Not Such a Great Relief - GARETH JONES of Speechly Bircham illustrates how shares aid may not always be tax efficient.

The Finance Act 2000 introduced a new tax relief to taxpayers who give away listed shares to charity. However, problems can arise in particular with taxpayers whose income which is taxable at the higher rate consists exclusively (or mainly) of dividends. This will typically be a relatively wealthy retired individual, with little or no pension. Dividends are always treated as forming the top part of a taxpayer's income, and so other forms of income such as bank interest will only be taxable at the higher rate if they exceed the taxpayer's allowances and higher rate threshold.

An example best demonstrates the problems. Assume that Mr Pickwick (who has used his capital gains tax allowance for the tax year in question) has a shareholding worth £10,000, of which £4,000 would be chargeable to capital gains tax (after taper relief and indexation as applicable), if he were to sell the shares. After tax on £4,000 at 40 per cent, the shares are effectively worth £8,400 to Mr Pickwick in capital terms.

If Mr Pickwick wished, he could transfer his £10,000 worth of shares to charity. He will be exempt from capital gains tax on this gift, and the charity will be able to sell the shares free of tax. Following the introduction of shares aid, Mr Pickwick will also be able to reduce his taxable income for the year in question by £10,000, i.e., the value of the shares. He will, in addition, be able to reduce his taxable income by the amount of the expenses arising from the gift to the charity, but let us ignore that for these purposes.

If Mr Pickwick had £10,000 of income which was taxable at 40 per cent, it follows that this would result in a reduction in his tax bill for the year of £4,000.

The problem is that dividends received by higher rate taxpayers are not taxed at 40 per cent. Instead, they are subject to a notional tax credit system, which works as follows:

The result is that the taxpayer pays tax equal to 25 per cent of the dividend he receives from the company.

Two issues arise out of this, which cause the tax savings associated with shares aid to be not quite so significant as one might expect:

• Shares aid works by reducing an individual's taxable income. In the case of dividends, taxable income includes the notional tax credits. The upshot is effectively that if Mr Pickwick gives away £10,000 worth of shares, he will only get income tax relief on £9,000 of actual dividend income received.
• The reduction in income tax does not extend to enabling the taxpayer to recover the tax credit.

Effectively, therefore, tax relief on Mr Pickwick's gift of £10,000 worth of shares is limited to 25 per cent of £9,000, i.e. £2,250.

So, if Mr Pickwick made a gift of the shares to a charity, he would be:

• worse off by £8,400 (the value of the shares to him after capital gains tax); and
• better off by £2,250 (the reduction in his income tax bill).

In other words, there is a net cost to him of £6,150.

It is interesting to compare this with the position where Mr Pickwick chooses instead to make a gift to the charity of £7,800 cash under the gift aid scheme. Under gift aid, this sum will be deemed as being net of basic rate income tax at 22 per cent, i.e. £2,200 in the hands of the charity. The charity is permitted to reclaim this deemed basic rate tax and will therefore receive a total of £10,000, as it would in the case of a gift of shares worth £10,000.

Meanwhile, and assuming all his higher rate income is dividend income, Mr Pickwick will receive income tax relief of £2,250, even though he only gave away £7,800 of cash. This may seem surprising, and it results from the way gift aid works, which is to give relief from higher rate tax on the amount of the cash gift to the charity grossed up at 22 per cent.

So, if Mr Pickwick gave cash to the charity, he would be:

• worse off by £7,800 (the amount of cash given to the charity); and
• better off by £2,250 (the reduction in his income tax bill).

So the net cost to him of the gift would be £5,550 – an additional saving of £600 compared with shares aid.

Check it first

Most taxpayers would assume that shares aid is preferable to gift aid, since it confers capital gains tax relief as well as relief from income tax. It is clear from the above that, even in the case of shares which stand at a significant gain, gift aid relief will be preferable for some taxpayers.

In addition to the simple cash advantage highlighted above, the taxpayer will benefit from the dividend stream from the £10,000 worth of shares still invested and the potential for capital growth.

Gareth Jones is a member of the private capital team at Speechly Bircham.

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