takes place.

    @YoungFi Guy. Can you clarify what you meant when you said that in calculating CGT on acc units “you can deduct the total income tax you paid on those units” Do you not just add the dividends before tax to the purchase cost? Am not sure where income tax comes in to it.

  • 40 Naeclue March 29, 2018, 2:35 pm

    Another thing I am trying to work out how to handle is the best way to help our children buy property. I am happy to give/lend them the money for this, but I would likely need to sell some investments to do that. If I just did that with investments outside our ISAs, that would likely land us with a CGT bill. Instead we could sell some investments inside our ISAs and withdraw the cash, but that seems very counterproductive.

    A stock market crash would be helpful, hopefully coinciding though with a property crash ;).

  • 41 Jeff Beranek March 29, 2018, 2:47 pm

    Another great way to avoid CGT (and IHT if transferred to a spouse) is to die before you get around to selling your shares, at which point they also get revalued at the current market value (CGT uplift). Reminds me of Hotblack Desiato in the Hitchhiker’s Guide who spent a year dead for tax reasons… But seriously, a diversified portfolio of higher yielding FTSE 100 ‘defensives’ bought and held forever, with only the natural yield taken when you need it, is not a bad way to go if you’ve got enough cash (and the stomach to ride out the volatility).

  • 42 Xyz March 29, 2018, 3:00 pm

    @Kris Wragg, #26

    GnuCash may well be misleading you here with FIFO. Perhaps badly.

    The US allows FIFO, LIFO and average cost methods of computing capital gains. The UK only permits average (section 104 holding). Computing the average resembles blockchain(!), with each transaction dependent entirely on the result of the previous one. Somewhat more painful than specific share identification, but no choice in the UK.

    With funds and OEICs, you might also have to deal with the effects of dividend equalisations. These are things that the US tax regime doesn’t have, and so GnuCash almost certainly won’t support.

    My suspicion is that you might want to look closely at what GnuCash is doing here, to see how far off it is from UK capital gains tax reality.

  • 43 e17jack March 29, 2018, 3:00 pm

    @ianh Your world tracker has dropped 5% and you are dithering over new strategies and whether to sell and crystallise your loss?!

    You are a disgrace to the Monevator readership!

    Revisit this Lars Kroijer article (http://monevator.com/why-a-total-world-equity-index-tracker-is-the-only-index-fund-you-need/)

    Then sit back, relax, and find something better to do with your time.

  • 44 The Rhino March 29, 2018, 3:00 pm

    @JB – yes I recently discovered about CGT uplift on death, slightly bizarre but true..

  • 45 Vanguardfan March 29, 2018, 3:12 pm

    @ianh. Not sure which fund you’ve bought, but you could sell and buy vanguard lifestrategy 100 as a close alternative (or the LS80, which should reduce volatility with very little reduction in return).
    But also, what e17jack said. 🙂

  • 46 Vanguardfan March 29, 2018, 3:14 pm

    @doctor. Yes, the sale of the ‘bed’ part of bed and ISA is CGT liable. Sorry if I gave wrong impression above. But the 30 day rule is irrelevant (ie buy back exactly the same holding immediately in the ISA and it does not nullify the disposal).

  • 47 Kris Wragg March 29, 2018, 3:20 pm

    @Xyz Thanks, looks like I need to do more reading! Here I was thinking it wasn’t that difficult doing my own accounts, I’ve learnt a lot today and need to do more reading before I start on my tax return for the 2017-2018 tax year 🙁

  • 48 ianh March 29, 2018, 5:09 pm

    @e17jack v. funny. To be fair I’m not planning to sell out during a downturn but do what the article and other commenters suggest and switch investments between funds to lock in some tax gains. The question I’m weighing up is whether the small potential gain is worth the additional risk. What TI suggests is that getting off the sofa once a year to optimize your CGT position is a good idea.

