CGT: I’m feeling a bit hard done by

It’s time for a moan.

I was looking at my personal investments the other day and decided I should reduce a couple of my larger long-standing holdings. The only problem is I’m going to have to pay quite a bit of capital gains tax (CGT).

Just to quickly recap: capital gains are those profits you make from selling an asset at more than the price you paid for it. Capital gains tax – as the name suggests – is the tax you pay on those profits.

Now, I’m not opposed to paying my fair share of tax and have paid some CGT over the years in the management of my portfolio.

Admittedly, it was a little irritating mostly because my gains came from investing money which I had already paid income tax on. But given the practical necessity of taxing both income and capital, I didn’t mind signing the cheque too much.

In fact, when I was younger with not much spare cash, I used to joke that it would be nice to have a CGT problem! But after 30 years of saving and investing, I’m in a position where I feel the joke’s on me and others like me.

An odd state of affairs

Of course, there’s an obvious way to get around CGT – just don’t sell anything. CGT is known as an ‘optional’ tax after all. Optional, in the sense that you only become liable for it if you decide to sell an asset. So if you never trade, you don’t crystallise any gains – and you’ll never have to make a CGT payment.

But that’s a dangerous game to play. Even those of us who try and take a long-term view need to make some trades.

My average holding period might well be over three years, but I still have to ring some changes to keep the list feeling sufficiently fresh. It’s like tending a garden. You have to pull out the weeds and encourage new growth – otherwise you’ll find the weeds can take over.

But as I said, I’m not against CGT in theory. The problem is that the CGT regime has undergone some changes in recent years.

It all started with Gordon Brown and political tinkering by successive chancellors means that we’ve ended up with an odd state of affairs. The only constant is that there’s an annual allowance on gains, below which you don’t have to pay tax.

So how did we get to this point?

Let’s look at how CGT was levied ‘BGB’ – that’s before Gordon Brown!

Cleaning ladies paying more tax than fund managers

It was pretty simple really. You paid tax at your marginal rate on gains above the annual tax-free allowance. But importantly, those gains were adjusted for inflation. This meant that if an investment had only kept pace with the retail price index (RPI), there would be nothing to pay.

Which was fair.

But then Gordon Brown changed things. He wanted to tinker with the rules to encourage long-term investment. So out went inflation adjustment and in came ‘taper relief’.

Taper relief meant your gains were ‘tapered’ depending on how long you’d owned the shares. So, after three years, they started to be reduced, and by the tenth year of ownership, you would only pay CGT on 60% of the gain.

Where the fun and games came in was with ‘business assets’. These received accelerated relief – so only half the gain was taxable after one year, and only a quarter if the asset was owned for two or more years.

Shares listed on Aim benefited from this generous treatment – so I found myself thanking Mr Brown when I banked a profit on Aim.

Unfortunately, as often happens when politicians tinker with the rules, this had unintended consequences. Suddenly, wealthy private equity fund managers found themselves paying an effective 10% income tax rate – lower than their cleaning ladies as one executive pointed out.

That was political dynamite.

So, cue more changes.

Out went taper relief and in came a simple flat rate of 18% for CGT for everyone. Then came another change where higher rate taxpayers now pay CGT at a 28% rate.

It’s a bit frustrating frankly

So that’s where we’ve ended up. No relief for the impact of inflation. No incentive to invest for the long term. Which leaves me feeling a bit hard done by when I consider selling shares I’ve held for ten years. Even in this ‘low-inflation era’, the RPI has gone up about 40% over the last decade.

The other oddity is that wealthier people get a much better deal with the 28% rate than basic rate taxpayers get with their 18% CGT rate.

At least it’s easier to do the sums nowadays, which is a blessing in the world of tax.