Good reads from around the web.
I am soon going to sell shares in a private company I co-founded a few years ago and later left. The company has been pretty successful, not least because of the drive and talent of the people at the top, who remain good friends.
I believe selling now makes sense for all concerned, but I do so with a few qualms. Unfortunately, one of those is that it will trigger a capital gains tax event.
The sale of my shareholding will generate a significant five-figure gain, far beyond the £10,600 annual CGT allowance. Despite having a 5% or greater shareholding, it seems I don’t qualify for entrepreneur’s relief as I haven’t been employed by the company within the last 12 months. This means I’m potentially on the hook for 18% at the basic rate of capital gains tax, or 28% if I breach the higher rate bracket.
Tax avoidance is perfectly legal, and needless to say I’m engaged in reducing my CGT liability. For example, the market volatility since April has been kindly timed for me – whereas before April I was defusing capital gains on various shareholdings, now I’m carefully selling losers to offset the far bigger gain that’s coming due. (More on this next week).
I’ll probably also reinvest more into my current business this year, rather than draw too much income out of it only for that to inflate my tax bill.
Taxing matters
Despite my disquiet about excessive public spending, I’m not a survivalist nutter who believes the state should confine itself to pointing nukes at the Ruskies.
Everyone ought to pay their share of taxes, and I do.
I’m also aware that private equity firms and the like exploit the rules on capital gains tax to pay lower rates than their secretaries, despite often engaging more in City chinwags and financial chicanery than in real entrepreneurship.
But I have to say I am pretty miffed about the tax treatment of a private individual’s modest capital gains, whether on a company they started or on shares and the like.
The £10,600 allowance might seem a lot when you start investing, but once you’re into six figures (and you’ll need to be, eventually) it’s a joke. I’ve noticed that older investors are much keener on ISA-ing and SIPP-ing their stocks and shares than new investors are, and I’m sure this is why. Even I didn’t use tax-exempt wrappers until 2003, and I regularly regret it.
When I co-founded that business back in 2005, I put about one-fifth of my entire worldly wealth into it. More importantly, I gave up most of my other work, which slashed my income by more than 80%. We didn’t pay ourselves at all for a year, despite a six day week of 10-12 hours a day. When a salary did come, it began at less than I earned in my first (poorly-paid!) job out of university.
We took all the risk. We didn’t take a penny of State money, grants, or anything like it. Yet the State wants a share.
Fair enough, there is entrepreneur’s relief in some circumstances, but it doesn’t fit mine and I don’t particularly see why my own risk-taking should be penalised on technicalities.
And what about capital gains tax on everyday share investing?
Again, I am sympathetic to income redistribution, especially in this age of spiraling inequality. The rich will always get richer, and that’s ultimately unsustainable. Personally I’d do more redressing through inheritance tax, though I seem to be in a tiny crowd on that score.
In any event, taxing a small investor who gets a break is hardly going to curb the rise of the 1%, or prevent capitalism eating itself as Marx predicted.
It also does nothing to encourage a culture of saving and prudent investment. Rather, it encourages people to follow the herd into the next property bubble, given that capital gains made on your own home are entirely tax-free.
I have on my shelf a copy of Investment Made Easy, by Jim Slater. It was the first book on investment I ever bought, and it was published in 1995. Slater cites the capital gains tax allowance as £6,000.
That means the CGT allowance has gone up 77% in the 17 years since then. Sounds good, but let’s compare it to the CGT-free status for housing.
According to the Nationwide, the average UK house cost around £51,000 when 1995 began. After peaking in late 2007 at £184,000, the average price is now down to around £162,000. That’s still a gain of 217%, which means the CGT tax-free perk on housing has in money terms become much more valuable over time, compared to the CGT allowance.
Of course, CGT isn’t payable on homes at least partly because the government doesn’t want to slow down the market – and hence mobility, employment, and the like – by putting people off selling up.
But I’d still question whether our priorities are entirely in order here. At the least, an annual CGT tax-free allowance on other gains of say £20-30,000 seems appropriate.
In my case, the lack of ISA sheltering and the winners-and-losers nature of stockpicking means I’m not too badly off. I’ll be able to offset most of the gains, albeit at the cost of turnover and associated fees that would make The Accumulator dizzy. Ironically, my tardiness in sheltering shares over a decade ago is going to save me thousands of pounds.
But I think this is an unusual set of circumstances, and they probably won’t be able to help me next time I sell a business or similar. (I’m not that bad a stockpicker, and I’m not that rich!)
I’ll leave the last word to Investment Made Easy author Jim Slater. Despite his championing of small cap growth shares, he urges his readers to first buy their own home, not least for the enormous tax break I’ve cited above. Anyone who followed his advice would have been hugely enriched by it.
Good with money, that Slater.
