Why Are Percentage Gains Used for Capital Gains Tax Calculations?

Question

In the context of UK investments, I'm led to believe that encashing a general investment account (OEIC/UT) can result in a capital gains tax liability. My understanding is that when calculating this liability, you consider the difference in a fund's initial purchase price and its current sale price to work out the taxable gain.

Let's say I've got £5,000 invested in "Fund A" within a GIA today. I bought this for £2 per unit in 2013 and I want to encash it now when it's worth £2.50 per unit.

My initial attempt to work out the gain is was therefore: £5000 ÷ £2.50 = 2000 units 2000 × £2.00 = £4000 initial value £5000 - £4000 = £1000 gain

However, I've been told that the above is incorrect and I should be looking at percentage gain instead: (£2.50 - £2.00) ÷ £2.00 = 0.25 (i.e., 25% gain in share price) 0.25 × £5000 = £1250 gain

Now, I don't understand how the percentage-based method can possibly be the correct way to work this out. Surely if I buy 2000 shares for £2 each and then sell them all at £2.50 then I've gained £1000 by doing this buy/sell transaction? Any explanation would be greatly appreciated.

Answer 1

You pay tax on your gain, i.e. on £1000.

0.25 x £5000 makes no sense at all, yes the asset has increased in value by 25%, but that's a 25% increase from £4000, not £5000, so it's 0.25 x £4000, which is £1000, as you calculated.

You can deduct costs too though, at least those relating solely to the gain (e.g. acquisition and disposal costs), so if it cost you £50 to buy and sell, you'd be liable for capital gains on £950 in fact.