How to cut the tax pain on capital gain

Although Capital Gains Tax is paid each year by only a few thousand people, it probably causes more headaches than any other tax. So what is CGT, how is it calculated, and what should you bear in mind when you sell shares?

In the words of the Inland Revenue: "A capital gain arises when something you own (an asset) is given away as a gift, exchanged, sold or disposed of in any other way and its value has increased since you acquired it." CGT is paid at your highest rate of income tax.

However, not all capital gains are subject to CGT. Gifts between husband and wife are exempt and furthermore, everyone has an annual allowance. Gains below the limit do not attract CGT. Last year the allowance was pounds 6,300, while for the 1997-98 tax year it is pounds 6,500.

Also, losses on transactions from a previous year can be brought forward and offset against the current year's gains. However, any unused portion of the annual allowance cannot be carried forward.

There are also assets which are exempt from the tax. The principal ones are: your main home, Personal Equity Plans, National Savings certificates, Government stock and corporate bonds (excluding convertibles).

Items such as antiques which are sold for under pounds 6,000 each are exempt - however, a set of six chairs selling at pounds 7,000 count as one item.

In general, only realised gains or losses since 31 March, 1982 are taken into account. Furthermore, the gains since that date are adjusted to take account of inflation. Consequently, CGT is not paid on gains which are a result of the increase in the cost of living.

The adjustment for the effects of inflation is achieved by what is technically known as the indexation allowance, which is based on the Retail Price Index (RPI).

In simple terms, a gain is an asset's selling price less its cost. When an adjustment is made for inflation, the effect is to increase its cost by the percentage increase in the RPI from the date of its acquisition to the date of its disposal.

The result is to decrease gains, and - if the RPI has increased at a faster rate than the value of the asset - to turn a gain into a loss, which the Revenue will treat as having made no gain.

Since 30 November 1993, the indexation allowance cannot be used to create or increase a loss. However, if you have a gain after deducting the cost, but a loss after deducting the cost and the indexation allowance, it is treated as making neither a gain or a loss.

How does CGT relate to shares? If you sell shares or unit trusts bought before 31 March 1982 - a date arbitrarily chosen by the Chancellor - their purchase price is normally taken as their value at 31 March 1982. However, if it is to your advantage to base your calculations on their actual cost, this is allowed. CGT is based on the difference between the 1982 value of the shares (or cost if this is greater) and the amount received when they were sold. However, the gain is adjusted for inflation.

You can find out the price of a particular share at 31 March 1982 from your local tax office. Each month the Inland Revenue publishes a press release giving tables of ready-made indexation factors which are used for making the inflation adjustment.

Copies are obtainable from your local tax office. Armed with the relevant information, you can calculate the chargeable gain on shares bought before the end of March 1982, as illustrated in the table below. The same procedure is adopted for calculating the chargeable gain for shares purchased after 31 March 1982, except that the actual cost of the shares is used in the calculation instead of their valuation at March 1982.

Of course, investors do not necessarily make a one-off purchase of a company's shares. Acquisitions could be made periodically or the holding added to by taking scrip instead of cash dividends.

When only part of such a holding is sold, how do you know which shares you are selling? If you have shares in a particular company, the Inland Revenue treats them as a single asset which grows and reduces as you buy and sell the shares. The arrangement is known as share-pooling.

The concept of CGT is simple, but active investors find that working out their chargeable gains involves complex calculations. Throw the effects of rights and scrip issues and the purchase of shares by instalments into the calculations and one can appreciate why so many people find the tax confusing.

If your tax is dealt with by your accountant, he or she willbe able to give you guidance on how to minimise or legitimately avoid your liability to CGT. These include "bed-and-breakfasting" shares in the years when your annual CGT allowance is not fully utilised.

This is selling them at the close of business one day and buying them back when the market opens the next. The effect is to increase the cost of the holdings for CGT purposes and consequently reduce any future gain.

It could also include transferring shares to your spouse, so as to take advantage of any unutilised CGT allowance. Inevitably, full use of Peps will be recommended to create your own personal tax haven.

Remember that any windfall building society and life company shares received have a nil cost value and can therefore be transferred to a self-select Pep at nil value.

If you have a sizeable portfolio, it does make sound sense to seek professional advice. Look on the fees you pay as an investment to help you reduce your tax billn