Ideas & Debate

How to minimise tax impact on your pocketbook

NSE

An employee of the Nairobi bourse answers an investor’s queries. Taxes on capital gains can have a big impact on investment results. FILE PHOTO | SALATON NJAU |

Much has been said about the recent re-introduction of the capital gains tax and its effect on the equity market. While some fear that the five per cent rate may “dry-up” the market, others remain clueless on its end impact.

It is true the law allowing capital gains tax (CGT) will certainly alter the game but no one can tell to what extent.

Nonetheless this will be a big consideration especially for short-term traders to ponder due to their active trading nature. In this article, I’ll look at the tax benefits of effectively managing capital gains by making smart trading decisions. 

Beginning January 1, 2015 managing how much tax you will owe on your gains will be a crucial element for traders to consider. Speculators or “short termers” will be forced to revise their strategies to avoid getting “hit” by the tax. This is essential since taxes on capital gains can have a big impact on investment results.

Traders should start considering tax advantages of using longer term strategies. Here is a good opportunity to consider the buy-and-hold strategy especially in view of the long-term effects of compounding on reduced or zero-income taxes incurred today.

Traders can stand to benefit if they hold on to stocks for the long run. This is key since capital gains (or losses) will only be applied to a traders’ tax return when they are realised.

If traders actually embrace Warren Buffett’s philosophy: to invest in good companies for the long haul, this will be in contrast to the notion of buying a stock with the simple hope of selling it to someone else in a few months (or even days) at a higher price.

Traders can also simply match profits and losses made in the same year in order to reduce their overall tax burden. If a trader makes a bad choice and loses Sh10,000 on a stock and later in the same year, makes a good trade and earns Sh15,000, these two transactions should offset each other. After netting the two transactions, the trader will only face taxes on the Sh5,000 of the Sh15,000 gain.

This means traders can actively choose to cross out (perhaps temporarily) losing positions so that they can successfully match their capital gains with offsetting losses in order to reduce their tax burden.

The bottom-line is that traders will need to understand that part of a successful trading plan is astute tax management: ensuring they actively take advantage of tax avoidance opportunities that can apply to their situation.

Any trader who wants to stay profitable will need to be knowledgeable on tax issues since this is crucial to produce even greater gains in the end.

As the old saying goes, there are only two certainties in life: death and taxes. While we have yet to a way to avoid either, there are a few tricks of the trade that can minimise the impact the taxman has on your pocketbook.