    @vanguardfan the fund I have is vanguard ftse global all cap fund GB00BD3RZ475 and I am considering a swap to the vanguard global small-cap fund IE00B3X1NT05 (well, the income variety), some of which would go into a 2018-19 ISA.

  • 49 Vanguardfan March 29, 2018, 5:26 pm

    @ianh – the small cap fund will have a very different risk profile and volatility to the all cap global fund, and can’t really be considered equivalent. You shouldn’t be changing your asset allocation in order to crystallise the losses – that really is the tax tail wagging the dog!
    I suggest you clarify what your intended asset allocation is, and then, if you do decide to crystallised the loss for CGT management, choose something more similar (eg lifestrategy 100, or the VWRL ETF.) But remember that fund trades can take several days to clear, and you might lose more than the £700 while you are out of the market!

  • 50 YoungFiGuy March 29, 2018, 5:56 pm

    @John Nicholas –

    I’ll try to explain by an example (it’s worth reading the links TI has posted at post 29):

    Say you have a one unit of a fund worth £100. Over the year it accrues £5 of dividends from the underlying investments. At dividend date, for an income fund they give you £5 in dividends. So you still have investment: £100; and now cash £5. With an accumulation fund, that £5 is put back into the fund, so its investment: £105.

    Say you then sold the fund for £110, if you did the “standard” CGT calculation: £110 – £100 = £10 you’d be including income as part of the gain (you’ve only actually gained £5, £5 was dividend income). So that’s why you have to subtract the aggregate notional dividends reinvested back into the fund. Then you’d have £110 – £100 – £5 = £5.

    But depending on your fund you may (I’m not sure how the market place works since the 16/17 tax changes, as I haven’t had an Acc fund for some time) have had some tax taken off before it gets reinvested in the fund. If that’s the case, then it isn’t the gross figure that’s reinvested (£5) it’s the net (and lower) figure that has been reinvested into the fund. That’s where the interaction with income tax comes in.

    For you Accumulation fund, each year you’ll get a tax voucher and it will show the net notional dividend figure. These are the ones you add up to calculate the total notional dividend to subtract from the sales proceeds.

  • 51 YoungFiGuy March 29, 2018, 6:07 pm

    @ The Rhino – The Wealthy Accountant does do rather well for himself. Alas, I’m not a tax accountant, so always take what I say with a large grain of scepticism. Quite frankly, tax rules in this country (and most other countries) are mindbogglingly complicated – and there are much more fun things to do!

  • 52 YoungFiGuy March 29, 2018, 6:13 pm

    @John Nicholas and TI – Sorry for the spam, I think: ” But remember, each of these dividends was subject to income tax. So before summing them up, you can deduct the total income tax you paid on those dividends.” Was a bit confusing. The key is, it’s the Net notional dividend that’s reinvested into the fund, not the gross figure. So when you are calculating the aggregate dividend, you sum the net figures. The principle is that these dividends are classes as income for tax purposes, not capital.

    Teaches me for commenting on my phone.

  • 53 ianh March 29, 2018, 6:33 pm

    @vanguardfan yes I agree – I mentioned in my first post the only directly comparable fund I found (Halifax Fund of Investment Trusts A) was not a good match, and VWRL may be better. I have a lot of that in my ISA and SIPP anyway though. Explicitly including small cap fund in my portfolio is based on my reading of Michael McCLung’s book Living off Your Money, whose recommended portfolio includes significant global small cap elements. I’m loathe to tinker too much TBH and am fairly happy with how I have things set up. But I have to sell for annual drawdown and to make an ISA transfer in the first few months of the new tax year anyway.

  • 54 xeny March 29, 2018, 7:44 pm

    @The Rhino, I think iWeb automatically calculate a running average of any asset you’ve bought in multiple tranches, so that saves some work.