(Investment Made Easy is out of print, but active investors might want to pick up The Zulu Principle
Money and investing blogs
- How to do asset allocation in five minutes – UK Value Investor
- Why asset allocation should change with age – Oblivious Investor
- Star fund managers and flame-out rates – Rick Ferri
- Trust your way to riches – Mr Money Mustache
- The end of finance as we know it –The Psi-Fi blog
- Stocking picking: Confirming the case for quality [PDF] – GMO
- Severe real S&P 500 bear markets in history – RIT
- Plummeting bond yields everywhere – Investing Caffeine
- Do you really need insurance? – The Money Principle
- How to lend money to family and friends – Len Penzo
Book of the week: Antony Beever’s just-released The Second World War
Mainstream media money
- On market timing, Buffett, and dividends – Motley Fool
- Has Angela Merkel learned the wrong lessons of history? – The Economist
- The poor economics of bank robbery – The Economist
- Confirmation bias, momentum, and the Euro crisis – Investor’s Chronicle
- Swedroe: An investment plan to handle global crises – MoneyWatch
- The risks and rewards offered by high-yielding PIBS – FT
- Active investing can beat a sideways market – FT
- 4.9 million fixed rate savers face interest rate shock – FT
- A slew of specialist discounted investment trusts – FT
- Basic tips on how to maximise your pension – Telegraph
- The lop-sides rules that allowed China to secure the LME – Telegraph
- Celebrities who went bankrupt [Gallery] – Telegraph
- Happiness is a glass half-empty – The Guardian
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Comments on this entry are closed.
Hi TI
Couldn’t agree more. CGT is one issue preventing me from reducing my total portfolio TER which as you know is important to me. To sell some of my older holdings, then rebuy the same asset types in a lower TER fund would expose me to CGT, making me worse off than staying with the higher TER investments. Frustrating that governmnet meddling means fund managers get rich at the expense of my own wealth creation and I can’t do anything to stop it. That’s just one of many market distortions caused by goverment policy.
I am however still slowly reducing it by taking dividends from the high TER fund and pushing into a lower TER offering of the same type. It’ll take some time, and while I’ll still be worse off, at least I’ll be better off than keeping my head in the sand and reinvesting in the same old funds.
Cheers
RIT
Are you not able to give half your share to your partner (assuming you’re not single!), and split it over two tax years? I’m no tax expert, but I’ve heard that the partner-gifting is allowed?
Hi TI,
I’m in the small minority (now there are two of us!) who share your views on inheritance tax and CGT exemptions on residential housing.
You’ll probably have also had the experience of being greeted with outrage and abuse at the mere suggestion that inheritance tax reliefs are too generous and that higher inheritance tax would have many benefits. I have some sympathy for the policy once espoused by the Lib Dems of taxing the recipients of inherited wealth.
I believe that the tax system should be constructed on the basis of a few simple principles which should be codified. Simplicity, fairness, an element of redistribution, encouragement of genuine entrepeneurs, ease of collection are a few that come to mind. But it won’t happen partly because selfish pensioners (BTW I’m over 60!) would howl and they vote in large numbers!
I have some sympathy for your position especially when you have amassed a capital gain through worthwhile, wealth-creating activity which may also have created employment. This is in contrast to the accumulation of unearned wealth through the passive role of sitting on the rising tide of residential property. It’s now the wrong time to introduce taxation on residential property but it’s a great shame that that bubble was inflated and kept inflated by government policies for over 50 years.
Investor, I couldn’t agree more with both your points on inheritance tax and CGT on primary residences but don’t have a huge amount of sympathy for you on selling your business. (On which, many congratulations!)
In general I don’t see any real economic or moral reason for treating capital gains and income differently. As it is you’re paying a lower rate of tax and with higher allowances than someone who recieved that money as an income. Entrepreneurs and investors should make decisions based on risk and reward, I don’t think it’s the government’s place to subsidise them to take more risk as they do now let alone even higher subsidy as you are asking for.
You claim you didn’t take a penny of state grants but you did set up your business in a country with an educated, healthy workforce and customer base, a decent infrastructure, law and order, defence, property rights etc. etc. That’s not to say either way whether the state should be smaller or bigger, merely to point out that claiming entrepreneurs don’t get anything out of our society is disingenous. Now having to pay 18% or 28% of the gain from your hard work, compared to 32% or 42% (including NICS) on an income really doesn’t seem like a bad deal to me.
Thanks generally for the blog which is always a thought provoking read on a Saturday morning.
‘We took all the risk. We didn’t take a penny of State money, grants, or anything like it. Yet the State wants a share.’
That’s life in the West, just be thankful that the State isn’t taking more. I’m not comparing exactly like-with-like here but in Holland they took 52% of the profit I made on some share options… Now that stung!
You can sell half now and half next April 6th and/or use the allowance of a spouse. Failing that, selling losers is the best you can do to offset this gain.
We use every CGT trick in the book, but my wife still has a fat four figure CGT bill every January.
@Nathan — Not married. 🙂
@All — Thanks for all thoughts, and some generous comments. I don’t mean to jump in here while people are still expressing their own views, but I think I should stress again I’m not against CGT per se, it’s the balance of reliefs I’m mainly complaining about.
