Taxation

“The only two certainties in life are death and taxation,” was famously said by Mark Twain and if we try and evade the latter, we could find ourselves falling foul of the law.  So let’s take a nauseating look at taxation with respect to trading.

Capital Gains Tax (CGT) is levied on the profits made when you sell or otherwise ‘dispose of an asset such as shares, and certain other investments, securities or debentures, according to HMS Customs.  The asset is disposed of when you cease to own it. If you sell the asset, give it away, transfer it to someone else or exchange it for something else, this all falls within the category of disposing of the asset.

An important point worth noting is that taxation is paid on the gains made, not the amount of money you receive for the sale of the asset. For example, if you had bought shares for 10,000 USD in 2010, then you sell those shares for 13,000 USD in 2013 you’d be liable to pay CGT on the appreciation, 3 000 USD. If, however, you sell those shares for 9,000 USD, you’d make a loss of 1,000 USD, there would be no capital gains, and hence you’d not be liable for CGT, moreover you’d be able to deduct those losses from your capital gains liabilities. I would look at this in more details later.

So when you make total gains above a certain level when you dispose of assets, including shares, you may have to pay Capital Gains Tax (CGT).   

Whether or not you pay CGT depends on your total gains during that tax year. If you have made capital gains over £10,900 in the financial year 2013 to 2014, then any amount over this threshold attracts CGT. It is expected to change to £11,000 for 2014 to 2015 when Royal Assent is given in July 2014, according HMS Customs.  
Capital gains include gains on the disposal of any assets that attracts CGT. With respects to trading that includes shares, debentures, securities and other financial instruments.  
They say it is not the amount of profit you make that counts but rather the amount that you actually keep. So let’s look at ways of optimizing your trading with tax efficiency in mind. For example, did you know that CGT liabilities can be reduced by factoring in the cost of acquiring and disposing of the asset. Your broker’s fees, solicitor’s fees, valuations and stamp duty can be summed up and subtracted from your capital gains in that financial year. You may be entitled to certain reliefs, which can also be deducted from your capital gains in that financial year. Sometimes this relief is applied automatically, other times you have to claim them.                                                                                                                                                                   Furthermore, the deduction of allowable loses from the disposal of the shares or other assets can also be set against your capital gains. 


There are a number of steps you need to follow when calculating your capital gains liabilities. In the first instance work out how much you have received.  For shares this would be typically their sale price, which is the amount of money you received for the shares when you sold or disposed of them. However, sometimes you need to use the market value of the shares instead of the sale price. The market value is the price the shares might reasonably be expected to have fetched on a sale in the open market.


If, for example, your shares have lost most or all of their value, you may be able to make a claim that the shares are worthless or almost worthless. This is known as a 'Negligible Value Claim' and you would then use the amount specified in the claim.
The next step is also straight forward, just work out the cost of your shares, which is the amount you paid when you bought them. Note that this cost also includes, brokers’ commission, legal fees and stamp duty. 
Finally, now you can work out your gains or losses.                                                                                                                            For example, assuming you’d bought shares in February 2003 for £40,000 and you paid £2,000 in brokers’ solicitors’ fees to acquire these shares. In May 2014 you sell the shares for £250,000.  To calculate CGT deduct the amount paid along with costs and fees (40,000 + 2,000) from the sales price of the shares (250,000). So the profits gained would be £208,000, which is above GCT threshold of £10,900 and therefore, liable to capital gains tax.                                                         Assuming, in this hypothetical example you sold the shares in September 2008 for £41,000, you would have made a loss of £1,000 (£41,000 minus £42,000, amount paid along with costs) and not liable for CGT. 
So, as explained earlier, losses in your portfolio can be useful because they can be deducted from your profits, thereby reducing your CGT bill.


Taking this a notch further it then stands to reason that engineering a loss, albeit a theoretical loss, in your portfolio could be an effective way of avoiding taxes. Hedging can be used to create a theoretical loss. For example, assuming in part of your portfolio you own shares valued £60,000 in a FTSE 100 Company and the share price appreciates 20 percent during the financial tax year. If the asset is sold it would be liable to GCT. Now assuming that you have hedged the position using a derivative such as a CFD (contract to sell at a stipulated price) or you hold a put option (the right to sell the share at a predetermined price in the future).  In this instance, while you may have gained from the appreciation of the share by physically owning it in your portfolio of investments you have also accumulated an equal loss from your short derivative position. It may be prudent to liquidate the derivative position and offset the £12,000 loss from your capital gains in that financial year. 
Actually, in practice you are still in profit, because all you have done is used derivates to reduce you CGT, whilst still retaining your profitable position in the shares in your portfolio.  


Needless to say every country has a different tax regime. In the US the long-term capital gains tax rate is 15% (0% for taxpayers in the 10% and 15% tax brackets, and 20% for taxpayers in the 39.6% bracket. Moreover, in the UK its 18% and 28% tax rates for individuals-the tax rate depends on the total amount of your taxable income. 
So while it may be prudent for traders to use tax efficient methods to avoid taxes, evading taxes is still illegal. Remember that it wasn’t the CIA who got Al capone, it was the IRS!

Darren Winters