Tax Mitigation

Tax Mitigation

Capital Gains Tax

If you have disposed of assets for a sum in excess of that originally paid you may be liable to tax on the gain.  It may even be that you have already paid the tax or that your accountant has informed you that Capital Gains Tax (CGT) is payable following a recent asset sale. In any case it may be beneficial to obtain professional independent advice in relation to your financial affairs and get an insight into the many tax mitigating products available.

Capital Gains Tax – The Basics

Individuals have an annual CGT allowance of £11,700 (18/19)

If you are a basic rate tax payer, CGT is currently charged at 10% on anything above the allowance (18% for residential property)

If you are a higher rate tax payer, CGT is currently charged at 20% on anything above the allowance (28% for residential property)

CGT can arise from disposal of an investment property, disposal of a second home, disposal of a business or transfer/sale of assets or investments.

Capital Gains Tax – worked examples

We discussed options for managing their CGT liability, including the types of schemes that are currently available - such as Enterprise Investment Schemes (EIS). These schemes aim for capital preservation or investment growth whilst providing CGT deferral, Inheritance Tax (IHT) relief and income tax relief.

Scenario 1 – High Value Second Home

Mr and Mrs Jones own a second property in London. They bought this property for £100,000 but it sold for £1,193,630. From the table, you can see that this generated a gain of £1,093,630. 

They each had an annual CGT allowance of £11,100 in 2016/17, so the chargeable gain was £1,071,430. As they were both higher rate tax payers 28% was charged; meaning £300,000 had to be paid.

As Mr and Mrs Jones had no immediate requirement for the money, we suggested an investment of £1,071,430 from the proceeds of the house sale into EIS with the aim to defer £300,000 of the CGT, achieve 30% income tax relief (capped at the sum paid) and also reduce their contingent IHT bill.

 

1 - High Value Second Home

Original Purchase Price

£100,000

Sale Price

£1,193,630

Crystallised Gain

£1,093,630

Annual Allowance (x2)

£11,100

Actual Gain

£1,071,430

Tax Charge

28% (higher rate)

Amount to Pay 

£300,000


Scenario 2 – Buy-to-Let Property

Mr and Mrs Brown sold their rental property for £180,000; double the original purchase price. From the table below, you can see that this generated a gain of £90,000.

Again, they each had an annual Capital Gains Tax allowance (£11,700 in 2018/19) so the chargeable gain was £66,600. Mr and Mrs Brown are basic rate tax payers so a 18% tax rate will be charged; resulting in a £11,988 bill to pay.

We discussed Enterprise Investment Schemes with Mr and Mrs Brown as a means of mitigating this liability, and having discussed the clients’ needs, suggested putting the whole amount (£66,600) into an Enterprise Investment Scheme. 

The benefit of this investment was that the CGT liability was deferred and that the investors were able to receive up-front income tax relief of 30% of the investment value (capped at the total income tax paid in the year).

 

2 - Rental Property

Original Purchase Price

£90,000

Sale Price 

£180,000

Crystallised Gain

£90,000

Annual Allowance (x2)

£11,700

Actual Gain

£66,600

Tax Charge

18% (basic rate)

Amount to Pay 

£11,988


Scenario 3 – Business Sale

Mrs Smith holds shares within a business. She purchased the shares for £10,000 but the business has recently been sold creating a gain of £990,000.

Like everyone else, she had an annual CGT allowance of £11,100 (2016/17), so the chargeable gain is £978,900. She is a higher rate tax payer and would normally be subject to the 20% CGT tax charge.  However, as one of the business owners, she was entitled to Entrepreneur’s Relief.  Entrepreneurs’ Relief is a lifetime allowance that can be claimed to reduce CGT following the disposal of a business asset.  This means the gain is taxed at only 10% rather than 20%. As a result, tax of £97,890 will have to be paid.

Mrs Smith wanted to use a substantial amount of the money for home improvements and income generation therefore, she wanted to commit £200,000 for the EIS.  This deferred £20,000 of the £97,890 liability, while also reclaiming all of her income tax paid over the past 2 years.  In addition, she benefited from a reduction in her taxable estate for IHT purposes.

 

3 - Business Owner

Original Purchase Price

£10,000

Sale Price

£1,000,000

Crystallised Gain 

£990,000

Annual Allowance

£11,100

Actual Gain

£978,900

Tax Charge

10% (entrepreneurs’ relief)

Amount to Pay

£97,890

 

These simple scenarios outline the benefits of careful planning, so whether it's CGT planning or general tax planning, there may be a number of options available to you.

If you feel CGT may be an issue for you now, going forward or even looking back, and you would like to discuss this further with our professionals, please call or email our financial planning team. 

Please bear in mind these real client scenarios have been simplified for the purposes of presentation. The actual benefits of EIS investment will depend upon your personal circumstances and tax affairs.

 

Inheritance tax

If you have assets approaching the threshold for Inheritance Tax, then you may wish to obtain professional advice in relation to Inheritance Tax planning. Professional advice can save much more than it costs and ensure that those closest to you benefit as fully as possible from your estate on your death.

Inheritance Tax — The Basics

Inheritance tax (IHT) is currently charged at 40% on the value of your estate in excess of £325,000.

Married couples and civil partners can transfer their unused allowances to each other on death; this effectively means that for a couple who are UK domiciled up to £650,000 can be left free of Inheritance Tax. In addition, the residence nil rate band (RNRB) was introduced in April 2017 and allows individuals with a qualifying residential interest to pass up to £125,000 (2018/19) of this interest onto direct descendants without liability to IHT.

Inheritance tax is calculated on the value of the deceased's net estate, i.e. the value of everything they owned at the point of death less money owed.

With rising house prices and a freeze on the Inheritance Tax allowance, it's important to remember that Inheritance Tax isn't something that only 'wealthy' people have to pay.

Inheritance Tax – An Example (predating RNRB)

Mrs B is aged 80, widowed and living off her state and private pension income. She recently downsized and moved home. Her current house is worth £160,000 leaving her with £625,000 from her old house. Including other assets, such as cars, personal effects and bank accounts, her total estate is worth £830,000.

Even though her husband is deceased, she is still subject to the joint allowance of £650,000. Based on these figures, Mrs B has an Inheritance Tax liability of £72,000 (£830,000 - £650,000 = £180,000 x 40% = £72,000) without necessarily realising. She wanted to complete some renovations on her current house but did not know what to do with the remaining money or her contingent tax liability so she spoke with us. 

We first recommended that Mrs B invested £200,000 into an approved Inheritance Tax scheme with the aim to reduce her Inheritance Tax liability by £80,000– this scheme completely removed her liability within 2 years rather than her having to wait 7 years as would be the case if a gift were made. Furthermore, she retained control of the monies throughout.  

We then suggested that she puts £235,000 into a stocks and shares portfolio to put her money to work and potentially beat cash savings rates. We also suggested taking up the ISA allowance of £15,240 (now £20,000) in order to improve the income tax and capital gains tax on the investments.

Many people do not realise that there are solutions to tackling inheritance tax. Some do not even know they have an inheritance tax liability at all. Seeking professional advice can help put your mind at ease knowing that your money is still yours.

Whether it's Inheritance Tax planning or general Estate Preservation, there are a number of options available to you. This is just an example used to explain what we can do. Through careful planning we can help you retain the value that you've built up within your estate.

If you feel inheritance tax is an issue for you and you would like to discuss this further, please call us or send an email. This is an area of practice to which our team at SWLaw Investment & Financial Planning Ltd can contribute by working together with our Private Client team at SWLaw Solicitors Ltd.