Even Institutional Investors Find the CGT Regime A Challenge

The FT published a timely piece by Cliff Weight of ShareSoc earlier this year, campaigning on behalf of individual investors.  His piece raised the difficulties that individual investors face when they sell shares and are required to calculate the capital gains tax (CGT) due, from the rebasing rules of 1982, to the cost apportionment rules for complex corporate actions and ‘equalisation’ on units in a unit trust.

Mr Weight is right that the CGT regime has a great deal of complexity to it. By virtue of the imminent reduction of the CGT annual exemption (the amount of capital gains an individual may make each year without paying tax), he is also right that even more people will unexpectedly find themselves caught under the regime and subject to the intricacies of CGT.

Those individuals aren’t alone in struggling with the demands of the regime – because even investors with large institutions face difficulties.

Clients expect their advisors to be across the details – including tax

Clients of institutional investors expect their investment manager to know how the choices they make will affect their clients’ tax liability.

For example, say there were two investment options, one with an advertised yield of 6% and another 4%.  You might be happy at first if your investment manager chose the 6% option as, on the face of it, it looks like a better return on investment.  You might be dismayed later on if you found out that the 6% looked more like 3% after tax when the 4% option was fully tax exempt.

So, the tax effects of an investment option should be baked into the thinking of any investment manager.

Institutions pay for a platform to host a great deal of data, including all the transactions, stocks and shares and securities, and client data.  But so often that platform cannot cater for the UK’s CGT regime – or it has gaping holes in the programming.  Has the 30-day matching rule been applied on a share sale?  Has the notional income or ‘excess reportable income’ of an offshore reporting fund been included?  Have losses on deeply discounted securities been excluded from the totals?

An investor who gets a poor quality tax report may not realise it at first.  If they use an accountant or tax advisor as their agent to handle their tax affairs, the agent may not check the calculations in the tax report to avoid so-called ‘duplication of effort.’  But if HMRC carries out a compliance check and calculates the investor’s affairs differently according to all applicable tax rules, that investor may receive an unwelcome letter about unpaid tax (and penalties).

Issues still arise in big institutions

Mr Weight gave the example of a ShareSoc member who traded units in a unit trust and found “complications arose from multiple sales and purchases, equalisation, switching to a different lower-cost unit class, and a change in the CGT calculation rules in 2008”.  That member is not alone in feeling confused – even seasoned tax teams in big institutions get mixed up regarding unit trusts.

An individual investor with a spreadsheet of 127 rows could easily miss these things. In contrast, an investor whose affairs have been taken care of by a large investment bank will expect the fiddly details to be captured correctly in their tax report.  And if not, why not?

(By the way, the spreadsheet investor should not feel ashamed in the slightest: plenty of reputable tax professionals did complex mixed fund analysis between 2017-19 entirely via formula-laden spreadsheets.)

How does an investment tax department keep in step with tax law?

The tax departments for wealth managers and investment banks know that the UK CGT regime is complex and that they may need help interpreting the rules and applying them to their clients’ circumstances.  This includes the software they use to process their clients’ investments.  Where those teams do have tax knowledge, that knowledge needs to be embedded into their processes and personnel.

When a client transfers an asset from their account to another person’s account, the team should know to ask the right questions: “what is the relationship between these people [connected person rule]?”  “What type of asset was transferred [matching rules and chargeability]?”  “What date was the transfer effective [correct tax year]?”  “Did any distributions or other corporate actions on the asset go ‘ex’ before the transfer?”

Just as an investor – be they an independent individual or an institutional investment manager – should know the potential pitfalls of a transaction, so should a tax team know the potential pitfalls of inadequate processes.

Unit trusts are among the most common investments in the UK outside tax-advantaged options such as pensions or ISAs.  An institution should have data that records equalisation rates, the software to automatically deduct equalisation from the base cost, the processes to ensure the figures reconcile with the tax voucher, the physical money received (if applicable), and the knowledge to spot when the software has applied the matching rules incorrectly.

It should not be left to an individual to struggle with a cumbersome spreadsheet.

How does CGiX deal with the examples from the FT article?

Mr Weight’s article gave a few examples of issues that members of ShareSoc had struggled with.  Out of interest, we ran these examples through our software, CGiX, to illustrate how the software approached each scenario (with certain assumptions where necessary).

Take the example of an individual’s inherited shares generating a capital gain decades later.  Running the example through our CGiX software, an individual who inherited 120 shares in Flight Refuelling (later renamed Cobham) in 1985 at a probate value of £624 and 180 again in 2004 at a probate value of £1132, whose shares were acquired by Advent International in their 2020 takeover of Cobham, and who had taken up the rights issue in 1986, would have a capital gain of around £4,067 on the takeover.

If the individual changed platforms in 2012, the platform would take on the shares at the value price at transfer date and the history is forgotten when the takeover by Advent International takes place in 2020.

This would lead to the gain/loss at the time of the takeover not being accurate as per the below:

The above highlights that when the chargeable gain/loss on the acquisition cash is calculated using the accurate history, the chargeable gain realised is £4,067. However, in contrast, when the position is calculated not using the history and rather using the transfer value, then the takeover results in a chargeable loss of £2,077.

By using the transfer value that generated a loss, the client would assume they have this available to offset against other gain producing assets in the tax year. Or they would even carry the loss forward into the next year, causing an inaccurate representation of the client’s CGT position for that tax year and potentially future tax years.  Such inaccuracies can lead to HMRC issuing ‘inaccuracy penalties’.

Mr Weight goes on to highlight the issue that can arise when assets have been held for a lengthy period, in particular those that were held prior to March 1982.  There is a particular rule that the base cost for CGT purposes for these assets must be ‘rebased’ or reset to the value as of 31 March 1982.

Let’s take the Cobham PLC example for an individual who is unaware of the rebasing rules and who acquired, say, 85 shares at a cost of £157 prior to March 1982.

After taking all relevant corporate events into account, at the time of the takeover, they would have a gain of £4,371.  However, if the individual were to correctly rebase to the March 1982 price, then the correct gain would be £4,325, a difference of £46.  Not significant in this case, but in many cases the difference can be noteworthy.

The CGT regime is unwieldy for all

From the challenges of finding March 1982 prices for stocks that have been through several name changes and corporate events to the complexities of applying equalisation, and Group 1 and Group 2 payments from unit trusts, tracking one’s investments in compliance with the UK’s CGT regime can be a daunting task.

No wonder individual investors are calling for change when the big banks ask for help too.