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Bed and ISA: Help clients use their exemptions with minimal disruption

21 January 2020

How the rise of ‘bed and…’ options help your clients use their exemptions without major disruption to investment holdings...

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The trouble with annual tax exemptions and allowances is that they are just that, unless any carry forward rules apply. The capital gains tax (CGT) annual exemption is a classic example: use it in the tax year, or you lose it. What the legislation describes as the ‘Annual Exempt Amount’ has neither carry forward nor carry back provisions.

The exemption is not one to waste. The £12,000 of gains per person (not proceeds, as some investors believe) covered by the exemption could attract tax of up to £2,400 for higher and additional rate taxpayers (£3,360 if residential property or carried interest is involved).

Normally the exemption does not need to be claimed on a tax return, unless it is exceeded by gross gains realised. However, detailed calculations for each disposal must be supplied if total proceeds exceed four times the exemption (i.e. £48,000 in 2019/20).

In 2018/19, the latest year for which HMRC data is available, the annual exemption meant that only 260,000 individuals paid CGT (though the tax collected from that select band amounted to more than £8.2bn).

Late and early

Up until 1998, a process known as ‘Bed and Breakfast’ (B&B) made it relatively straightforward to use the annual exemption without major disruption to investment holdings.

B&B involved selling an investment to realise the gain and then buying it back the next day. The trades were carried out late and early (hence the name) to minimise the risk of a significant price movement between sale and repurchase. There was still the overnight risk, but that was unavoidable because the CGT legislation made sale and repurchase on the same day ineffective for exploiting the annual exemption.

In the 1998 Budget a revised set of identification rules were introduced which said that any disposals of securities must be identified with an acquisition of securities...

  1. Of the same class;
  2. Acquired by the same person in the same capacity; and
  3. Acquired within 30 days of the disposal.

All three conditions must be satisfied if the 30-day rule is to be triggered. Its arrival put an end to the traditional B&B business, much to the chagrin of some private client stockbrokers.

Instead, in the best whack-a-mole tradition of tax legislation, the new rule spawned a range of ‘Bed and…’ variants, each designed to avoid the new identification principles and thereby allow gains to be realised with minimal investment disruption. There are three widely used examples.

Bed and ISA

As the name suggests, this involves selling investments held personally and using the sale proceeds to fund an ISA which then (re)purchases those same holdings. Where a platform is used, there may well be costs en-route and delays for investible cash to appear if pre-funding is not offered. The latter needs to be borne in mind if the exercise is carried out close to 5 April (a Sunday in 2020).

Bed and ISA is effective in realising gains because condition two of the identification rules is not met. While the individual selling the investments is their beneficial owner after the repurchase, the acquisition is carried out by the ISA manager. The disposal therefore escapes the 30-day rule and crystallises gains which can be set against the annual exemption.

Some discretionary portfolio management services have bed and ISA as an inbuilt feature. The argument for doing so is strong: the result will always be to move a portion of assets from a taxed environment to one free of UK taxes.

Bed and Pension

This works in a similar way to Bed and ISA. The investor sells their holding and then uses the proceeds as a net contribution towards their SIPP, where it is reinvested. Here pre-funding becomes more important as the investor will either receive the 25% uplift of basic rate tax relief at source immediately if pre-funding is offered or, if not, up to 10 weeks later while the platform waits for HMRC to pay up.

Bed and pension works for the same reason as bed and ISA – the repurchase is made by the SIPP trustees, not the person selling the investment.

Bed and Spouse

The UK tax system tends to be inconsistent in its treatment of marriage and civil partnerships. On the CGT front, a gift (or sale) by one spouse to another is deemed to take place on a no loss, no gain basis (provided they are living together in the tax year concerned). This prevents a simple exchange of shareholdings from being a B&B alternative.

However, if one spouse sells an investment and the other spouse buys the same investment in the open market, then the transaction is an effective way of realising a gain, even if the (re)purchase is financed by a gift of the sale proceeds. The gift must be outright – HMRC could mount a challenge if subsequent dividends were directed to the seller’s bank account.

There is no reason why these B&B alternatives cannot be combined, as the example below illustrates.

Case study: Bed-and-spouse-and-ISAs

A little over three years ago, just as Donald Trump was elected, Bob invested £28,000 in a USA OEIC. He now feels vindicated by his judgement, as the investment is worth £40,000. He wants to maintain his exposure to the world’s largest stock market, but also wishes to use his annual exemption to crystallise the £12,000 gain he has built up.

His adviser suggests:

  • £20,000 of his holding is used for a bed and ISA exercise in his own name; and
  • The other £20,000 is sold and repurchased in an ISA in his wife’s name.

Any future gains will be outside the CGT net and the dividend income generated – about £400 a year – will also disappear from tax calculations.

One twist on the ‘Bed and…’ exercise which merits more attention as index-tracking spreads is ‘Bed and Something Very Similar’.

Selling the ABC FTSE 100 Tracker Fund and reinvesting in the XYZ FTSE 100 Tracker Fund triggers a gain because condition 1 (same class of security) is not met, even though there is no difference in the underlying securities.

‘Bed and…’ options provide advisers with an opportunity to add value to their clients’ year end planning, even when the client has no spare capital as April looms. Are you making the most of them?

How can the Zurich Intermediary Platform help?

Selling and buying funds for the same client can all be done online. Whether moving from an Investment Account to an ISA or Retirement Account, even if a new tax wrapper is being set up to receive money from an existing one for the first time, no signature is required.

There are no additional platform costs associated with this tax planning exercise and everything is fully pre-funded, minimising the time your clients spend out of the market.

As we approach the tax year end, timing is important to ensure the transactions are completed on time. We have also published a schedule of platform deadlines for the 2019/20 tax year to help.

Find out more about the Zurich Intermediary Platform

The tax position will depend on the personal circumstances of the investor and tax rules may change in the future.

For use by professional financial advisers only. No other person should rely on or act on any information in this article when making an investment decision. This article has not been approved for use with clients.

Zurich is a trading name of Sterling ISA Managers Limited. Sterling ISA Managers Limited is registered in England and Wales under company number 02395416. Registered Office: The Grange, Bishops Cleeve, Cheltenham, GL52 8XX.

Zurich Intermediary Group Limited. Registered in England and Wales under company number 01909111. Registered Office: The Grange, Bishops Cleeve, Cheltenham, GL52 8XX.

This content was last reviewed in January 2020