There are several theories as to why the UK tax year runs from April 6th to April 5th, instead of following the normal calender year.
Most blame the switchover from the Julian to the Gregorian calendar in 1752, and the Treasury’s desire not to lose a single penny in the kerfuffle. The Inland Revenue website provides no official justification – though it does offer an interesting history of income tax, which was originally only a temporary measure to finance the Napoleonic Wars!
After all, the Irish changed their tax year to the calendar year in 2002. How hard can it be? (On second thoughts, perhaps Ireland is not the greatest of financial role models).
The key to defusing capital gains
Keeping the tax year in mind isn’t just important for making sure you have everything in order when it comes to submitting your details to the Inland Revenue (and you must – life’s too short for a tax investigation).
The end of the tax year is also a critical date for investors who hold shares or funds of any significant value outside of tax-sheltering ISAs and pensions.
This is because every tax year you’re permitted to make a certain amount of capital gains before tax becomes payable: £10,100 each year as I write.
It makes sense to use as much of this capital gains tax allowance as you can each year.1 By doing so, you can defuse ongoing capital gains tax liabilities, and so reduce or even avoid heftier capital gains tax bills in the future.
The allowance cannot be carried forward if unused – it’s case of use it or lose it.
Wealth warning: Tax law is very fiddly, and full of exemptions and caveats. This article should be thought of as a general introduction to the concepts, NOT advice from a tax professional. In particular, if you want to do anything out of the ordinary (e.g. give your partner shares to save dealing fees or similar) then you’ll need to do more research and possibly pay for some professional tax advice.
How to defuse your capital gains
There’s nothing complicated involved in defusing capital gains on shares, though it pays to do it carefully and to keep good records, both to get the maths right and also in case you’re required to submit details to HMRC.
The basic idea is to be sure you sell enough shares or fund holdings that are sporting capital gains in order to use up as much of your annual capital gains tax allowance as you can.
Remember: It’s not a taxable gain until you actually sell the shares.
Step 1: Calculate your total capital gains so far
The first thing to do is to determine what gains if any you’ve already made from trading shares, funds, or any other chargeable assets this tax year (i.e. starting last April 6th).
Here’s where your records (or your online broker’s statements!) come in handy.
You need to see every sale you made over the tax year (regardless of what you did with the money afterward) and work out your total capital gains.
- Any share holding or fund (outside of ISAs or pensions) that you sold for more than you paid for it has made a capital gain.
- Subtract the purchase value and any costs (such as dealing fees) from the sale proceeds to work out the capital gain you made.
- Add up all these capital gains to work out your total capital gain for the year.
Note that shares and funds are not the only chargeable assets for capital gains tax. You need to add all such capital gains into your total for the year, since they all count towards your personal CGT allowance.
For instance, any property other than your main home that you sell is potentially liable for capital gains tax. (Property is a whole other post; for now, see the HMRC pages on property gains if you need to).
Some commonplace assets are exempt from CGT, including:
- Your car
- Personal possessions worth £6,000 or less
- Cash held in sterling, and foreign currency held for personal use
- Savings Certificates, Premium Bonds and British Savings Bonds
- UK Government bonds (gilts)
- Betting, lottery, or pool winnings
- Shares in an Enterprise Investment Scheme (EIS) company or a Venture Capital Trust (VCT) (provided you’ve met the qualifying terms).
- Shares held in an approved Share Incentive Plan
- Personal injury compensation
- Any assets you hold in an ISA or pension
Step 2: Calculate your capital losses, if any
What if at any point in the year you sold shares, funds, or a dodgy buy-to-let flat for less than you originally paid?
- In this case, you’ve registered a capital gains loss.
- Add up all such losses you made over the year to get your total loss.
- Note that loss-making sales of the exempt assets I listed above don’t count towards capital losses, either!
Happily, totaling losses isn’t just an exercise in self-flagellation. The one good thing about these losses is you can set them against your gains.
For instance, if you made £14,000 in capital gains from share disposals over the year, and you made capital losses of £6,000, then your total gain is £8,000 – which is less than your CGT allowance.
One ironic cheer for losing share trades!
Note that you can also offset capital losses from previous years, provided you notified the Inland Revenue via your tax return of the loss.
- See this HMRC page for more on such losses.
Step 3: Consider selling more assets to use up more of your allowance and so defuse future gains
You should now know what your total capital gains for the year are (from step 1), after subtracting any capital losses (from step 2).
