Shelter from April showers
In the first of two articles on tax planning, Anthony Bailey looks at some of the ways you can protect your investments
Sunday 12 February 1995
Many people go into overdrive at this time of year, as accountants, solicitors and investment companies promote legitimate ways to keep money out of the Inland Revenue's hands.
How important is it to rush to beat this deadline? For investors with substantial portfolios, it is vital. Each tax year they can shield assets, through personal equity plans. Yet, for these investors, 6 April, the start of the new tax year, is possibly more important than 5 April.
If they have investments to shelter from tax, they may as well do it at the start of the tax year. Good-sized portfolio investments make it worth considering fairly involved planning to avoid capital gains tax. One favourite technique is called "bed and breakfasting".
The idea here is to make gains within the annual £5,800 capital gains tax exemption. This changes to £6,000 from 6 April; in addition any gains in line with inflation are exempt from the tax.
This applies only to gains realised within the tax year. If sufficient gains are not realised by 5 April, they cannot be carried forward into a future tax year.
The fact that one may not have any investments to sell permanently does not matter when it comes to bed and breakfasting. It is possible to sell one day and buy back the next. In this way, one "realises" a gain.
When the investment is eventually sold for good, the buying price for working out any capital gains tax bill will be higher than when one first invested.
One can also bed and breakfast investments to create a loss, offsetting it against gains made on other investments.
Many brokers or unit trust companies offer special bed-and-breakfast deals.
Another way of cutting the tax bill is to use the indexation rules - which means that capital gains in line with inflation are tax-free. In addition, up to £l0,000 of indexed losses can be made between 30 November 1993 and 5 April 1995.
After that date, one can use indexation only to reduce a cash gain to zero and not to create or increase a loss. Get advice if you think this might apply to you.
Investors who do not have huge capital gains to worry about, but still want to avoid paying unnecessary tax, can pursue other routes. Top of the agenda are income-tax-free personal equity plans, or PEPs.
Every UK resident over 18 can put up to £9,000 each tax year into a PEP. But this annual allowance has to be used up within the tax year. Speed is of the essence here: if cash has not been put in the plan by 5 April, the allowance is lost.
Indeed, the deadline is generally earlier than 5 April, because, in most cases, one has to be given a seven-day cooling-off period after a purchase.
There is no doubt that the tax benefits of PEPs are real enough. Their investment returns are free of both income tax and capital gains tax. The income tax saving on share dividends and unit trust distributions is the biggest carrot.
The income tax saving in a PEP can be a boon, so long as it is not gobbled up by extra charges levied for running the fund itself. In the case of PEPs run by companies for their own unit trust funds, there are usually no extra charges.
However, investing purely for tax-saving reasons is not always a wise move.
Most taxpayers come nowhere near making enough capital gains, even outside a PEP, to hit the capital gains tax exemption threshold.
Beware of being rushed. The most important thing is to choose investments with care.
If funds are limited, and if one wants a more risk-averse investment, it may be worth waiting until 6 April, when a new breed of high-income, lower-risk, bond-based PEPs is due to come on stream.
And when it comes to the single-company PEP, extra care should be taken. The rule of thumb is that unless the investor already has a portfolio of direct shareholdings, or intends to build one up, the level of available funds probably means it makes sense to spread risk in a readymade unit trust portfolio.
o Next week: more ways to prepare for the tax deadline.
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