5 ways to protect your penny share profits from the Taxman
I hate paying more tax than I have to. But I am very wary of complicated ‘reduction’ schemes, such as those that set out to avoid inheritance tax. They generally cost plenty, and the taxman is always liable to change the rules after the event. He can render your efforts an expensive waste of time!
But here are five simple steps you can and should take straight away if you want to make the most of your tax allowances:
Tax Tip #1: Open an ISA
‘ISA’ stands for Individual Savings Account. Launched in the 1980s, they have stood the test of time, and are hopefully here to stay. Last year there was a suggestion Gordon Brown would reduce the annual contribution ceiling to £5,000. But he backed off. Even Mr Brown knows a vote-loser when he sees one.
So you can still put a maximum of £7,000 per year into an ISA, and you can invest the whole lot into shares, or else hold a part of it in cash. It used to be possible to reclaim the tax paid on dividend payments by shares held in your ISA. But that was too much for Gordon Brown to bear, and he removed that privilege. So the real advantage of an ISA is that any capital gains you make are tax-free.
Now you may be thinking – “I can take gains of £8,500 a year anyway before I am required to pay any capital gains tax. Why do I need the shelter of an ISA?” It seems a fair point at first. But your portfolio will grow over time. And that risks taking you above the CGT limit.
Suppose you make annual contributions into your portfolio of £3,500. Achieve an average annual return of 10%, and after 10 years the value of your portfolio will become £61,355. You would then find that a gain of just 14% in one year would trigger capital gains tax – unless you shelter your portfolio within an ISA.
What’s more, there is little to lose. My own provider does not charge anything up front. They then levy an annual administration charge of 0.25% of the total portfolio value, capped at £120. For that sum, they provide a cheap online dealing service, regular statements, and they deal with all corporate actions (such as rights issues, etc). But the biggest drawback of ISAs, of course, is that they cannot hold AIM shares.
Tax Tip #2: Keep Your Options Open
Do you have a large amount of money tied up in shares? If so, a good tip is to split your shareholding equally between your ISA and your normal portfolio. It can’t be an AIM share, of course. You can’t put those in your ISA. But for main market shares, this technique means you can sell half of your holding if you’ve already used up all your capital gains tax allowances. Or sell the half from your normal portfolio if you’ve got CGT allowances still to use.
Tax Tip #3: Trust Your Partner
We all have a personal tax allowance. If you are under 65 this is worth £4,895, rising to £7,090 for 65-74-yearolds, and £7,220 for the over 75s. You can earn this amount of income without having to pay tax. And everyone has a capital gains tax allowance of £8,500, too.
So if you split things equally with your partner, you can receive at least £9,790 of tax-free income, and take gains of £17,000 per year. If you are the one owning all the assets and receiving all the income, consider passing some of these assets, including your shares, to your partner. And by the way, you don’t have to be married to them – the Inland Revenue recognises civil partnerships.
Sorry to bring up the subject, but sooner or later the grim reaper pays us all a visit, closely followed by the grim taxman keen to reap our estate. A huge advantage of AIM shares is that, so long as they have been held for two years, they attract 100% relief from inheritance tax – in other words they fall outside the taxman’s net.
The second massive advantage of AIM shares concerns capital gains. If you still have RHPS issue no. 67 (June 2004), I explained this in detail. But the central point is that if you hold AIM shares for just one year, you will only be taxed on 50% of any gain; and if you hold them for two years you will only be taxed on 25% of any gain. By contrast, even if you hold main market shares for 10 years, you are still taxed on 60% of your gain.
Whether or not it makes sense for the Chancellor to encourage us in this way to invest in Russian oil plays or Chinese mining ventures is a subject for another day. But these are the rules. So if you are about to take a gain on an AIM share it is well worth checking back to the date that you bought it, and making sure you pass the 12 or 24 month hurdle.
Tax Tip #5: SIPP It and See
As I am self-employed, I can open a Self-Invested Pension Plan and indeed I’ve done just that. A SIPP is another tax-efficient vehicle in which to hold shares. It’s basically your pension fund, just like the package you may be offered by an employer’s scheme. But you keep full control of what goes in, when investments are sold, and how much.
I had always been put off SIPPs in the past by the high charges and the restrictions on what you can do with the money when you reach retirement. But the rules have been relaxed, and fees are coming down.
My SIPP provider charged me nothing to establish the account and charges a maximum annual administration fee of £150. I am then free to buy and sell shares within the SIPP at the usual low online rates. And unlike an ISA, your SIPP will not prevent you from buying AIM-listed penny shares.
Depending on your age you can pay up to 40% of your annual earnings into the SIPP, and these contributions attract tax relief at the highest rate you pay. The SIPP administrator reclaims the basic rate tax relief for you, and if you are a higher rate taxpayer you can reclaim the higher rate tax relief yourself.
Within the SIPP all investment returns roll up free of tax. From the age of 50 you can immediately withdraw 25% as a tax-free lump sum. You can then also draw an income from the fund, within prescribed limits, before being obliged to purchase an annuity when you reach 75.
All told, these five tips could save a nice chunk of your penny share profits going to the taxman. And who better to decide where your money should be spent or invested than you?
