Nobody likes to see the value of their investment portfolio fall. However, in every crisis there are opportunities, and I don’t mean the ridiculous mark ups on hand sanitiser that we saw.
When markets have fallen, taking the opportunity of crystallising capital losses to set off against future gains may help ease the pain a little once the markets recover.
Most of us will be familiar with the basic rule that capital losses incurred in a tax year must be set off against any capital gains that arise in the same tax year. If the losses exceed the gains, then the excess loss can be carried forward indefinitely and be set off against gains in subsequent years.
Carried forward losses have the advantage that the investor can decide how much of the loss they wish to use in subsequent years. This flexibility allows the investor to bring gains within their capital gains tax (CGT) annual exemption.
For example, if an investor sold two investments in the same tax year with one making a capital gain of £20,000 and the other a loss of £20,000, they would cancel each other out.
If, on the other hand, an investor made a loss of £20,000 in a previous tax year and a gain of £20,000 in the next tax year, they only need to offset £7,700 of the carried forward loss to bring the net capital gain down to within the £12,300 annual CGT exemption – so paying no CGT. The remaining loss of £12,300 can be carried forward to be used against gains made in future years.
Even if the investor doesn’t wish to change the investment they hold, they may still benefit from a sell and repurchase, though they need to be mindful of the CGT matching rules. Where the purchase of the same share or collective is made within 30 days of a sale, the transactions are linked together for CGT calculation purposes.
So, if the investor bought shares in ABC Ltd 5 years ago for £10,000 and sold them in the current tax year for £5,000, a loss of £5,000 has been generated. Under the matching rules, if the shares were repurchased within 30 days of the sale for say £5,200, it is this cost that is matched to the sale, creating a loss of just £200; the £10,000 original base cost remains. For sell and repurchase planning to be effective the investor would have to wait for more than 30 days before the repurchase.
Any concern with being out of the market that long is easily overcome by immediately re-purchasing the investment through their pension, ISA or have their spouse or civil partner re-purchase the investment. The matching rule doesn’t apply in such scenarios.
However, if the latter option is chosen, then there are anti-avoidance provisions to be aware of should the investment be subsequently transferred to the spouse/civil partner who made the original sale. HMRC’s stance is that where there is deemed to be an ‘arrangement’ with the main purpose being to secure a tax advantage, then any loss generated will not be allowable.
To ensure this doesn’t happen, the spouse/civil partner who re-purchased the investment should hold onto it for a at least 30 days before they consider transferring it to the spouse/civil who originally sold the shares.
It’s key that the exposure to market fluctuations in that period is also real, and there are, for example, no additional contracts or arrangements in place that significantly limit that economic risk. The transfer of the shares between the spouses/civil partners, after repurchase, is treated on a no gain/no loss basis and the recipient’s base cost will be the transferring spouse/civil partner’s acquisition cost.
Finally, it is important to note that a capital loss isn’t an allowable loss unless it is notified to HMRC. This is normally done on the investor’s tax return or notified separately in writing. The time limits to claim, though not required to be used, is within 4 years of the end of the tax year in which the loss was made.
Though there are a few technical issues to consider, sanitising clients’ portfolios now, while the pandemic continues to play havoc with some investments, opens up a healthier future in the tax planning front at least.
Neil MacGillivray is head of technical support at James Hay