Last update: 10th April 2019
âTax doesnât have to be taxing.â
So says everyoneâs favourite advert from HMRC. Well, it doesnât have to be, but theyâre making a good go of ensuring that it is.
Contrary to their claim, tax is a complex subject. 
However, there are a number of factors that make tax on stock market investments a bit more simple and much less burdensome than other types of tax.
This is great: we generally like to simplify and clear up information asymmetry as much as possible. Best seen on our app, of course. And it means you, our beloved community, have a number of ways to keep more of your sweet, sweet gains. 
So what kind of tax applies to investments?
1. Stamp duty (reserve tax)
Paid when: you buy a UK stock
Headache level: None
The charmingly named yet irritating tax that applies to UK-based shares bought electronically. Itâs a standard 0.5% sales tax paid on all UK-listed stocks, but not overseas shares or ETFs listed on UK exchanges but domiciled overseas (thatâs the case for most UK-listed ETFs).
You pay at the point of purchase and itâs transparently applied to the total transaction cost. You donât really need to worry about this, but if youâre allergic to extra tax, you can go for ETFs or overseas stocks.
Thereâs also another stamp duty paid on paper-based share transactions only with different rules. You really, really donât need to worry about this.
2. Capital gains
Paid when: you realise a gain (i.e. you sell the stock or ETF at a profit)
Headache level: None (with an ISA or SIPP), high with a GIA (general investment account)
The main tax on investment is capital gains tax.
Capital gains tax (CGT) is tax on the growth of an investment from when you bought it. Any investment â stocks, art, property (that isnât your primary residence).
Such as a waterpark
In the UK, weâre blessed with a relatively simple capital gains tax system. Check out the equivalent in the US if you want to go insane and fall asleep at the same time.
To stress again, CGT only taxes gains on investments, not the total value of your holding. It applies to investments held in GIAs, but not ISAs or SIPPs (more on this later).
And the tax is only incurred when you realise the gain by cashing in the investment.
E.G. You invest ÂŁ10k into an ETF through a GIA â it gains by 10% and you now have an ÂŁ11k position. If you sell the investment only the ÂŁ1k gain is potentially liable for capital gains tax.
Only the gain at the time of sale is relevant. If you waited longer to sell and the ETF goes down, reducing your gain to ÂŁ500, only that ÂŁ500 would be liable.
The CGT rate varies a bit depending on your income taxpayer status, but on stock market investments it usually applies as:
- 10% on gain for basic rate taxpayers (unless your gain is over the basic rate income level)
- 20% on gain for higher rate taxpayers
There are other limitations for whether CGT applies.
In the UK, we have a threshold before you pay capital gains tax. This is called the AEA (annual exempt allowance) and itâs a universal standalone allowance for all your investment returns across the year from any kind of investment.
Your CGT allowance includes all the realised gains you make across any investments youâve sold that year (i.e. stocks and funds, but also rental properties, art etc).
If your total net capital gain for the year is within the allowance (ÂŁ12,000 in 2019â2020), itâs tax-free and thereâs no need to report it.
Significantly, any capital losses youâve realised that year (i.e. investments youâve sold at a loss) count against your gains, which could keep you under the allowance.
If in a year, you sell one investment at a ÂŁ20K gain and another at a ÂŁ10K loss, your net CGT is ÂŁ10k and under the allowance.
Around ÂŁ12,000 of gain seems like a lot of money, and unless your portfolio is large or youâre an investing genius 
, itâs unlikely youâll make those sort of gains in a single year.
However, CGT is calculated on the gain from the original date of purchase not the growth of your portfolio year-to-year .
If youâre planning to invest long-term, either as a Buffett-esque investor or for retirement/financial freedom, through the magic of compounding ÂŁ12k starts to become a very achievable gain on comparatively small initial investments.
The S&P 500 has grown by c.4.7% per annum over the last 20 years. At that rate of return an investment would have doubled in 16 years and triple after 24 years. Suddenly a c.ÂŁ12k allowance doesnât look so large!
So if youâre investing for the long-term, itâs worth seriously considering an ISA â the you of 2048 may be incredibly grateful!
3. Dividend tax
Paid when: dividends are paid on stocks you own
Headache level: None (with an ISA or SIPP), high with a GIA (general investment account)
Dividends (weâll be talking about these more soon) are income paid by stocks. A dividend is a proportion of the net profits of a company you own as a shareholder. Some companies now reinvest all their profits into the business and donât pay dividends. But many still do.
Dividends are taxed as income, not capital gains. Thereâs a ÂŁ2000 tax-free allowance for dividend income per tax year.
After that, any more dividend income stacks onto your overall income and is then taxed at different rates, depending on your income tax status.
The other relevant dividend tax on for Freetrade customers is US dividend tax. Unlike UK stocks, dividends on US stocks are paid at source. In other words, this means the tax is taken from the big pool of dividends put together by the company, not from the individuals who receive them.
This means you canât completely avoid US dividend tax by using an ISA or SIPP.
The standard dividend tax-rate for non-US investors of US stocks is 30%, which means 30% of the dividend is automatically withheld. However, some countries including the UK have tax treaties with the US, which lets their investors pay a lower rate as long as they fill out some paperwork.
Most UK brokers, including us, get you to fill out a W-8BEN form before buying US stocks, which reduces your US dividend tax rate to 15%.
So you get more sweet, sweet dividend money. 
Accounting for taste
After your allowances, the biggest factor on the tax you pay on investments is the account you use to invest.