  • 55 The Rhino March 29, 2018, 8:30 pm

    Yes it does. Very handy.
    I took a punt and queued up two sales of 20k each to move into the ISAs
    I did double check the BTL CGT situation

  • 56 Derek The Elephant March 30, 2018, 9:11 am

    Ok, interesting comments. It seems I’m in the same boat as a few others who hold an Acc fund out with a tax shelter. I only hold one fund…Vanguard LS80. My account is with Charles Stanley & I’m looking at the 16/17 Tax Certificate they provide & trying to understand what figures I should be using for both CGT & Income Tax calculations.

    There are two columns, ‘Dividend paid’ & ‘Equalisation’.

    So for Income Tax… is it simply a case of using ‘Dividend paid’ for calculations? Anyhow, this is below the £5000 tax free allowance for dividends so I don’t think I owe HMRC in this respect unless I’m missing something?

    And I think CGT = (Sales Proceeds-Dividend paid) – (Purchase costs- Equalisation) ?

    From my own calculations using Trustnet dividend figures, simply multiplying the dividend (Trustnet figure) by Units Held on the dividend date results in a figure which equals (‘Dividend paid’ +‘Equalisation’) from the Charles Stanley Tax Certificate. I just feel this is a bit odd and perhaps my CGT formula above is wrong in respect of the ‘Dividend paid’ figure?

    Anyway, I guess I’ve learned that Inc funds are the way ahead in future for non-tax sheltered holdings! But any light shed on the above would be appreciated.

  • 57 Kris Wragg March 30, 2018, 10:16 am

    So to further the discussion with @Xyz with regards to using GNUcash for my accounts, it seems I wasn’t using it correctly but it can do them in accordance with section 104 holdings.

    The issue is by default it will create a new ‘lot’ for each purchase and do FIFO which is suitable for US tax rules, this yields incorrect CGT calculations for UK. But if you have a single lot and put all buys and sells in that then it seems to calculate the correct results based on some tests with this:

    http://www.cgtcalculator.com/calculator.aspx

    I think you’d need to do a bit more if you have purchases before 2008 though as slightly different rules? But that doesn’t effect me.

  • 58 Haphazard March 30, 2018, 3:37 pm

    For those of us who despair at the ACC fund calculations… can we fairly assume that we can hand this lot over to a high street accountant? Lots of them round where I live advertise self-assessment, in general terms – is the general idea that they understand all this investment stuff? Or is it a more specialist thing?

    Don’t want to hand over to someone who knows even less than I do.

  • 59 tom March 30, 2018, 4:59 pm

    Haphazard – hard to comment as everyone’s different, but in my experience, a lot of tax accountants, even at Top 10 firms, won’t know much about investments generally. If presented with a situation, a good accountant will look it up (or rather, get a junior to look it up), but this can rapidly create an expensive bill.

    It’s up to you, but if you’re a regular Monevator read, have the right articles on Acc Funds, and have one or two free evenings, I’d say you’d probably be better off working it out yourself.

    It is not fundamentally difficult, just extremely fiddly, and in my experience requires time and (sometimes a lot of) patience.

    In summary: a high street accountant may well know less than you.

    p.s. Thanks to TI for the Acc articles – they’re very much appreciated – it is quite scandalous really that you are the only person I can think of who has managed to explain what to do in ‘plain english’. Thanks for nothing Office of Tax Simplification!

  • 60 Vanguardfan March 30, 2018, 6:15 pm

    My tax accountant, who I think is very good, seems to be pretty clued up on managing tax on investments, and definitely knows more than me.

  • 61 Hospitaller March 30, 2018, 8:08 pm

    Above mostly focuses on capital gains on shares.

    Does anyone know if the following work re property? Let’s suppose you once bought a second property for say £100,000 and its now worth £200,000. Can you each year sell a chunk to a company owned by yourself and in that way gradually eliminate the capital gain, using your annual capital gains allowance? I know if you sell the lot to your own company, then that causes a capital gains taxable event. But is there some HMTC rule to stop you using the annual capital gains allowance in this way?

