Tax Basics

Unfortunately (or perhaps fortunately!) I am not talking about a terraced house run by a middle aged spinster in Barmouth with a penchant for polyester sheets, but rather the once-loved but now outlawed practice of 'bed and breakfasting' holdings of company shares in order to obtain tax advantage.

The way things were

Bed and breakfasting shares was not illegal, and was something most canny investors did to effectively uplift the capital gains tax (CGT) base cost of their shareholdings at no cost to themselves.

The premise worked as follows:

Assuming a CGT annual exemption of £6,000, Mr Savvy looks at his portfolio of shares and notices that, on current market rates, he can sell his entire holding of DoReMi Plc and crystallise a gain of £6,000. The following day he can use the sale proceeds to repurchase the DoReMi Plc shares, thereby uplifting his base cost of those shares by £6,000, with no capital gains tax being payable. Smart (SMAR.JK - news) move.

However, HM Revenue & Customs decided investors were just too smart, so changed the share matching rules such that shares purchased after a sale of the same shares would be matched, thereby removing any benefit of the practice.

The only way shares can currently be bed and breakfasted in the true sense of the word is to leave a gap of more than 30 days between sale and repurchase, which obviously leaves the investor exposed to a high risk of market fluctuation.

Just because the top raffle prize has been snaffled, it does not mean that the same methodology cannot be applied to similar effect, albeit in a way perhaps not quite as attractive as that frilly room by the sea. The following options, some more complicated or viable than others, are a way of getting some tea and toast at the taxman's expense:

Bed and Spouse

Under the overarching principal of independent taxation, there is absolutely nothing to prevent on party to a couple selling shares and the other party immediately buying them back. Looking at porfolios together then, the overall uplift in base cost benefit is still achieved.

If the couple are married, or in a recognised civil partnership, it would be possible for the second spouse to later transfer the shares back to the original spouse at nil gain/nil loss for CGT purposes.

However, as with anything spousal, please remember that independent taxation is just that, and if your spouse decides to run off to a tropical island and spend all the money on pina coladas, quite frankly, they can. Also, if entrepreneur's relief is a potential consideration, changing ownership between spouses is unlikely to be beneficial.

Bed and Another Vehicle

The most common other vehicle referred to would be a SIPP. Here, the investor sells the shares, which are immediately repurchased by the SIPP. The investor crystallises his annual exemption gain but still benefits from the investment performance of those shares, albeit over the longer term.

If the investor makes a pension contribution of the proceeds received in order to enable the SIPP to purchase these shares, he could also get tax relief on his contribution, depending on his personal circumstances, meaning he could generate a gain larger than the annual allowance but still pay no tax.

Repurchase through an ISA can, to a lesser extent, also achieve similar results.

Bed and lookalikes

The matching rules for CGT refer to the same class and type of share in the same company. As a result, if you were to repurchase shares that were slightly different, the matching rules would not be triggered and a good old bed and breakfast transaction ensues.

However, the aim of a bed and breakfast transaction is to crystallise a non-chargeable gain whilst maintaining the status quo of the investment. Previously, some investors have taken the view that one share in a particular sector is often much the same as another and have, for example, sold shares in one bank and repurchased in another. This is likely to be a little less popular now.

However, it could be said that tracker funds should all perform in a very similar way, being as they are all, after all, tracking the same index and investors might consider selling units in one such funds and repurchasing in another.

Bed and CFDs

Not for the faint-hearted, this is a somewhat more involved way of bed and breakfasting. In simple terms, the would-be bed and CFD investor sells his shares in Scary Plc and then immediately reinvests in a CFD based on the share price of the same company. After 31 days, the CFD is redeemed and the original company shares repurchased.

The CFD is supposed to protect the investor from market fluctuations. If the share price goes up, the profit on the CFD will pay the extra amount. If the share price goes down, the excess saved on the repurchase funds the loss on the CFD.

However, it is worth bearing in mind that CFDs themselves are liable to CGT and could therefore generate an additional capital gain, albeit in a later year. CFDs also attract an interest charge that will be an actual cost.

Having said that, if an investor has significant gains in one tax year, he could undertake this bed and CFD-ing with a holding standing at a loss, in order to generate a capital loss that can be offset against current year gains. Any subsequent gain (or loss!) on the CFD will fall into the next tax year and may fall within an annual exemption.

More from Sam Thewlis:

• Are You Scared About 31 October?
• The 2 Year Old Investor
• What Do You Get For Your NI Payments?