Wealthy investors who are selling properties ahead of April’s increased taxation of buy-to-let are using a complex – but entirely legitimate – means of avoiding capital gains tax.
They are siphoning the gains made on property sales into niche investments where all their tax can be recouped via other government incentives.
In exchange, however, they have to expose their capital to risk.
Figures from HMRC show a surge in the money being poured into such investments. Specialists in the field say much of the flows come from property sales.
This is how it works.
Say an investor has sold a rental property and crystallised a taxable gain, after his annual capital gains tax (CGT) exemption and other allowances, of £200,000.
He is a higher rate taxpayer. Remember that while CGT rates applying to gains on investments such as shares fell in April 2016 to 20pc (for higher-rate taxpayers) and 10pc (basic-rate), there is a surcharge for gains on buy-to-let investments. This was one of George Osborne’s several attacks on owners of multiple properties.
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So our higher-rate taxpayer here will pay 28pc of his taxable gain: £56,000. To work through the example in detail, assume the gain was made in this tax year (2016-17), so the tax bill would not have to be settled until January 2018.
His financial adviser – and you almost certainly need one for this – recommends he puts the £200,000 in to an “enterprise investment scheme”. This achieves two things. First, he can notify HMRC of the investment and that entitles him to an income tax rebate of 30pc of what he’s put in: £60,000 in this case.
Second, it means he can delay paying the CGT bill for as long as he owns the investment.
So if he’d done nothing he’d have pocketed his £200,000 gain and in due course would have paid £56,000 to the taxman.
But instead he’s got investments initially valued at £200,000 (before charges) plus £60,000 sitting in the bank to pay the CGT bill when it eventually requires to be settled.
There are, as you’d expect, quite a lot of niggly little catches. First, you need to have paid enough income tax to get the £60,000 tax refund. If you’re on a low income relative to the gain you’re attempting to shield, this isn’t going to be easy. But you can bring forward income tax paid on the year before the one in which you invest, along with the year itself. On that basis someone earning around £100,000 should be able to get back the £60,000, or near enough.
The investor also needs to hang on to the assets for three years minimum in order to retain the income tax rebate. Any gains made on the holdings are tax-free. But these are high risk businesses so losses are likely. The sweetener though is that any losses can be used to reduce taxable or income elsewhere.
So there are many aspects to this manoeuvre, some of which can be highly advantageous.
The likelihood of losses can’t be guessed. But take similarly-invested venture capital trusts as a yardstick: over the past five years the worst of these has averaged an annual loss of around 1pc after tax relief and costs.
When the investments are sold the original CGT liability resurfaces and needs to be paid. But deferring it gives the investor wiggle-room: if he’s on a much reduced income in that future year, he could pay the basic-rate CGT of 20pc, so £40,000 instead of £56,000.
Accountants and reputable advisers are probably most people’s first source of information on these schemes. The tax implications alone are likely to demand professional input, before any question of investment selection.
But for the critics of buy-to-let – and there are many among the readers of this column – surely this tax loophole is one to celebrate? Here, after all, is a taxpayer-funded subsidy that’s succeeding in driving investment in growth businesses.
Richard Hoskins of KIN Capital, one of the most knowledgable commentators on the venture capital world, said: “From UK Plc’s point of view it’s valuable. You’re moving capital from buy-to-let where it’s arguably unproductive, in to growth-stage businesses whose employees are earning and who will pay tax.”
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