The question I have is in relation to the practice in share dealing of "bed and breakfast" whereby it is possible to reduce one's capital gains tax liability. Can you explain whether this is true and how the process works?

Mr N.L., Dublin

The arrival of queries to this column about bed and breakfasting shares, much like that of the first cuckoo, heralds the advent of a new tax year. Unfortunately, like many things, it no longer appears quite as sweet a deal as it did heretofore but, certainly, it still exists.

Basically, as you suspect, the practice is intimately interwoven with the issue of capital gains tax. Used to its fullest extent it can reduce liability to capital gains unless you are the type of investor who will already have cashed in several tranches of stock during the year and, therefore maximised any gain for the purposes of capital gains. It is a device which attracts those who have no wish to dilute their portfolios but wish to maximise the tax relief they obtain on capital gains.

Anyone who makes a gain on capital investments such as shares, property, certain bonds and currency is liable to capital gains. If they are resident and domiciled in the Republic their liability is on worldwide disposals; if resident but not domiciled, the liability extends only to disposals in Ireland and Britain or gains which are brought into either of those jurisdictions; if non-resident, the liability covers only disposals of assets relating to property and certain exploration rights.

Every one of us has an amount we are allowed to earn by way of capital gains without paying tax in any given year. This currently stands at £1,000 (€1,270). Prior to April 1998, one spouse could use the surplus tax free threshold of the other, effectively granting married couples a tax free allowance of £2,000 but that is no longer the case. The tax-free capital gains threshold is now not transferable.

Over this limit, in most cases, capital gains are taxable at a rate of 20 per cent. This is a halving of the rate prior to December 1997. Certain items, such as development land, are taxed still at the higher 40 per cent rate unless it has outline planning permission, in which case it will be taxed at 20 per cent between April of last year and April 2002 as the Government seeks to encourage landowners to release suitable land for housing to ease the bottleneck in the housing market. Thereafter, disposals of such lands will be taxed at a higher 60 per cent rate. Other items, such as government stock, are exempt from capital gains altogether.

However, in your case, in relation to shares, the applicable rate is 20 per cent and the threshold £1,000 a year in capital gains. The first thing for you to assess is whether you have used your allowance already - a relatively simple exercise. Assuming, as I do, that you are an Irish resident and are domiciled here, simply calculate the gain you have already made on disposals of shares, currencies, any property or any other capital assets in the past year. If this figure tops £1,000 bed and breakfasting is of no use to you.

Remember, in assessing gains, you are entitled to charge legitimate expenses in connection with the acquisition and disposal of assets when calculating the gain. For instance, in the case of shares, any stockbroking charges would be allowable before calculating the gain. Another point to remember is that you are entitled to apply an indexation figure to any holding you have owned for more than one year, basically to allow for inflation.

The indexation relief figures are set by the Revenue Commissioners. For example, if you bought £100 of a given share in 1990/91 and sold it in the current tax year you would multiply the purchase price by an indexation allowance of 1.191. Thus if the shares are now valued upon disposal at £350, to calculate you capital gain, you would subtract (£100 x 1.191) or £119.10 from the sale price of £350 to give you a capital gain, before expenses, of £230.90, rather than the £250 you would have had if you had only taken the headline purchase and sale prices. Another factor to consider when calculating your capital gains liability is whether you have sold any stock at a loss during the year. In the same way as you are taxed on a capital gain in a given year, you can receive relief in respect of capital losses. This might allow you to contain any capital gain within the tax-free threshold.

A final point before deciding on the wisdom of embarking on a bed and breakfast transaction is to clear up who exactly owns the shares. If they are in joint names rather than simply your own, the allowance of both parties applies, effectively doubling the relief to £2,000 a year.

It is only after assessing your capital gains situation that you can decide on whether to bed and breakfast the shares. In essence, what such a transaction does is to sell the shares to realise the capital gain for the purposes of maximising your capital gains tax-free relief and then repurchase the shares for your portfolio. If, having assessed your capital gain, you find you still want to bed and breakfast the shares, you first need to approach a broker. They can sell the shares before buying them back at the same price. If, for instance, an investor had bought 5,000 shares in a particular company last November at £1 and those shares were now worth £1.25. The investor may have no wish to permanently dispose of the stock but they might not have used any of their capital gains allowance. By selling 4,000 of the shares and then buying them back at the same price, the investor, through the broker, can make a capital gain of £1,000, which is offset against the allowance for the current tax year. In fact, you would need to trade slightly more than the 4,000 shares to maximise the allowance as expenses - including the cost of the broker - are deducted from the headline profit figure. No indexation allowance would apply in this case as the shares were bought within the same tax year.

When tax free thresholds were transferable between spouses and the rate of tax levied on excess gains was 40 per cent, bed and breakfasting of shares was a prudent annual exercise and considerably more viable than it is today. However, if you are a small investor and have not already exceeded your limits, there is no reason why you should not legitimately avail of the opportunity to reduce your tax liability on stock disposals.

Please send your queries to Dominic Coyle, Q & A, The Irish Times, Fleet Street, Dublin 2 or e-mail to dcoyle@irish-times.ie. This column is a reader service and is not intended to replace professional advice. Due to the volume of mail, there may be a delay in answering queries. All suitable queries will be answered through the columns of the newspaper. No personal correspondence will be entered into.