Tax & Accounting News

Converting Income Into Capital Gains

04/08/2009

Individuals who are looking to avoid paying the new 50% income tax rate, but do not want to reduce their liability by income shifting, may be able to benefit instead from the lower tax rates on capital gains.

Capital gains are taxed at 18% - or even 10% in some cases – and the first £10,100 of any gain is tax-free, making the switching of existing investments into a form which treats any gains as capital gains, a potentially attractive option for high earners.

Unit trusts provide one option, as they are similar to investment bonds except that the investor owns shares, or units, in an overall fund. There are a variety of funds on the market, to suit different purposes, but some are specifically set up to provide low income and high capital growth, allowing investors to take advantage of the lower Capital Gains Tax (CGT) rates. Further savings can be made if units are only sold off gradually, so any capital gain is covered by the annual £10,100 exemption. Unit trusts do pay dividends, which are chargeable to income tax, but the aim of the fund is a low income-high growth combination.

Holding investments within a personal investment company used to be a popular choice, and may be about to become so again. This works by the investor setting up a company and buying shares in it with cash, which is then used to make investments in the normal way. Crucially, any interest or other income the company receives is charged to corporation tax (28%), then stays in the company until it is taken out or the company is liquidated, with the proceeds then charged at 18% CGT, leading to a net tax cost of 41%. However, there are additional costs involved in running a company, which should be factored against any tax savings, including statutory fees payable to Companies House and the cost of preparing annual accounts and tax returns.

Finally, property investments have recently been in the doldrums, but prices are now starting to rise, even though the market remains volatile. If an investor is willing to take the risk, the tax savings can be great, with a gain of £30,000 over three years, for example, liable to CGT of £5,400, compared to an income tax charge of £15,000.

For more information or advice please contact us.

 

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