Investing to save tax on gains

End of year planning

Every year, it is good practice to look for shares that are ripe for sale in order to make us of the capital gains tax (CGT) annual exemption. However, if potential gains exceed this the shareholder will either have to delay selling some of the shares, and so risk the price falling, or pay CGT on the gain. Alternatively, if they're willing to invest in an enterprise investment scheme (EIS) company they could claim some income tax relief and defer or even reduce the CGT bill.

Double up on EIS reliefs

While the income tax incentive for EIS investments is usually given top billing, if the investor can make use of the CGT deferral it makes the risky nature of the investment more attractive.

If an investment is made into an EIS portfolio rather than just a single EIS company the risk factor of the investment is reduced due to the spreading. Portfolios are fairly easy to invest in these days and can be found online or through a financial advisor.

Example. Gill, a higher rate taxpayer, sold shares in April 2021 making a capital gain of £13,000. Her annual CGT exemption is £12,300 and so £700 of the gain is taxable at 20%. Gill wants to sell more shares, but the trouble is this will result in a further gain of £15,000. If she sells she’ll have to pay tax on all of this. However, if within the following 36 months she invests in an EIS, she can defer when the gain is taxed until she sells or transfers the shares.

Note. The CGT deferral can also be used where an EIS investment is made within the twelve months before a gain is made.

Gill must own the EIS shares for at least three years or the income tax relief will be lost and the deferred capital gain will become chargeable.

Reducing the tax

While the EIS CGT break is only a deferral of CGT, it can be turned into a real tax saving.

Example. Gill bought EIS shares in April 2021 to defer the £15,000 gain on the further share sales. It’s now April 2024 and Gill could sell the EIS shares without losing the income tax relief she received for them. In fact, she wants to sell them, but naturally would prefer to pay as little CGT on the deferred gain as possible. She achieves her goal like this:

She sells no shares, or other assets subject to CGT, in the 2021/22 tax year. This means her annual exemption is unused at that point. In May 2024 she sells her EIS shares, releasing the deferred gain of £15,000. Her annual CGT exemption covers £12,300 leaving only the remaining £2,700 taxable at 20%.

If Gill was married and gave some of her EIS shares to her spouse (who also has an available CGT exemption) just before they are sold, between them the whole £15,000 deferred gain would escape tax.