In the UK, the three main investment accounts are:
-
GIAs (general investment account)
-
Stock and shares ISAs (individual savings account)
-
SIPPs (self-invested personal pension)
You can have multiple different accounts open at the same time and each have unique benefits and deficits. Much like Pokémon.
Letâs dive into the essentials.
GIAs
GIAs are a common term for what we call Basic Accounts on Freetrade: the first account we enabled for Freetrade. You can invest in most types of tradable asset (securities) with a Basic Account.
These accounts have no tax relief: theyâre exposed to capital gains tax and youâll incur tax on any gain or dividend over your total allowance.
If you do go over the dividend or CGT allowance in a Basic Account, youâll have to sort out the tax yourself through an annual self-assessment return. 
You also have more of a reporting burden; you have to report large stock sales (c.ÂŁ45,000+) regardless of what you gained or loss.
Stocks and shares ISAs
Stocks and shares ISAs are special tax-wrapped accounts. These are available on Freetrade now and weâve got lots of dedicated info on our Investment ISAs here.
There are limits on how much you can add to an ISA each tax year (ÂŁ20,000 right now).
However, all the returns you make on the money inside are tax-efficient and donât use up any of your total CGT allowance. You could potentially make a ÂŁ500,000+ tax-free gain in your ISA and still have your full allowance for any gains you make outside the ISA. Dividends paid on ISA-owned stocks are also tax-immune. 
If youâre planning to hold long-term, this is where ISAs start to become essential. Over many years, itâs very easy for a pretty small portfolio to have compounded far beyond the CGT threshold. You definitely donât want to incur tax on that return and ISAs keep the whole gain tax-efficient.
Itâs a gift from past you to future you!
There are also some limits on what assets you can own in ISAs, but you can own the vast majority of popular stocks and funds.
SIPPs
SIPPs are pension plans where the holder controls and selects the investments. Like all pensions, you canât withdraw the money until you reach a certain age: 55 currently or 57 from 2028 onwards.
SIPPs will come to Freetrade after ISAs but are a big priority too, as theyâre extremely tax-efficient ways to invest. You can invest in a huge range of assets with a SIPP, including physical gold and hotel room leases.
Remember the terrifying hotel room from 1408? You could very efficiently lease that out through a SIPP.
When they arrive, a Freetrade SIPP will only invest in stock market securities and ETFs, of course.
Like ISAs, all investments and dividends in SIPPs are UK tax-free and donât use up any CGT allowance. Furthermore, as itâs a pension, you also get extra tax relief from the government on your contributions. This means the government will add 25% of what you invested into the SIPP. If youâre a higher rate taxpayer (earn ÂŁ50,000+ in 2019â2020), youâll get an additional tax rebate.
If you invested ÂŁ8K into the SIPP, the government will put ÂŁ2K extra into the SIPP. If youâre also a higher rate taxpayer, youâll get an income tax rebate of up to ÂŁ2L as well. So youâd have a ÂŁ10K SIPP for a mere ÂŁ6K total cost! Pretty slick.
Again like ISAs, thereâs a limit on how much you can add into a SIPP annually (ÂŁ40,000 in 2019â2020 including the government relief). However, this limit varies a bit depending on factors like income and your other pensions.
Unlike an ISA, when you withdraw there is likely to be an income tax burden on the money you take out, despite the lack of capital gains tax. Most people can remove 25% of the pot tax-free, after which any more withdrawal will be taxed as regular income (but not CGT).
Letâs sum up!
Basic accounts
- Tax-liable holdings
- No limit on what you can add each year
- Can invest in most securities/tradable assets, but not all investments
Stocks and shares ISAs
- Tax-wrapped holdings
- Limit on amount you can add each year
- Can invest in most securities but with a bit more limitation than a GIA
SIPPs
- Tax-wrapped holdings, additional tax relief and potential rebate
- Limit on amount you can add each year
- Huge range of assets you can own in the SIPP, you can invest in anything from securities to property to physical gold
- May incur an income tax burden on withdrawal
OK, so what should I do?
If youâre certain your annual total capital gains will never go above the threshold, only want to invest short-term and donât expect to receive much dividend income, it might suit you to only use the Basic Account, since theyâre free at Freetrade.
However, if youâre investing even slightly long-term, the likelihood is that the ISA will prove much more efficient for most investors.
If you donât want to worry or think about investment tax at all, ISAs are an ideal option.
ISAs are also great if you plan to build a large portfolio over time (you should). Due to the annual limit on ISA contributions, you might not able able to transfer in a big portfolio you built outside the ISA in one go.
If you expect to build up a long-term portfolio that will eventually produce returns over the capital gains threshold, itâs definitely worth doing it in the ISA. Itâll also keep your dividends tax-free.
They also offer the most flexibility and simplicity; you can withdraw your money whenever you want without incurring any tax at all.
Overall for a combination of flexibility, simplicity and tax efficiency, stocks and shares ISAs are best. 
But you can always combine all of them to invest together.
Finally, if you want to be as tax efficient as possible, get free money from the government, are happy not to touch the money invested for a (very) long time and then withdraw it very conservatively, then SIPPs can be like ISAs on crack. Patient, prudent crack. 
There! We managed a comprehensive post on investment tax while maintaining some level of clarity. At moments, it looked in danger of becoming horribly complicated, but we steered it back!
Weâd like to thank HMRC for making it a challenge. 
Freetrade does not provide investment advice and individual investors should make their own decisions or seek independent advice. The value of investments can go up as well as down and you may receive back less than your original investment. Tax laws are subject to change and may vary in how they apply depending on the circumstances.
) so itâs a good time to catch up on the tax aspect of investing and how you can make your life much, much easier
