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Share Identification Rules

In order to calculate your capital gain or loss when you sell shares, you need to know the acquisition cost or 'base cost' of those shares. This base cost is deducted from the sale proceeds to work out the capital gain. One feature of shares is that unless they are numbered (and most shares are not), all shares of the same class in the same company are identical. If you have accumulated shares of the same class in the same company over a long period of time at different costs and then sell just part of your shareholding in that company - how do you know which of the shares have been sold and therefore what acquisition price or ‘base cost’ you should be using to calculate your capital gain?

Share Identification Rules
To get around this problem, HMRC introduced the Share Identification Rules - a set of rules which define the exact order in which acquisitions are matched to sales. When you sell shares in a company, you look at your overall holding of shares in that particular company and match the disposals with shares purchased in the following order:

  • Shares acquired on the same day as the disposal
  • Shares acquired in the 30 days following the date of disposal, matched on a first in first out basis (this is called the ‘bed and breakfasting’ rule)
  • Shares acquired before the disposal date, which are pooled together and their cost averaged (a “Section 104” holding).

Bed & Breakfasting
The “same day” and 30 day “bed and breakfasting” rules were designed specifically to stop investors manipulating their Capital Gains Tax liabilities by disposing of shares and buying them back shortly afterwards for the purpose of realising a capital gain free of tax (because eg it is covered by the annual exempt amount) or a capital loss (which can be set off against chargeable gains to reduce a tax liability) while still, in effect, holding on to the investment. The effect of the rules means that in situations where shares in a company are sold and repurchased shortly afterwards, the capital gain or loss is calculated as though the shares disposed of are those acquired either the same day or within in the 30 day period following the disposal. In such circumstances, the price received on the disposal is generally similar to the price paid shortly afterwards to repurchase the shares. As a result of the rules, any gain or loss arising on the disposal is then likely to be small.

The easiest explanation as to how the rules are practically implemented is by way of example.

Let us say you start building a position in a company ABC plc over a 3 month period:

  • 1 Feb 2009 Buy 1000 x shares ABC plc @ 100p each = £1,000
  • 1 Mar 2009 Buy 1000 x shares ABC plc @ 150p each = £1,500
  • 1 Apr 2009 Buy 1000 x shares ABC plc @ 200p each = £2,000

On the 1 Apr 2009 the share price leaps up, so you decide to sell your entire holding and take profits:

  • 1 Apr 2009 Sell 3000 x shares ABC plc @ 250p each = £7,500

3 weeks later the share price has fallen and the company looks undervalued so you purchase 1000 more shares.

  • 21 Apr 2009 Buy 1000 x shares ABC plc @ 120p each = £1,200

Taking into account the HMRC Share Identification Rules, the sale of 3000 shares on 1 Apr 2009 is firstly matched with the 1000 shares acquired on the same day:

Disposal proceeds: 1000 x shares ABC plc sold on 1 Apr 2009 @ 250p = £2,500
Less acquisition costs: 1000 x shares ABC plc @ bought on 1 Apr 2009 @ 200p = £2,000
Capital Gain: £500

This leaves 2000 of the 3000 shares sold on 1 Apr 2009 still to be matched.

Next we look 30 days into the future. The purchase of 1000 shares on 21 Apr 2009 falls within the 30 day bed and breakfasting period. And so, of the 2000 remaining unmatched shares from the 1 Apr 2009 sale, 1000 are matched with the 1000 shares purchased on 21 April 2009.

Disposal proceeds: 1000 x shares ABC plc sold on 1 April @ 250p = £2,500
Less acquisition costs: 1000 x shares ABC plc bought on 21 April @ 120p = £1,200
Capital Gain: £1,300

This is the case, even though the 21 April 2009 purchase happened after the sale and in the next tax year.

The remaining 1000 shares from the 1 Apr 2009 sale are matched with the shares purchased prior to the disposal date.

The purchases made on 1 Feb and 1 Mar 2009

  • 1 Feb 2009 Buy 1000 x shares ABC plc @ 100p each = £1,000
  • 1 Mar 2009 Buy 1000 x shares ABC plc @ 150p each = £1,500

are pooled together and their cost averaged, to form a single asset called a Section 104 holding, which grows and diminishes as shares are acquired and disposed of. The “Section 104 Holding” is deemed to have been created on 1 Feb 2009 and consists of the combined holding of 2,000 shares of total cost £2,500 - average cost 125p per share:

  • 1 Feb 2009 Section 104 Holding of 2000 x shares ABC plc @ 125p = £2,500

The remaining 1000 unmatched shares from the 1 April 2009 disposal are matched with 1000 shares from the Section 104 Holding, and the gain calculated as:

Disposal proceeds: 1000 x shares ABC plc sold on 1 April @ 250p = £2,500
Less acquisition costs: 1000 x shares ABC plc (Section 104 Holding) @ 125p = £1,250
Capital Gain: £1,250

Your total Capital Gain on the sale of the 3000 shares in ABC plc on 1 Apr 2009 will be £500 + £1,300 + £1,250 = £3,050; leaving you with a pool of 1000 shares in ABC plc of total cost £1,250 to carry forward into the following tax year.

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