This is guest post on spread betting tax avoidance strategies from Andy Richardson of the Financial Spread Betting website.
Before you find yourself packing your bags for an extended stay at Her Majesty’s pleasure, let us remind ourselves that tax avoidance [1] (arranging your affairs so as to pay no more tax than is necessary) is legal whereas tax evasion (failing to pay tax that you actually owe) is definitely illegal.
Some people have argued that tax avoidance is a moral duty. And of course some tax avoidance schemes are state-sponsored – think about National Savings, Individual Savings Accounts (ISAs), and pensions.
If we treat tax avoidance as a legitimate pursuit (and you can make your own mind up about that) then how might spread betting be used as a vehicle for minimising tax liability – specifically avoiding capital gains tax [2] (CGT) liability?
Let’s think about why spread betting is tax-free in the first place.
Why is spread betting tax-free?
The fact that spread betting proceeds are (usually) free from income tax and capital gains tax seems to rest on the fact that for most participants it is classed as gambling rather than investment.
(Editor’s note: How long this will last after the arrival of the potentially more mass-market Halifax Spread Trading [3] service, we’ll have to see!)
With spread betting, you don’t invest in companies by buying shares. You merely make a bet with a bookmaker on whether you think a company’s share price will go up or down. The bookmakers (i.e. the spread betting companies) pay tax on their profits, but you don’t pay tax on your winnings.
So suppose the HMRC did make spread betting proceeds subject to tax. What do you think would happen?
It is said that HMRC would then have to let you offset your spread betting losses against other investment gains, which would be a net loser for the Exchequer because – as we all know – there are substantially more losers than winners in the spread betting game.
But measures can be taken to make spread betting safer.
The logical conclusion of this article is that it may be possible to run a tax-free spread betting portfolio as an alternative to a traditional investment portfolio. But this doesn’t help anyone facing a potential CGT bill due to crystallising a profit [4] in their existing portfolio.
So let’s consider that first, after a quick reminder from Monevator‘s editor.
Wealth warning: While this article explains more sensible ways to spread bet, doing so is still more risky than buying traditional shares with cash – especially if you get your sums wrong! Spread betting on margin can rack up big losses quickly, and you can lose more money than you thought you were risking. This article is aimed at experienced traders and investors. We take no responsibility [5] for your losses in any circumstances.
Hedging a potential capital gains tax liability with a spread bet
One of the features of spread betting is that it is just as easy to take a short position (i.e. bet on a falling price) as it is to take a long position.
This raises the possibility of offsetting an existing position – perhaps in a share you own in the traditional way, or even in a company Sharesave scheme [6] – with a spread bet that neutralises any future fall in price, without you having to trigger a CGT liability by crystallising the profit in your initial portfolio.
Suppose you were lucky enough to ten-bag your shareholding in Penny Stock Corporation (not a real company!) so that your £10,000 investment has become £100,000. With the price so toppy, you want to take your money and run, without having to hand over a proportion of it to Her Majesty’s Revenue and Customs in the form of capital gains tax.
Rather than selling the shares, you might place an equivalent opposing ‘short’ spread bet on the same stock, to the effect that any subsequent fall in your traditional long position is offset exactly by the tax-free rise in the value of your short spread bet.
To help you get your head around this, let’s say Penny Stock Corporation is now priced at 1,000p-per-share (the company is no longer a ‘penny stock’ but at the time you bought it – before it ten-bagged – it was!).
1. A £100-per-point short spread bet should therefore exactly offset your ongoing £100,000 investment.
2. To effectively ‘insure’ the value of your investment in this way, the spread betting company will ask you to deposit a much smaller sum than £100,000 – but obviously you do need some spare cash with which to place the bet.
3. When the tax implications become more favourable, you can close all or part of your traditional long position and the matching short spread bet, so as to release your gains tax-free.
There are some other variations on this ‘hedging [7]‘ theme, like closing a position in your traditional portfolio to fully utilise your annual CGT allowance at the end of the tax year, while at the same time taking out an equivalent long spread bet to ‘keep you in position’ tax-free until such time (after 30 days, according to the HMRC rules) that you can legitimately re-establish your original share holding.
You might even want to crystallise a loss in your traditional portfolio to offset another CGT gain, but to stay ‘in position’ via a spread bet in the same company, just in case the price of the loss-making share recovers.
Spread betting as an alternative to traditional investment
So much for minimising CGT events in your traditional portfolio – do you actually need a traditional portfolio?
