When a PEP is no place for a windfall

READERS' LIVES: Free-share tax traps ... sex discrimination against second-named account holders. Your queries answered

A reader asked if it would be worth placing windfall shares in a PEP. Your reply contained an explanation of the capital gains tax implications if the shares were not placed in a PEP. You stated that on selling the shares, people would be able to claim an indexation allowance which would make part of the sale proceeds tax-free. Surely this is incorrect? You can claim an indexation allowance only by increasing the cost of buying shares (or other assets) in line with the retail prices index. But since windfall shares are acquired at nil cost there should be no indexation allowance to be claimed. ST London

You are absolutely right. No indexation allowance can be claimed for windfall building society shares because the acquisition cost is nil. Many apologies for this error.

However, this does not alter the thrust of the argument. Placing windfall shares in a PEP may not be cost-effective. The charges levied by the provider can come to more than the income tax saved on share dividends, especially for basic-rate taxpayers. (And keep an eye on the Budget. If the Chancellor abolishes the tax credit on shares, the income tax saving on PEPped shares will be zero for basic-rate taxpayers.)

As things stand, capital gains tax on the sale of shares can also be avoided if the profit on shares you sell falls within the annual tax-free exemption, pounds 6,500. If your shares are worth more than the annual tax-free amount when you come to sell, you can split the sale over two tax years, so using two years' worth of tax-free allowance, and/or reduce your taxable gains by crystallising capital losses during the same tax year (only the net overall gain is taxable).

You can also "bed-and- breakfast" shares at some point before you cash them in for good. This involves selling the shares one day and buying them back the next. Your acquisition cost will be increased to the cost of rebuying the shares (and you will be able to claim an indexation allowance from the date of the repurchase, too); your eventual taxable gain will be reduced accordingly. It is common for investors to bed-and-breakfast shares within the annual tax-free amount. The cost of doing this occasionally can be less than paying PEP charges year after year.

One other point. The acquisition cost of windfall shares is nil, so there is no cost to be indexed for the indexation allowance. But the same does not apply to shares or other assets you receive as a gift. You can claim as the acquisition cost the market value of the shares at the time you acquired a gift of shares, or their value for probate if inherited. Special rules apply for transferring assets between husband and wife.

I am cheesed off with the discrimination which second-named account holders appear to be suffering at the hands of demutualising building societies and insurance companies. We have held our mortgage jointly since our marriage in 1974, first with the Leeds Permanent and latterly with the Halifax. But although it is a joint debt, only my husband benefits from free shares because his is the first name on the account. I find this unfair in an era where sex discrimination is supposedly against the law. PD, Kent

The point you make is a valid one. Since most joint accounts tend to have the husband's name first, there will be widespread indirect sex discrimination as a result of windfalls going only to first-named account holders. Nor does it detract from the seriousness of your point to say that your husband did at least get his free shares, and you would hopefully share the benefit. There are probably many thousands who have missed out altogether because of similar anomalies. It may be too late for them, but customers of other mutuals should note the lessons. Here are a few:

q If you have a joint mortgage and remortgage with the same lender, ensure that the first name on the old mortgage is the first name on the new mortgage. (It may simply be changed by an absent-minded clerk without any discussion.)

q If a windfall has already been announced, you could find yourself cut out of the free share distribution. Or if a handout is announced later, you could miss out if the eligibility date is backdated.

q If you get divorced, be wary of changing the names on the mortgage. Typically, a wife takes over what was a joint mortgage. Naturally, a husband will be keen to get his name off the mortgage to end his legal liability for paying the interest. But in doing so, both husband and wife could miss out on free shares. What you do may depend on how amicable you can be on divorce, and on whether your lender has already announced plans to demutualise. If the husband's name does stay on the mortgage, the wife will want an agreement in writing that she will receive half the free shares.

q If someone with a savings (share) account dies, ask how the heir to the money (for example, a husband or wife) can also inherit the right to any free shares. Get advice in writing. Many Halifax clients received poor advice and have lost out.

q Likewise, get advice in writing and a promise that you will not lose out on free shares if you want to make any significant changes to any of your accounts (for example, you may want to transfer to a different type of savings account).

q Are you the first name on a club account (for example, a scout pack account)? And do you also have an account with the same building society in your own name? If so, consider asking someone else to be the first name on the club account so that the rights to two lots of any free shares are secured.

However, there is a possible risk here that a society may make an announcement to demutualise in the next few weeks or months and could backdate the key qualifying date for membership.

q Write to Steve Lodge, Independent on Sunday, 1 Canada Square, Canary Wharf, London E14 5DL, and include a phone number. Alternatively, fax 0171-293 2096 or 2098 or e-mail: indybusiness@independent.co.UK. Do not enclose SAEs or any documents that you wish to be returned. We cannot give personal replies or guarantee to answer every letter. We accept no legal responsibility for any advice given.

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