  • 62 Atlantic March 31, 2018, 12:35 pm

    I too am whistling and looking down at my feet. You’re not the only one. To be fair there seemed no pressing reason in days of yore to ISA (or PEP) my all. There was no higher rate tax to pay on dividends in my case. The annual CGT allowance whispered that in retirement I would be able to stagger disposals to get at any ill gotten gains tax free. There may have also been an ISA/PEP platform charge? In my case the root cause was simply admin:- my savings scheme didn’t originally offer monthly direct debits into an ISA – I continued with my monthly direct debits into a non-tax favoured savings scheme for some 20 years. The wake up call for me was the dividend allowance coming down to £2,000 – I had no tax to pay when the allowance was £5,000. I’ve now spent hours researching the capital gains tax base cost of my shares to work out how many shares to sell to use the capital gains allowance and the first tranche is sold and the proceeds waiting on 6 April 2018 to put it into an ISA:- this will be the first of a few Bed and Isa-ing exercises. All completely avoidable I know but no crystal ball at the time that I knew of forecast the dividend allowance. On the issue of new legislation having adverse effects on perfectly reasonable planning/transactions done years ago, I now find that the AVCs I put in for most of my years into a DC pension scheme may create a lifetime allowance charge when I come to 65 or more likely 75. A nice problem to have I hear you say, but would I have paid AVCs in for all those years had I known that the lifetime allowance charge was on the horizon ? – almost certainly not. I wonder what’s next for the sitting ducks of retirement taxees? How about dividends in ISAs remaining tax free by virtue of a 0% tax rate but using up your basic rate band?

  • 63 John B April 1, 2018, 7:44 am

    When doing CGT defusing disposals I try and keep the gain £500 below the limit to avoid being caught out by my mistakes, and normally below 4*allowance so I don’t need to show my working to HMRC. So glad I’v finally disposed of the M&G monthly savings plan that had quarterly reinvestment of dividends. 16 transactions per year!

    Make sure your funds are UK reporting, even if Irish domiciled, as in some jurisdictions capital gains are counted as income for tax purposes by HMRC

  • 64 Boltt April 1, 2018, 11:12 am

    @hospitaller

    I have a few BTLs and also wondered if I could sell a % annually to a ltd company to manage Tax.

    So far Ive not found any useful info, but if I do find some I will post.

    My daughter lives in one of the properties and I also wondered if I could gift a percentage every year to manage IHT.

    Nice problems to have!

  • 65 Hospitaller April 1, 2018, 12:37 pm

    @Boltt “I have a few BTLs and also wondered if I could sell a % annually to a ltd company to manage Tax. So far Ive not found any useful info, but if I do find some I will post.”

    Indeed, a nice problem to have but also a bit of a pain to manage. Yes, please do let me know if you find anything on that as a way to manage capital gains tax.

  • 66 Boltt April 1, 2018, 3:28 pm

    Piecemeal disposal of assets/property to reduce CGT:-

    These two websites seem to indicate partial sales of property is possible – the property will probably need to be mortgage free and some valuation fees will apply. But seems like a fine idea to me.

    https://www.wealthprotectionreport.co.uk/public/Piecemeal_disposal_to_utilise_CGT_annual_exemption_.cfm

    https://www.accountingweb.co.uk/any-answers/gift-my-btl-property-to-children-in-stages

    In true monevator style DYOR, no warranties provided.

  • 67 Benjamin Fabi April 2, 2018, 10:56 am
  • 68 Haphazard April 3, 2018, 11:59 am

    Thanks that’s a very helpful link on the tax voucher…
    The local accountant in town charges £360+VAT for self-assessment – certainly makes me think again about doing my own.
    I noticed last year that you can’t just stick “dividends” in a box, if I have understood rightly. Because if you have any funds domiciled elsewhere e.g. in Ireland, presumably that is “foreign” income, for the foreign pages?
    There’s also a Monevator article in the archives on “excess reportable income”… so many things to potentially get wrong!

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