Thursday, December 1, 2016

Saving tax with Deferral of Capital Gains

While Capital Gain Taxes have been slashed in the recent budget to 10% and 20% (from the 18% and 28% that it used to be), CGT has remained unchanged for residential property gains. While the tax rate for gains is lower than the one for income, amounts tend to be much bigger and far appart, making it harder to use allowances and low rate bands.

This is where deferral comes in handy. The Enterprise Investment Scheme (EIS) provides one of the mechanisms that allows such a deferral. Most people misunderstand that the general EIS conditions for income tax relief are much more restrictive than the conditions for CGT deferral. In particular the requirement that one owns less than 30% of the company or that one is connected to the business only applies to the income tax relief component of the EIS, not the CGT deferral. Same thing for the requirement that the investment be held 3 years or more: if you sell earlier the deferral just ends then (see HMRC note).

Obviously the most obvious benefit of the EIS investment is the 30% income tax reducer. But even if you are not eligible to the tax reducer, the deferral is convenient because it allows you to not only defer the tax but also reduce the actual tax itself. Indeed by selling the investments in stages, one can make full use of allowances and low bands over a number of years. And if the amount invested would have been subject to the low 10% rate because of Entrepreneur's relief, that 10% will still be available when the gains emerge at the end of the deferral.

Funnily enough, the opposite is not true. Because the legislation regarding EIS referral relief does not specifically mention gains on disposal of residential property, a gain on residential property that would have been taxed at 28%, will emerge at the end of the deferral as a general gain and therefore will be taxed at the much lower rate of 20%. Not bad considering that a staged exit will allow you to reduce that further!