Overnight gains with bed-and-breakfasting

Iain Morse explains the pros and cons of selling shares and buying them again the next day

For many people, bed-and-breakfasting is a cheap alternative to staying in hotels. But if you have an investment portfolio it can be a means of avoiding Capital Gains Tax (CGT).

Or at least, it could be - subject to the Chancellor of the Exchequer's Budget speech yesterday. If events have not overtaken this report, bed- and-breakfasting remains a useful weapon in the tax-avoidance armoury.

So what is it all about? CGT is levied on gains realised from the sale or disposal of certain classes of asset. Raising about pounds 1.25bn or just 1 per cent of the Treasury's annual tax receipts, it is complex to administer. Under current legislation, all UK taxpayers are granted an annual CGT exemption, standing at pounds 6,500 for the current tax year ending on 5 April 1998. This exemption allows you to realise gains of up to pounds 6,500 before paying any tax. Excess gains are taxed at the same rate as your highest rate of income tax.

Each year only about 100,000 private investors pay any CGT on gains from investments, including shares, unit trusts and investment trusts. PEPs and Tessas are exempt, as will be the new Individual Savings Account (ISA).

Caution is needed with un-PEPed windfall shares; these have a "zero" value when received but on sale their full value is deducted from the exemption of pounds 6,500.

According to Brian Dunk, a Director of Accountants at Coopers and Lybrand: "It is easy to build up a CGT liability in a portfolio, and be locked into particular investments as a result. This can create real problems for portfolio managers, who are more focused on the quality of investments held than tax issues."

What makes the tax complex to administer are further allowances both for indexation of gains and offset of capital losses. Indexation adjusts the amount gained between purchase and sale by chances in inflation, or the retail price index, over the intervening period. This means you pay tax only on real capital gains.

For example, an investment of pounds 20,000 made in September 1992 and sold exactly five years later for pounds 30,000, would show an adjusted gain of pounds 7,140. After claiming the annual CGT exemption, this leaves just pounds 640 liable to tax.

If you sell investments which have fallen in value, these capital losses can be used to reduce your tax gains before paying tax. But losses are not subject to indexation. If these are greater than gains, the excess can be "carried forward" or used in future years to reduce gains.

Bed-and-breakfasting, the sale of shares at the end of a trading day on the Stock Exchange and their re-purchase at next morning's start of trade, allows investors to realise gains and use up the annual exemption.

This can be expensive, with stockbrokers charging a fixed percentage of the value of any sale or purchase. But according to Bryan Johnston of Bell Lawrie White: "If you are an established client, private discounts can usually be arranged."

As an alternative, look out for discount tele-brokers offering to buy and sell shares on an execution-only basis. Most offer to buy back shares at a reduced cost. Teletrade, the discount arm of Midland Bank's stockbroking division, takes 1 per cent in the value of sales worth up to pounds 5,000 with a cash minimum of just pounds 15, but will "breakfast" shares at no extra charge.

This year, bed-and-breakfasting has reached record levels in anticipation of changes to the annual exemption limit. But advisers warn against second- guessing the Budget as being good reason to make changes.

Kevin Offer, of tax consultants John Chown & Co, argues: "Only make changes if you already have a CGT liability or for reasons of investment strategy. A new tax regime will not be aimed at those with windfall shares."

Like many, he expects a two-tier system may be introduced aimed at rewarding long-term investment. "Short-term capital gains, say over less than two years, could be treated as income, and taxed accordingly. Long-term gains could then be taxed at a lower composite rate of 10 to 15 per cent."

Brian Dunk thinks that collecting the tax may be simplified by abolishing indexation and the offset of losses. The annual exemption limit could be raised to compensate, but even so, "this would leave anyone with large losses in a very unfair position".

Ideally, he would like the tax to be payable only on disinvestment: "Letting savers roll over their gains into new shareholdings, only paying CGT when they decide to do something else with the money, would remove the effect of the tax on investment choice."