Money: Taxman to crack down on PEP capital gains: Caroline Merrell on why bed and breakfast deals may never be the same

The Inland Revenue plans to crack down on investors who use personal equity plans to escape capital gains tax on shares.

Instead of being able to rush deals through overnight, investors will have to be out of the market for two days under new rules that could come in as early as next week.

Present rules allow investors to bed-and-breakfast shares each year to mitigate capital gains. This involves selling shares to the value of the annual allowance of pounds 5,800 and buying them back to establish a new base price.

There must be an overnight gap between buying and selling to make it valid, exposing investors to the risk of a share fall.

More and more PEP providers have been allowing bed and breakfast investors to switch newly- bought shares directly into PEPs, free from capital gains tax ever more. The Inland Revenue has become increasingly concerned about the practice as PEPs aimed to encourage new investors into share ownership.

It is also concerned about deals between PEP providers and market- makers on 'bed and PEPing', where the shares are bought back at the same price as they were sold, which means that the investor has had no true market exposure.

The new rules will ensure that the sale of shares to use the capital gains tax allowance and the purchase of the PEP are totally separate transactions.

Increasing market exposure in this way means that the risk taken by the investor is far greater.

This could end some of the share exchange schemes offered by many of the big investment houses.

Rules governing the management of PEPs are in the Revenue's PEP Managers' Handbook. A draft copy reveals the Inland Revenue's intention to crack down on the abuses.

The Inland Revenue is meeting the PEP Managers' Association on Tuesday to discuss the new proposals.

If it goes ahead with the new rules, it will implement them quickly. Any investor wishing to limit the risk of bed and PEPing should act swiftly.

Martin Dodd, Pepma liaison officer, said: 'There has been a lot of confusion about these rules. We have received a discussion paper from the Inland Revenue. We are concerned about how investors will be affected by the proposals. We are at the discussion stage and are seeking to clarify the situation with the Inland Revenue.'

Craig Walton, head of marketing at Foreign & Colonial, said: 'Many companies offering, for instance, single company PEPs sell all the shares at 4pm and buy them through a PEP at nine the following morning.'

M&G, one the biggest PEP providers, will switch investors wishing to bed and breafast into its PEPs overnight with a discount.

Jeremy Burchill, M&G compliance officer, said: 'Any changes instigated by the Inland Revenue could have an impact on all bed and breakfast transactions.'

Any move by the Revenue to increase market exposure could be carried over into the general rules of bed and breakfasting where market exposure overnight is considered insufficient.

Last year's bull market means that many people will be looking at substantial gains, and will be keen to find ways to shelter capital gains.

Invesco, one of the large PEP providers, offers investors a free exchange service that sells shares, and switches the proceeds into one of its PEPs.

A spokesman said that it did not expect Revenue changes to invalidate its share exchange scheme because the two transactions were clearly separated.