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How can investors mitigate capital gains tax with the help of tax efficient schemes?
Earlier this year in the Chancellor’s 2021 Budget announcement, many investors were surprised to find a lack of mention of a change in the rate of capital gains tax (CGT), but experts across the industry have suggested investors “shouldn’t sit tight” ahead of forecasted increases in 2022/23.
With the UK economy gradually levelling out in recovery from the Covid-19 pandemic, there are concerns that CGT rates could take a hit as the Chancellor looks to recuperate finances lost by extended tax exemptions.
Varying from industry to industry, one of the most noteworthy was the temporary reductions to Stamp Duty Land Tax on residential property transactions introduced from from July 2020 to June 2021, which some suggest could bear a key influence on the need to rebalance other tax rates 2022.
With CGT not falling under the ‘triple lock’ (which is said to prohibit increases to income tax, national insurance and VAT rates) such claims have carried further weight, with the tax being outlined as an “easy target” for the Chancellor to single out in 2022’s budget announcement.
Consequently, for experienced investors especially, this has made identifying the most effective routes for mitigating capital gains tax all the more important when portfolio planning for the coming years.
How does capital gains tax work?
Capital gains tax applies to gains on the disposal of chargeable assets (assets qualified by the government as liable to capital gains tax) of which personal possessions worth more than £6,000, any property other than your first home, and shares (other than those held in a tax-efficient scheme) are all examples.
The UK capital gains tax rate, announced in the 2021 budget, remains at 10% for basic rate taxpayers (or 18% on residential property) and as much as 20% for higher rate taxpayers (or 28% for residential property).
Capital gains tax is applicable to gains on disposals of chargeable assets that exceed the Annual Exempt Amount (AEA), which for 2021/22 sits at £12,300, and so for investors, multiple homeowners or any individuals exceeding this annual budget, learning how to mitigate capital gains tax via the most effective route can save thousands of pounds annually.
How can investors mitigate capital gains tax?
Though a host of complex routes and processes can be utilised for minimising capital gains tax, for investors in particular, two routes can often be identified that have the ability to reduce capital gains tax straightforwardly, whilst offering a range of potential impact and growth benefits.
Initially, one route investors can follow is to make use of capital losses. This means that any capital losses realised over a given year can be offset against the gains of the same tax year, or if not utilised to their full extent, can be carried forward to offset capital gains taxed in future years.
Whilst a relatively straightforward route to follow for minimising CGT on a smaller scale, for experienced investors that may not realise capital losses on an annual basis or simply may just wish to cut the rate of CGT they pay more substantially, another route that exists to mitigate capital gains tax effectively is by making use of government-backed tax efficient investment schemes.
Read more: 6 ways to invest tax efficiently
Ranging from individual savings accounts (ISAs) to self-invested personal pensions (SIPPs) to Venture Capital Trusts (VCTs), a range of investments currently exist for UK investors looking to minimise their tax bill in various forms, but the two often outlined as the most generous - and those that offer dedicated CGT reliefs - are the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS).
Introduced in 1994 and 2012 respectively, the EIS and SEIS were introduced with the common goal of stimulating growth across the UK’s innovative early stage companies with the help of generous tax incentives angled at private investors.
Differentiated by the SEIS’s focus on particularly early stage startups, both schemes offer investors a host of generous tax advantages that contribute to minimising investment risk, maximising returns, and significantly reducing the tax bill.
When singling out the pair’s capital gains tax mitigating benefits, two of the EIS’s headline advantages are capital gains tax exemption and capital gains tax deferral.
This means that not only do investors pay zero capital gains tax when their returns are realised via the EIS (providing income tax relief has been claimed and the shares have been held for at least three years), but should an investor wish to defer the gain to a later year, they can (as long as the capital remains invested and the EIS conditions are not breached).
Similarly to the EIS, the SEIS offers capital gains tax exemption upon disposal of shares that have been held for at least three years, but unlike the EIS, instead provides the option of capital gains reinvestment relief.
Capital gains reinvestment relief allows an individual who has disposed of an asset - that would normally be liable to a chargeable gain - to treat up to 50% of the gain as capital gains tax exempt when they have reinvested all or part of the gain into qualifying SEIS shares.
This tax benefit applies up to a maximum of £50,000 being treated as capital gains tax exempt. For example, should an investor realise a capital gain, such as by selling a second property, and that gain was, for the purpose of this example £100,000, normally £28,000 of that gain would be due in CGT, but with SEIS’s reinvestment relief, the investor would be able to halve this figure and only be liable for £14,000 of CGT should they choose to reinvest into SEIS-qualifying shares.
What this means for investors
Two examples of powerful capital gains tax mitigating routes, the capital shielding abilities of the EIS and SEIS - also headlined by 30% and 50% income tax relief - often go under the radar for many investors, but when looking to minimise annual tax bills, their potential is undeniable.
For high net worth individuals especially, the value of being able to disqualify the 20% of capital gains tax usually present with other investments can be especially significant in the long term.
Not only this, but by claiming relief in deferring (EIS) and re-investing (SEIS) shares, investors have the enhanced ability to effectively plan for future tax events and maximise the capital gains realised from other assets on their tax bill.
Though not the only routes experienced investors can follow when mitigating capital gains tax across their portfolio, the extensive generous tax benefits offered by the EIS and SEIS and potentially considerable growth and impact benefits the schemes can achieve through some of the UK’s most promising early stage companies can make them an especially attractive route for Britain’s most ambitious venture capitalists.
Download: Free Guide to Tax Efficient Investing