INVESTMENT - 16.03.2006

The meaning of LIFO

LIFO rule

Rule of thumb. You would normally want to sell your earliest purchase of shares in your holding first, in order that your holding period for taper relief is maximised, minimising any Capital Gains Tax (CGT) bill.

In other words, you want “first in, first out” (FIFO). But you can’t have it. When it comes to identifying which shares have been sold on the part-disposal of your shareholding, the law says you must use “last in, first out” (LIFO). Why could this be a problem?

For example. In years gone by you have made a couple of purchases of shares in a quoted company, and this investment now seems to be going pretty well. To be precise you have bought the following shares in Newdawn plc; January 1998 - 5,000 shares costing £5,000; and in January 2004 - 5,000 shares again costing you £5,000. Total (10,000 shares) £10,000. The shares are now worth more than this. You are thinking of taking your profit on part of this shareholding. So you plan to sell half of the shares in three months’ time. This is because the CGT payable on your profit should be reduced as the next level of taper relief kicks in.

Taper relief on the disposal of non-business assets can be as much as 35% from the anniversary date compared with 30% at present. Your gain will be quite substantial, so taper relief will have a sizeable impact on your tax bill. Here’s the plan - sell and obtain 35% taper relief. But will it work?

The problem. No, it won’t. Taper relief at 35% will be given on non-business assets owned prior to March 17, 1998 and sold after April 5, 2006. So provided that the 5,000 shares you are selling are the ones bought in January 1998, then you will be entitled to the 35% relief. But unfortunately, the rules don’t work that way. You are stuck with LIFO so the shares you propose to sell will be deemed to be the shares you bought in January 2004, and the rate of taper relief on non-business assets owned for only two and a bit years is 0%. Calamity. So is there anything you can do about this?

Spousal sidestep

Tip. Achieve what you want by first giving some shares to your spouse. If you give them the right amount, you’ll be left with only your original purchase of shares - the ones that attract the highest possible level of taper relief.

Example. You dispose of 5,000 shares in February, and because of the LIFO rule, it’s the January 2004 shares you have given away. There is no tax to pay here of course, because transfers between spouses are made on a no gain/no loss basis for CGT purposes. You are left with the 5,000 shares you bought in January 1998. Problem solved. When you sell these in April, you indeed become entitled to taper relief at 35%, as you will be selling the January 1998 shares.

Tax avoidance? The Taxman might argue that this is a pre-ordained series of transactions and unpick them for tax purposes. We argue that the subsequent sale (following the gift to the spouse) is not pre-ordained - after all, the sale might well be aborted if the stock market moves beforehand in an unexpected manner. More importantly the Taxman has already indicated that he will not take this point (Tax Bulletin 54).