Use up your tax allowances with care

The taxman has cottoned on to an old ruse used by investors to cut their tax bills, says Merryn Somerset Webb. So be careful how you use up your tax-free allowance.

I wrote recently about the way in which capital gains tax makes it all but impossible for people to make a real return in Britain, because there is no allowance for inflation in our system (Alistair Darling, the then chancellor, abolished indexing in 2008).

Let's say you buy something for £20,000. Over the next ten years, inflation averages 8%. Your investment also goes up around 8% a year. You sell it for £43,200. As far as you are concerned, you haven't actually made any real money all you have done is maintained your purchasing power.

But that's not how the taxman sees it. To HMRC, you have made a gain of £23,200 (£43,200 £20,000) on which you get to pay tax at either 18% or 28%. The way this is structured means that the vast majority of people pay the higher rate.

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Let's further assume that you have already used up your tax-free capital gains tax (CGT) allowance in this year. The result is atax bill that leaves you with only £36,700 (after tax of 0.28 x £23,200, or about £6,500). Despite your apparent cleverness in keeping up with inflation, you have just lost a chunk of your purchasing power in ten years.

Obviously, it isn't always this clear cut. When we invest, we hope not simply to match inflation, but to beat it and if we do we have a chance of breaking even after tax.

There are also various assets that come CGT-free. Many people swear by wine investing (I don't); and gold coins, such as sovereigns, count as legal tender so they don't attract the tax (they do, however, trade at a premium and come with a huge spread between the prices at which you can buy and sell, which goes some way towards making up for this).

Finally, most of us find that if we use our Sipp (self-invested personal pension) and Isa (individual savings account) allowances, and add in our CGT allowance, we can manage to pay very little capital gains over an investing lifetime.

That said, you need to be careful with the way you use your allowance. I have had several emails from readers asking if they can simply sell their assets at the end of one tax year, claim the allowance and then instantly buy the assets back. That way the allowance has been used, but, bar the costs of trading, they still have the assets (this used to be known as bed and breakfasting shares').

Unfortunately, HMRC is on top of that neat trick. These days, if you buy back the shares within 30 days of selling them, they still count as the same holding for tax purposes under the matching' rules. This prevents you crystallising a loss or gain purely for tax purposes. Sorry.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.