It is one of the Inland Revenue's best kept secrets – fewer than 0.2 per cent of the British public use up their capital gains tax allowance each year.
With so many people sitting on unused allowances, there is a great opportunity for IFAs to enhance returns for their clients.
We are given three taxation allowances. First, there is the personal tax allowance – this is an allowance given to every individual automatically and, provided that you earn income, it is also used automatically. We have no control over this.
Then there is the Isa allowance of up to £7,000. Isas have quickly proved popular and, with more than one million people deciding to invest in an Isa last year, it would seem that people are keen to take advantage of the tax breaks they offer.
The third tax allowance is the CGT allowance which is currently £7,200 a year – it is likely that will increase in line with inflation in the March Budget. It is vital that the CGT allowance is not pushed into the background although there are fears it is being ignored in some quarters.
Perhaps many think it is the preserve of the rich but, of course, this not the case. It may be that investors need time in getting used to new concepts. When Peps were launched in the late 1980s, they took time to become popular with the masses and there is perhaps a similarity with CGT.
But there are many ways for IFAs to take advantage of the CGT allowance. Investments that carry tax breaks include Isas, gilts, pensions, endowments, enterprise investment schemes and venture capital trusts.
There have always been ways to take capital from collective vehicles to make the most of the CGT allowance and offer clients with a tax-free return. However, this is not an automated process, it creates paperwork and takes up a lot of time.
For many years, therefore, IFAs have used insurance bonds as a simple way of generating this “income” for their clients rather than utilising the annual CGT allowance.
Take offshore bonds, for example. Regulations enable investors to draw down 5 per cent of their original investment on a tax-deferred basis for up to 20 years or when the bond is finally cashed. On encashment, the realisable gains are charged at the investor's marginal rate of tax as if it were part of his taxable income.
But today, income planning is proving more and more difficult. The low interest rate environment, falling dividends and gilt yields and the demise of the welfare state is putting a strain on people looking to supplement their income. The question is how can the increased need for income be satisfied in a tax-efficient manner.
Our quest to resolve the question led to the development of Blue. The fund allows investors to withdraw the maximum amount they can each month with the lowest risk attached. It is designed as an effective vehicle for any taxpayer who is not using their CGT allowance. The advantages become more marked for higher-rate taxpayers.
To get an annual income of about 5 per cent, a higher-rate taxpayer would need to be earning about 8.5 per cent gross, which requires a relatively high degree of risk-taking. This solution, on the other hand, only needs to generate a yield of 5 to 5.5 per cent to allow investors to withdraw 5 per cent of the fund each year without the original investment being affected.
While making the most of the client's CGT allowance is important, there are other ways to escape the CGT net altogether.
Gifts are exempt from CGT. If the client is likely to breach the exempt amount but their spouse or children are not, then they have the option of transferring assets to them because transfers to spouses are tax-free.
Unfortunately, the good old days of bed and breakfasting – where you sold shares on April 5 and bought them back the next day to realise a gain – are now largely over. Nevertheless, if your client is married, there is the other tactic of “bed and spousing”. This is another way of realising gains on investments annually to avoid a big tax bill later. It means selling one partner's assets on April 5, realising a small gain within or close to their CGT-exempt amount and then the other partner buying the same shares back on April 6.
VCTs are also proving very popular among investors looking to avoid being penalised on capital gains. The market is booming. It may have only started in 1995 but already more than £1bn has been raised through around 50 trusts. Investors can defer up to £100,000 of CGT by reinvesting capital gains in a VCT. Enterprise investment schemes, although thin on the ground at present, allow investors to defer unlimited amounts for CGT purposes.