How capital gains tax is charged on shares – and how to reduce it

Britain’s capital gains tax burden is soaring due to rising asset prices and a government crackdown on tax-free allowances.

Investors and property owners paid £16.8bn in capital gains tax in the first five months of this year – compared to £14.1bn in the same period in 2022 and just £11bn the year before.

Jason Hollands, of the wealth manager Evelyn Partners, said: “The tax environment for capital gains has become increasingly restrictive with a sharp reduction in the annual exemption this year to £6,000 and plans to halve it again next April to £3,000.”

The dramatic cut to the tax-free allowance will force thousands of investors to pay tax on the profits from selling shares and funds for the first time. 

If you think you could fall into the net, then it is vital you take the steps to shield your investments from the taxman. Luckily, there are many ways you can protect yourself.

How do I work out my capital gains tax bill? 

Capital gains tax is charged on the profit you make when you sell an investment or a second property.

Basic-rate taxpayers will be charged 10pc when selling shares and 18pc for profits made on a property sale, whereas for higher and additional-rate taxpayers the rates are 20pc and 28pc respectively.

You will only need to pay tax if the gain – the difference between how much you sell and bought the investment for – is larger than the allowance. 

More investors will find this is the case now that the allowance has been slashed, and will be cut again next year.

Laura Suter of stockbroker AJ Bell said: “An investor who made £12,300 of gains a year would have incurred no capital gains tax last tax year. But when the allowance is reduced to £3,000 in April 2024 they will be paying £930 extra in capital gains tax each year if they are a basic-rate taxpayer, and £1,860 a year if they are a higher rate taxpayer.”

Use up your allowances

If you hold investments outside of a tax-free wrapper, the best thing to do is transfer them into an Isa or – assuming you can part with the money for longer – into a pension. 

The annual allowance for an Isa is £20,000, while most taxpayers can contribute up to £60,000 a year into their pension without paying tax. 

If you are already sitting on large capital gains, you can sell the assets to realise a gain up to your remaining CGT allowance and then repurchase the investments within your Isa or pension to protect any future gains from the tax man.

These processes are called “Bed and Isa” or “Bed and Pension” and can be facilitated by your stockbroker.

Ms Suter said AJ Bell saw more people carrying out Bed and Isa transactions last year as savers rushed to lock in gains and protect themselves from tax. “Lots of investors were spurred into action at the end of the last tax year, in a bid to beat this hike in wealth taxes.” 

Transfer money to your spouse

If you are married or in a civil partnership, then you can use two sets of capital gains tax allowances and ultimately realise gains of up to £12,000 this tax year without incurring a charge. 

Ms Suter said: “If your spouse is in a lower income tax bracket to you there’s a double benefit, as they will pay capital gains tax at a lower rate than you. That means even if they have used up their allowances, there could still be a benefit to shifting the assets to them.”

You can also use up your partner’s £20,000 Isa allowance, if yours is fully used up.

A word of caution on interspousal transfers. “It is important to understand before you transfer an asset to your spouse that they will become the full, legal owner of that asset,” Mr Hollands said, “and therefore you should think twice if your relationship is rocky.” 

Use your losses

 If one investment makes a gain but in the same tax year another makes a loss, then that loss could be offset against the gain to potentially bring yourself under the tax-free limit. 

If you do not use them this year, then you can carry your losses forward to offset against future gains. But you can only claim up to four years after the end of the tax year in which you sold the asset.

Mr Hollands said you can also deduct certain transaction costs, such as estate agent or solicitor fees, when calculating a capital gains tax liability.

Take steps to drop your income tax band

If you cross over into the higher-rate threshold, then the rate of capital gains tax you pay is immediately doubled.

For investors who have crossed this threshold, it may be worth taking steps to bring yourself back into the basic rate tax band. One way to do this is by contributing into your pension. 

Ms Suter said: “When you contribute to your self-invested pension, or Sipp, the gross value of the contribution has the effect of extending your basic-rate income tax band.” 

She added: “If you have used your full pension allowance this year or cannot make a pension contribution, you can also lower your taxable income by donating to charity. If you’re eligible, you can then also claim gift aid on the donation.”

What if I make a big capital gain? 

Mr Hollands said investors should avoid making a “pregnant gain” where a long-held investment accrues a large capital gains tax liability. 

“To avoid this big end-of-the-road tax bill it is possible to use your allowance each year by disposing of a portion of the asset while staying within the annual allowance and not triggering capital gains tax. If you want to remain invested in the long-term, after a short period (30 days) you can buy back the same investment.”

He added that it is also possible for investors who have a substantial gain to defer a capital gains tax liability by reinvesting the gain into Enterprise Investment Scheme companies.

These are early-stage, unquoted companies, so investing in them is high risk. However, purchasing a share in an EIS company gives you a 30pc income tax credit and no capital gains tax will be due once the shares have been held for at least three years. 

The liability will recrystallize after the EIS shares are sold. At death the liability will disappear and the shares will also be free from inheritance tax, provided they have been held for at least two years.

However Mr Hollands said that with capital gains tax rates relatively low at 20pc, higher-rate taxpayers may decide it is better to pay the tax than to take a risk on an EIS investment.

“Should a future government align capital gains tax and income tax rates, a move some Labour MPs support, this feature of EIS may become more tempting,” he said.