Capital Gains Tax - Emergency Tax Planning Guide Review

I have been saying for quite some time that the difference in rates between UK income tax at 50% and capital gains tax at 18% is unsustainable. Sooner or later the government will seek to close the gap. Well it looks like that time has come. There are undoubtedly major tax increases on their way but if only it were entirely that simple. UK Chancellors have for many years been trying to simplify the tax system only to end up making it more complex.

The whole debate recently about capital gains tax raises a number of questions. As we stand a few weeks before the emergency budget a new book has been published which very usefully seeks to answer and identify the main questions that need asking now. "Capital Gains Tax: Emergency Tax Planning Guide" is a brand new title by Carl Bayley. The book was published in early June just weeks before the scheduled June 22nd emergency budget. You may want to give a little thought as to why someone would go to all the trouble, time and cost of producing a painstakingly constructed 105 page book that has a shelf life of only a few weeks. I suspect that the author realises that the ideas and planning expressed will endure beyond the emergency budget. I would tend to agree with this but as always tax law changes constantly so you need to take professional advice before taking any action.

I have to admit that I am a fan of Carl Bayley's work. This author produces 'Plain English' tax Guides specifically for the layman. He has a particular talent for translating the complex and often inexplicable world of taxation into the kind of clear, straightforward language that UK taxpayers can understand. As a UK tax professional I am very used to having to trawl through dry, complex legislation. Reading Carl's work is a breath of fresh air. Very often his guides give me an idea I can put into practice or remind me of something forgotten. I am usually one of the first to go out and buy as soon as I am aware Carl has produced a new guide.

Many people are indeed considering their options and asking themselves key questions, such as:

How will my business or investments be affected?
Should I sell before the increase takes effect?
When will that be?
Is it already too late?
Is it worth it?
Is there another way I can beat the increase?

In tax planning it is vital to take all taxes into account, not just the one you are trying to avoid! I always say there's no point doing one thing to save inheritance tax if at the same time by taking this action you inadvertently give yourself a capital gains tax liability. One thing I do like about this book is that it recognises this important concept so often overlooked by the amateur do it yourself tax planner.

One of the major problems with this guide is alluded to earlier. Published only a few weeks before the budget and by the time you read it won't it be too late to take action? Well of course there is that strong possibility in which case if you're serious about this you had better get this guide pretty quick. There is a possibility however that none or at least all of the doors will be closed on 22nd June.

ETF Trading and Your Tax Planning

The tax efficiency benefit of ETFs (exchange-traded funds) quite often goes unnoticed when considering the other advantages like flexibility, low operating cost, and transparency. Looking towards the end of the year, we need to take stock of how an investor can reduce their tax liability by changing some of their portfolio instruments to ETFs. We will also look at other strategies in ETF trading that can lighten the tax burden. It would be wise to discuss your proposed action with your tax consultant first.

Taxes can have a negative impact on fund performance depending on the quality and timing of management. Even well managed mutual funds have lower tax efficiency than ETFs. Mutual fund managers, to fence in capital gains have been known to sell rather late in the year. The gains to current shareholders would be distributed pro-rata.

The indices tracked by ETFs generally sell and buy securities a lot less often than do mutual funds. There is therefore no need for most ETFs to distribute any year end capital gains to go into the 1099 form for your tax file. The largest suite of ETFs, iShares has never distributed capital gains to its investors. Lucky or astute investors, would you not say!

Another point is that shareholders of mutual funds redeem and purchase shares from the fund which could result in the distribution of gains to the other fund shareholders. An investor could find themselves falling afoul of capital gains commonly called "imbedded capital gains", whereby the sale of an investment made years ago affects a shareholder who was not in the fund then. The ETFs on the other hand sell and but ETFs on an exchange basis without affecting other shareholders. The ETF investor therefore has a better transparency and control on the liability.

These tax advantages that are clear to the eye can also be used as a toll in reducing your tax load.

Instead of keeping stocks that are held at a loss, an investor could turn to ETFs. An investor with, let us say, a loss on healthcare stocks in their portfolio, could sell them off and buy into an ETF sector like iShares DOW Jones U.S. Healthcare Sector ETF.

There are double tax benefits when switching to an EFT from a position of loss on a mutual fund that is actively managed. The first benefit is that of losing on capital without losing the value of the exposure. The second is a more efficient tax position and the added benefit of a limit chance of a distribution of capital gains.