There is little that is fundamentally different about holding equity positions in a spread betting account and holding shares in a traditional brokerage account.
- There is no limit to how long you can hold ‘rolling’ equity spread bets.
- You can collect dividends on those positions, albeit at a reduced rate.
- Just like in a traditional share dealing account, when the price of a stock goes up you make money .
- When the price goes down, you lose money.
Which begs the question: why bother with a traditional brokerage account when you could run your ‘investment’ portfolio in a spread betting account, tax-free?
For smaller accounts, this could make perfect sense, because a trader or investor with limited funds can get more bang for his trading buck due to the leveraged nature of spread betting.
You may be able to take a £10,000-equivalent position with a margin deposit of only £2,000, providing you have the balance held elsewhere (in case the spread betting company demands it) or providing you have a very tight risk-management policies using stop orders to limit your potential downside.
For larger account holders, it may not be so easy or advisable to squirrel away a substantial proportion of net worth in a spread betting account.
Still, it could provide a good home for surplus funds beyond the annual ISA and Self-Invested Personal Pension contribution limits, especially if your portfolio that you have sitting outside of these tax shelters seems likely to run up against the capital gains tax-free allowance [8] any time soon.
There are some caveats, of course.
Whereas you pay a one-off dealing fee (plus stamp duty reserve tax) to open a traditional share holding position, a rolling spread bet incurs ongoing financing charges that are levied by the spread betting company in exchange for it ramping up your position size through leverage.
Therefore, your rolling spread bet positions are not so much owned as mortgaged.
For a long spread betting position held overnight, you will normally be charged financing at LIBOR (currently 0.5%) plus 2.5%.
i.e. At (0.5%.+ 2.5%)/365 days, you’d pay 0.008% for each day you held the position.
Of course, in the present low interest rate environment – with many companies trading at what some think are historically low valuations that could multi-bag in short order – the financing charges could pay for themselves. It’s your call.
(Editor’s note: If you do not want to use leverage, but simply want the tax free benefits of spread betting, you can offset some or all of the financing charges by holding an equivalent cash balance in a high interest savings account. Whether it’s possible to match your costs with interest earned (after tax) will depend on prevailing interest rates at the time. Remember you’ll also need access to ready cash to meet any margins calls).
What about dividends? Well, although you receive dividend-equivalent adjustments on spread bets sooner than on traditional share holdings (i.e. at the ex-dividend date rather than a later payment date) those dividend adjustments are typically 80%-90% of the actual dividend. (For more on this, see the advantages and disadvantages [9] article on my website).
Finally, spread bet positions in individual equities bestow no voting rights or other benefits upon the holders of those positions, unlike share holdings.
Remember: You don’t actually own the shares. You’ve simply made a bet with a bookmaker as to whether they will go up or down in price.
What about index tracking?
Many investors don’t buy individual shares at all, of course. They rely instead on index-tracking funds [10] or exchange traded funds (ETFs) to simply follow the market up and down.
Spread betting may provide a more efficient way of doing this, because I’d argue that a spread bet on a stock index is far more transparent than the tracking errors and Total Expense Ratios (TER) associated with traditional index funds.
If the underlying index rises, your index spread bet position will rise by exactly the same amount, and likewise if it falls. There’s no obfuscated tracking error or TER to worry about – just the simple bid-ask spread and the ongoing cost of financing your position.
In addition – and perhaps more importantly – tracking overseas markets or shares via spread betting eliminates currency risk [11]. All your positions will be quoted in pounds sterling, as will your profits and losses.
Let’s suppose you’re trading the crude oil contract, which trades in USA dollars.
You opt to buy, staking £1 a point. If oil then rises 400 cents to $104, your profit is 400 times £1 or £400.
If you had bought a USA crude oil futures contract or an ETF, by contrast, your trade and profits would have been in USA dollars. So, if the dollar went down by 5% against the pound during your trade, your profit on oil would have transformed into a loss!
You will find a very wide range of domestic and international indices that you can spread bet, and best of all, the proceeds from this form of index tracking are currently CGT-free!
- Further reading: See my website for other ways to make intelligent spread bets [12].
Disclaimer: Due to the nature of this article it is important that we include a specific disclaimer. The author of this article is not a tax advisor or investment advisor, therefore you should treat the information given here as for educational purposes only and seek independent professional advice on matters of tax planning and investment.