A windfall for you, a bonus for the Revenue

Think about the taxman before you spend all of a windfall on a new car or holiday. Hector may well be entitled to a slice of the action

A lot of people in the UK have had, or will shortly be getting, a windfall from a building society conversion or a demutualisation of a life insurer. Unscientific research - me asking the people I come across who have one - suggests these windfalls get earmarked for extra holidays, savings, a better car and so on. I've yet to meet someone who volunteers the fact that some of his or her windfall should be earmarked for friendly old Hector, the taxman.

A lot of people in the UK have had, or will shortly be getting, a windfall from a building society conversion or a demutualisation of a life insurer. Unscientific research - me asking the people I come across who have one - suggests these windfalls get earmarked for extra holidays, savings, a better car and so on. I've yet to meet someone who volunteers the fact that some of his or her windfall should be earmarked for friendly old Hector, the taxman.

The fact that the Inland Revenue is also getting a windfall when an organisation pays out may come as a bit of a surprise to some. But continuing that unscientific research I referred to earlier with the question "Well, what usually happens when you get some money?" does tend to make people ruefully concede that the Revenue might want a slice of the action.

The reason for this particular attempt by the taxman to stick a shovel in your store of wealth is the payout is normally treated as a capital gain. Effectively, you have disposed of your rights in relation to the ex-building society or whatever, in exchange for a cash payment. Capital Gains Tax (CGT) takes an interest when you sell something for a gain over what you paid for it - so with no particular cost to set against the payout, CGT is looming into view.

How much tax?

There is, of course, the CGT annual exemption - currently £7,200 - which means you can make gains up to that amount before CGT actually bites. Gains above this are taxed at 10, 20 or 40 per cent, depending on your top rate of income tax.

CGT is a tax whose sting can be lessened considerably by sensible planning. Much can be achieved with good use of the annual exemption. Splitting a holding of shares with your spouse can utilise their annual exemption as well as your own, and phasing your disposal over two tax years can also make sure you double up on annual exemptions.

Sadly there is no carry forward of annual exemptions if you don't use them!

None of this planning is available if you simply get a large cheque. You have made your gain and that's it - so time to put aside a bit of money for the proverbial rainy day, when Hector comes calling. The rough figure would be 40 per cent of the excess of your windfall over the magic £7,200 figure.

Where you might be able to get planning going is if there is a choice of taking something other than cash. Taking shares from the acquiring company when your company is taken over will defer the capital gain until you sell the new shares.

Do I have to own up?

If you are one of the lucky nine million who fill in a self assessment tax return every year, then the way to tell the Revenue about your good fortune is already there. You'll have to record the details in the CGT section of your return, which may mean asking the taxman for the relevant extra pages.

But what if you don't get a tax return? Now you have to pay attention to a little-known obligation and deadline. You have to tell the taxman that you have something on which tax is due which he doesn't know about!

The deadline for doing this is 5 October after the tax year in which the income or gain arises. So, if you've got a payout this month, you have plenty of time to own up - but you might want to mark 5 October 2001 in your diary so that you don't forget.

This notification requirement has its origins in the earliest days of income tax and the "church door notice". Those who were liable for the new-fangled tax were expected to sign up for it, usually on a list displayed where everyone would see it, which in many communities would be at the door of the church.

These days, if you don't get a tax return and you have items such as rental income, freelance earnings or interest which hasn't had any tax deducted, you're still supposed to sign up, not at the local church but with a letter or call to the local tax office.

The penalty for not putting your hand up can technically be the same as your entire tax liability for the year. It almost certainly wouldn't be but it's as well to bear in mind the need to tell Hector - and to pay.

The good news is any money you get this month falls into the tax year 2000/01 and a tax payment, if one is due, will not have to be made until 31 January 2002. In the meantime, you could always put that potential tax slice into a deposit account ...and earn some interest, which Hector will also want a slice of.

John Whiting is a Chartered Tax Adviser with Pricewaterhouse Coopers