CAPITAL GAINS TAX - 26.11.2010

Dodging the 28% rate

In his Emergency Budget the Chancellor upped the rate of tax for capital gains, but not for everyone. The new higher rate is linked to the level of your taxable income; does this mean an income tax deduction can also save you Capital Gains Tax?

Tax squeeze

Being the Chancellor of the Exchequer must be a nightmare of a job; it seems that the harder you squeeze taxes, the more slips through your grasp. The new 28% Capital Gains Tax (CGT) rate is a good example. But to take advantage you need to be able to spot the weakness in the Chancellor’s grip.

Two-tier tax

The new 28% CGT rate only applies to capital gains you make after Budget day, June 22 2010. Up until then gains are taxable at 18%, after first deducting your annual exemption (£10,100). Even for a post-Budget gain, the 18% rate applies until the total of your income plus capital gains exceed the basic rate band of £37,400. Anything above that will be taxed at the new 28% rate.

Example part 1. After deducting her annual tax-free allowance of £6,475, Sarah’s taxable income for 2010/11 is £38,000. She also made a gain of £25,500 from selling some shares in November 2010. As Sarah’s income is greater than the basic rate band, the whole gain is taxable at 28%, resulting in a CGT bill of £4,312 (see The next step). But there’s a way Sarah can reduce this.

Tip. Paying a personal pension premium before April 6 2011 will reduce taxable income for 2010/11. And, as a result, it increases the amount of basic rate band that you can use when working out how much capital gain should be taxed at 18% and how much at 28%.

Example part 2. Assume the circumstances in Example 1 are the same except that Sarah makes a contribution of £6,000 to her personal pension on March 31 2011. This means she has an extra £6,000 basic rate band that can be used against her capital gain of £25,500. Her CGT bill is reduced to £3,772; a saving of £540. The income tax relief on the pension contribution is unaffected; Sarah will still get this - the CGT saving is just the icing on the cake.

Not just pension contributions

Pension contributions aren’t the only payments that reduce both your income tax and CGT bill. Gift Aid (GA) payments do exactly the same job. Making a GA payment just to save tax isn’t a good idea, as even after taking off tax relief it will still cost you. But if you already make GA payments there’s a neat way you can use them to reduce a CGT bill.

Tip. The tax rules allow you to carry back GA payments made in one tax year and treat them as if they were paid in the previous one.

Example part 3. Assuming that Sarah made a GA payment of £1,200 to her local church during 2011/12, she can elect to carry this back to 2010/11. This would increase the amount of basic rate band by £1,200 meaning more of the capital gain for that year would be taxed at 18%, knocking another £120 off her CGT bill (see The next step).

Trap. The GA carry-back must be claimed before, or included in, your tax return for the year in which you want the carry-back to apply, e.g. if you want to shift 2011/12 GA to 2010/11, it must be done before or on your return for 2010/11. There’s a box in the GA section of the tax return for this purpose, or you can send a letter giving the details.

For the full calculation behind the examples, visit (TX11.05.02).
If you claim income tax deductions for pension contributions and Gift Aid payments, they can cut your Capital Gains Tax bill where they reduce your income below the basic rate tax limit. There’s also an option to bring back GA payments made in the next year and use these in the same way.

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