We have a system that incentives you to get into as much debt as you can to buy the biggest house you can afford and hope prices rise. Unsurprisingly, perhaps, we have had a property bubble and a national obsession with doing up houses, and so on, rather than any evident entrepreneurial wave.
Back in 1995, that CGT allowance was worth roughly 1/8th the average house price. Now it’s worth 1/16th. I think that’s out of whack.
I do appreciate the benefits of living in the UK, and as I said above I am not completely against taxes. (The biggest hidden benefit of being in the UK for entrepreneurs is I think the National Health service. American entrepreneurs take on a much bigger risk in that regard, unless they’re already wealthy and fully insured).
Without wanting to sound patronising, until you’ve quit employment, worked for a couple of years on nothing/metaphorical tinned beans, and seen various businesses go bust around you while you inch towards profitability as key career years go by, it is perhaps hard to appreciate how irksome it is to then be faced with a nearly 30% tax bill on not-vast proceeds, while others just sat in the office funding their inflated mortgages. 🙂
A very disproportionate number of people I’ve met over the years who have been successful in business (with notable exceptions) came from wealthier backgrounds. This is perhaps another reason why — much less risk in absolute terms.
I wouldn’t even be against the top rate of CGT going up to 35% but the relief rising to say £50,000 or better yet £100,000.
I think we need to encourage modest risk taking in this country, not leave it to the already wealthy while the rest of us slave away for our overpriced semis.
I’m not calling for multi-millionaires to get an extra million to encourage them to bother to set up Amazon, or what have you. Perhaps I fall through the gaps with entrepreneur’s relief, which is good scheme marred by arbitrariness — we live in an increasingly diverse business ecosystem though, and that relief seems designed to reward a very specific form of enterprise.
@TI
Registry weddings are cheap, divorces a bit more expensive- get a decent pre-nup, and some lady willing to help out on a short-term basis and all’s sorted! 🙂
Got to be worth it surely?
Could be worse I suppose, you could have started the business in Greece!
Seriously, you get £10,600 of the gain free of tax. You have the choice, perhaps, to realise your investment over a number of years and take advantage of the yearly allowance.
The CGT rules were in place when you started so you can’t say the goalposts have been moved.
Have a moan, take the hit and move on.
I’m pretty sure that CGT used to be amortised a while ago through a taper relief. That, and yearly indexation ought to be implemented. Not sure about raising it significantly since it would encourage income tax avoidance schemes.
If CGT were to be payable on the primary residence then an RPI taper ought to apply, otherwise inflation would be too beneficial for the government.
Taper relief had its advantages but was also very hard to keep track of. Not that section 104 holdings are any easy with lots of buys and sells …
I’ve never been convinced that there is any good argument for capital gains tax in the absence of other wealth taxes. Why should we pay more tax because we choose to wisely invest full-taxed income?
BTW, has TI looked at SEIS? It’s even better than EIS as you get full CGT relief and 50% tax relief even if not paying tax at 50%. All the usual EIS red tape applies, and some extra, but it’s worth a good look.
What makes CGT so irksome is that it can be avoided to a large extent given the right planning and if the time is available.
I’ve long argued that primary residences shouldn’t be exempt with the gain being deducted at time of sale by the sellers solicitors pretty much along the lines elsewhere in Europe with a credit available if you’re buying another primary residence.
Your only option is a phased disposal Mr M if that’s option is available, possibly by selling some of your shares back to the company if the other shareholders are not in a position to buy.
The Happiness Is A Glass Half Empty article is excellent, offbeat and curiously heartening. A positive message for all you active investors too. Apparently it’s good to fail 😉
@Investor
Nice to dream about taxing housing and inheritances, but with UK governments of any party largely made-up of privately educated multi-millionaires with 2-4 residential properties each its not going to happen is it…
…the current system is no accident 🙂
I tend to agree on inheritance tax, I cannot really think of a strong morale case for inheritance.
I think that income tax and corporate tax probably ought to be at a similiar rate. My rationale for this is that it is relatively easy for people to move income into capital gains, and the low rates of tax paid by venture capitalists is largely a result of them taking their income as capital gains.
I do agree with capital gains tax being charged on primary residences. I also quite like the idea of somone being able to roll the deferred charge into the next residential property they buy. I would like something similiar with council tax and long term care, so the state would have a lot of legal charges on property – especially the property of the elderly. As I don’t really care for inheritance this means the elderly are not forced to make payments when they are asset rich and cash poor. Instead the state in effect lends them money to pay taxes and government charges secured against their children’s inheritance.
@Dave
Thats all sensible enough, but you would have to monitor the flow of money between family members, e.g. parents and grandparents making large (currently tax free) financial gifts
The banking mechanisms set up for catching money laundering would work just fine with institutions like the land registry to pick up non-financial gifts of land property
However…just thinking of the “Daily Mail” and “Daily Telegraph” headlines would be is making me laugh at what an unlikely prospect it all is 🙂