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switching income to capital gains to avoid tax?

(12 Posts)
ilovecrisps Tue 07-Dec-10 14:12:34

SO I've read about this twice on here now.
Surely this can't be legal?!!
How do I go about it?

(I don't work but I'm curious)

riksti Tue 07-Dec-10 15:16:40

It's legal. But most people who can do it need to have quite a lot of money since capital gains usually accrue over a longer period of time. The easiest way to do it is to invest your spare cash (which is currently earning interest somewhere) into shares. If those shares don't pay dividends then there is no income coming from them during the time you hold them. Therefore there is no income tax to pay. Hopefully they will rise in value instead so when you want your cash back and sell the shares you will have a gain. Under normal circumstances gains on the sale of shares are treated as capital gain. Voila! You will pay CGT instead of income tax.
Of course, investment in shares is inherently riskier and you will need to have quite a lot of spare cash to make it worthwhile. And obviously there are a lot more complicated schemes that sometimes work and sometimes don't work. I just gave you this simple example to show how it is done and how it's not nearly as sinister as media manages to make it sound.

herhonesty Tue 07-Dec-10 19:57:35

errr... you always pay cgt when you sell shares, if you are over the annual threshold, regardless of whether or not you have earnt dividends on the shares.

sarah293 Tue 07-Dec-10 19:58:30

Message withdrawn

Chil1234 Tue 07-Dec-10 20:12:43

'Capital Gains' is the profit you make when you sell an asset. Can be property (not your main home), shares, diamonds, art or other assets. Capital Gains Tax is the tax you pay on the profit. You're allowed to make £10,100 profit in a year before you pay CGT.

So if you bought £100,000 worth of shares and sold them for a profit of £20,000 then you would pay CGT on £9,900 of that profit at 18% - 28% (this depends on your income)

As riksti rightly points out, of course, this depends on you knowing that the value of the asset is going to increase. And if you were to ask your employer to pay you in diamonds rather than cash in an effort to dodge paying income tax I'm pretty sure HMRC would be onto you pretty sharpish!

sarah293 Tue 07-Dec-10 20:59:52

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ilovecrisps Tue 07-Dec-10 21:34:19

But surely if you use your income to buy shares you first need to pay tax on that income?

The first case on here was of someone running language classes for children how does that work then parent pays £100 pound cheque for the term and you need to declare and pay tax at 40% surely?

How can you just say it is a capital gain and pay less?

thanks for the answer BTW

Chil1234 Wed 08-Dec-10 07:09:30

If someone is paid £100 in cash for providing a service then they have to declare that for income tax. I can't see any legal ways around that.

What sometimes happens is that people are paid in shares as well as or in place of cash. Employee profit sharing schemes are quite common in big organisations and many directors are given share options as part of their package. The tax payable is deferred until they come to sell the shares and, in the case of many employee profit sharing schemes, not payable at all.

Less common is being paid in goods rather than cash. If, for example, you take a job and were given a house to live in as part of the package you may be taxed on the value of the accommodation as a 'benefit in kind' - similar to a company car or company health insurance. If you were given a house 100% and it became yours to sell then I it would fall under the CGT rules. My tax knowledge is not enough to give you chapter and verse

riksti Wed 08-Dec-10 09:06:36

Converting income to CGT does not really work on (for want of a better term) - primary income, e.g. your salary. Like Chil points out there are certain schemes that allow you to get paid in shares but obviously that cannot be the only method of payment since people need money to live on before selling those shares. And to avoid income tax they have to hold the shares for quite a long time (about 5 years off the top of my head). Like my example in the beginning states... people who have extra cash (i.e. money they've earned and already paid tax on) can invest it into non-dividend paying shares rather than bank deposits or dividend paying shares. That means that this money isn't generating any income while it's invested, which means there will be no income tax to pay. CGT becomes payable when you sell the shares.

Herhonesty, I never said you don't pay CGT if you do get dividend. Since the question was about converting income to capital gains then I mentioned the non-dividend-paying aspect. It would defeat the purpose of converting income to capital if you were to still get dividend which you have to pay tax on.

herhonesty Wed 08-Dec-10 10:59:14

"It would defeat the purpose of converting income to capital if you were to still get dividend which you have to pay tax on"

so why do people buy shares? or buy to let properties? or any other income generating investments?

even if you can convert income into share save schemes etc which are purchased from pre tax salary thereby avoiding income tax on a portion of earnings, they are often for dividend bearing shares and that dividend is still classed as income so liable to income tax.

ilovecrisps Wed 08-Dec-10 11:09:34

I guess your tax on the dividend is less than the tax on the income IYSWIM
then when you sell the shares you pay tax at CGT rate if at all.

I'm still curious about my teacher example I wanted to ask at the time but the thread was about something else. Surely it costs more to set up a company and sell yourself shares in it than it does to just pay the tax!! Especially if using an accountant (although I suppose that's tax deductable!!)

herhonesty the BTL question can be answered by the fact that it is easy to run your property at a loss you rely on building up equity then all you have to do is move into it for a while before you sell and your profit is all tax free.

My neighbour lived in a property for 3 weeks before pocketing around 400k tax free and it was definately his business, another guy I know is just pocketing 100k if the sale goes through again for his 'business'

all tax free.

riksti Wed 08-Dec-10 13:35:11

Herhonesty - because not everyone wants to convert their income tax to CGT. Like ilovecrisps says - tax on dividend (at the moment) is a lot less than tax on savings income for example. People with lots of money to spend on various investment options usually have investment advisors, tax advisors etc who look at their unique situation (and their risk profile, i.e. how risk averse they are) and make investments based on that. Some people even invest in more than one type of fund/bond... to minimise the risk and are therefore paying some income tax and some capital gains tax.

ilovecrisps - your teacher example cannot avoid income tax on the payment for classes. If the teacher receives a payment for services then that is taxed as income regardless. But if that £100 was then invested into a bond that pays interest then the teacher would also have to pay income tax on that interest. If he, instead, invested in shares that don't pay dividends, then he wouldn't have to pay tax until he sells those shares and makes a gain.

Setting up a company doesn't really cost that much. That is why a lot of people do it - there are other issues to consider though and I wouldn't recommend anyone started a company without discussing the options with his accountant first. Your teacher, for example, might possibly have problems with VAT if he was working through a limited company rather than as a sole trader.

As far as the rental property gains are concerned then strictly speaking those gains should not be tax free. Granted - sale of a property is taxable as a capital gain (unless buying and selling properties is the business, in which case it would be treated as income) but living in there for 3 weeks does not exempt the gain from CGT. The reason he was able to get away with it is that HMRC doesn't have enough investigators to follow up these sorts of situations. If the facts are as you describe then his behaviour is considered tax evasion and therefore illegal.

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