CFDs can be used to replicate a
'Bed & Breakfast' tax saving schemes
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Last update : September 2010
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| A few years ago the Treasury eliminated the use of 'Bed & Breakfast' style trading on the stockmarket.
This is where shares were sold one day (the final day of the tax year) and bought back the next (the 1st day of the next tax year) in order to create a tax loss.
The tax loss could then be offset against other capital gains. Bed & Breakfast deals were not illegal but the Treasury obviously thought that they were losing out on tax revenue and so put a stop to it.
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| Slamming the door on these types of deals was easy because a ruling was made that shares bought or sold within a 30 day time period were deemed not to have been sold at all. However many canny investors have switched to using Contracts for Difference to re-open the door to this type of tax-management strategy.
If you're unsure what Contracts for Difference (CFDs) are and how they can be used - see this introduction guide.
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| How to replicate B&B style trading using CFDs |
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Part 1 - Selling the shares
- An investor bought 5,000 shares of ABC company 6 months ago at £3.00 and the price is presently £2.00
- The date is 4th April (one day before the close of the tax year)
- He calls up his regular stockbroker and sells the shares at £2.00 so crystallising a loss of £5,000 (commissions and other charges are excluded in this exercise)
Part 2 - Buying the CFDs
- The investor immediately calls his CFD broker and buys 5,000 shares in ABC
- Remember Stamp Duty is not levied on CFDs but because they are leveraged products they charge daily interest
- Daily interest would likely be charged around 6% per annum which equates to £1.64 a day or £51 for 31 days - See - How CFDs work to understand how financing works
Part 3 - Selling the CFDs
- After 31+ days the CFD position is sold at the current ABC market price
Part 4 - Buying back the shares
- Once the CFDs have been sold the investor then calls his regular stockbroker and re-purchases 5,000 shares
- The Bed & Breakfast deal is now completed
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| Summary |
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By using CFDs the investor has never been out of the market so it doesn't matter what the share price does. If it rockets within the time period then profits will be built up on the CFD trade to offset re-buying the shares at a high price.
But if the shares slump then the loss on the CFD trade is offset by the cheaper price of the shares when they're re-bought (Part 4 above).
CFDs and other leveraged products often get a bad name due to their perceived riskiness. But people often don't take the time to look behind the curtain and see that these tools can offer other uses such as helping to reduce risk via hedging or as we've seen here sensible tax-management.
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