Taxation and Tax-Efficient Investment
Domain 7: Taxation and tax-efficient investment
This domain tests UK tax rules as they apply to investments and wrappers. Candidates must calculate gains and income tax, select suitable wrappers, and recognise where tax relief interacts with investment suitability.
Core UK tax rules
- Income tax applies to interest, dividends and rental income. Dividends have their own rates and dividend allowance; interest may benefit from the personal savings allowance.
- Capital gains tax applies to disposals of shares, funds and property. The annual exempt amount is £3,000. Gains are taxed at 18% or 24% depending on the taxpayer’s remaining basic-rate band and the asset; residential property and carried interest have specific rules.
- Losses can be offset against gains in the same year, with unused losses carried forward subject to notification rules.
- ISAs allow tax-free income and gains, with an annual subscription limit of £20,000 across cash, stocks and shares, innovative finance and lifetime ISAs, subject to product rules.
- Pensions receive tax relief on contributions, subject to annual and lifetime allowances; withdrawals are taxed as income, with tax-free cash rules. The annual allowance is £60,000 but tapers for high earners.
- IHT may apply to estates above the nil-rate band and residence nil-rate band; some business and agricultural reliefs apply to qualifying shares.
Worked example
An investor sells shares for £80,000 that cost £55,000, producing a gain of £25,000. She has no losses. The annual exempt amount is £3,000, leaving £22,000 taxable. Assuming she has enough basic-rate band, part may be taxed at 18% and the rest at 24%; if all falls in the higher rate, tax is £22,000 × 24% = £5,280. If she had unused losses, those would reduce the taxable gain before applying the annual exempt amount. Realising the gain inside an ISA would not create a CGT liability.
Traps
- Confusing the annual exempt amount with a tax-free allowance for income.
- Assuming ISAs are free of inheritance tax; they are not.
- Treating pension tax relief as tax-free withdrawal; withdrawals are generally taxable income.
- Ignoring the 30-day rule when selling and repurchasing the same shares, including bed-and-ISA.
- Forgetting that charges, stamp duty and allowable costs affect the gain calculation.
Key points
- CGT: proceeds less allowable cost and losses, then annual exempt amount.
- ISA subscriptions are tax-free but not IHT-free.
- Pension contributions attract relief; withdrawals are taxed as income.
- Dividend and savings allowances differ from the CGT annual exempt amount.
- Wrapper choice should follow suitability, not tax alone.