- If your total gains are higher than your CGT allowance, then you’re set to have to pay capital gains tax on the gains above the allowance. Before the tax year ends, you could consider selling an asset you’re currently carrying at a loss in order to crystalize that loss and set it against your gains. This will reduce your CGT bill (or even take you back below the allowance).2
- If your total gains are less than your CGT allowance, then you won’t have to pay any capital gains tax on those gains. Before the tax year ends, you could consider selling other assets you’re carrying that are showing a capital gain, in order to use up more of your CGT allowance for the year – without going over it, of course! By doing so, you ‘defuse’ some of the gains you’re carrying, which may help you avoid exceeding your allowance in future years.
Note: There is a fine line between taking sensible steps to avoid a higher tax bill and allowing tax to sway your investing. In practice, I think the average private investor can do a fair bit of selling to defuse CGT, since most of us can repurchase the assets within an ISA or pension (see below) without derailing our strategy. But always remember CGT at least proves you made a profitable investment! I’d far rather pay tax than not make profits…
Step 4: Reinvest any proceeds from sales
If you made any sales in step 3 to finesse your capital gains position, then you will now want to reinvest the money you raised, rather than blow it all on pizzas and fast cars.
- Ideally you’d reinvest the money within an ISA or pension, so putting that money beyond the reach of capital gains tax for good. You can hold most tradeable assets in these vehicles – including the specific company shares or funds you just sold. Also remember that an ISA allowance is another ‘use it or lose it’ affair – and that a new allowance kicks in on April 6th.
- If your ISA allowance is already used up, you don’t want to earmark the money to fund next year’s ISA, and you don’t want to or can’t add any more to your pension, then you can reinvest the money in a different asset as soon as you’ve completed your sale. This new investment starts with a clean slate for capital gains tax purposes.
- However, if you want to reinvest in the same share or fund outside of an ISA or pension, then you need to wait 30 days before you do so. If you flout this so-called ’30-day rule’, then for tax purposes the holding is treated as if you never sold it – and so you fail to realise (and defuse) the capital gain. Back to square one, do not collected £200!
- Alternatively, if you’re married and you can’t stand for your household to lose exposure to that specific and presumably super-hot asset for even 30 days3, then you can sell it and your spouse could repurchase the same asset in the market in his or her own account. Both spouses have their own capital gains tax allowance, and the new holding starts ‘fresh’ from a CGT perspective.
Costs: One other complication we shouldn’t ignore
We shouldn’t skim over this final issue, but I’m going to because this is already a monster post and I’m sure you’ve got funny cat videos on YouTube to be watching.
This can’t-ignore factor is the cost of trading – both in terms of your dealing fees and any stamp duty you pay on reinvesting the money, and also the bid/offer spread on the ‘churn’ of your holdings.
Aside from your dealing fees, the friction that this churn hits you with will largely depend on the nature of the asset you’re selling: Is it a very liquid ETF with a small spread, a micro-cap company with a large spread, or a fund with (please say it ain’t so!) high initial fees?
Such costs can significantly reduce the benefits of defusing gains in your portfolio for tax avoidance purposes, especially on small sums, and even more so if you’re only liable for CGT at the lower 18% rate.
For this reason and others, realizing capital gains is best done as part of your rebalancing strategy, when you’ll likely be spending money to reduce your holdings in outperforming assets and adding to the laggards, anyway.
You’re going to have to run your numbers for yourself, since personal circumstances will vary. I’d generally favour defusing some gains where possible, but you should do so in an intelligent manner.
Think of it partly as an insurance policy: You may as well use the allowances you’ve got now, in case in the future you’ve got more money and more gains, but not more allowances!
- Check out HMRC’s page on reporting capital gains to see whether your overall trading activities mean you need to report your gains and losses, even if your total capital gain is less than your allowance.4
- Do not confuse this allowance with your personal income tax allowance. It is a separate allowance. [↩]
- Note that if you have made an overall capital loss rather than a gain, then you should note this on your tax return, as it can be used to offset against future profitable years. [↩]
- Please do let us know this hot tip in the comments on Monevator! [↩]
- At the time of writing, if you sold chargeable assets amounting to four times or more your personal allowance, then you will need to complete the capital gains pages of the Self Assessment form, even if you have not exceeded the allowance. [↩]