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KEY POINTS
- Tax rates to rise and personal allowances to reduce for wealthier clients.
- Future changes to rates applicable for dividends, trusts and NICs.
- Mitigating the effects of the new 50% tax band.
- Partnerships, pensions and properties – some ideas.
- Watch out for time limit changes for claims.
- Some year-end tax planning ideas.
So you’ve (nearly) finished all the self assessment tax returns and billed everything that moves to bring in some cash for all that hard work. Now, thoughts turn to the new tax year and what you can do to help minimise your clients’ tax liability in the coming months.
The 2010/11 tax year will provide particular challenges. There are the impending tax increases and personal allowance restrictions for those at the wealthier end of the spectrum.
There are yet more complicated rules for pension relief restriction and the end of well-established tax breaks for furnished holiday lettings. In addition, we will have two Budgets and two Finance Bills, bookending a general election.
Speculation is already mounting about whether an incoming government will raise the rate of capital gains tax and remove some reliefs to either raise funds or fund tax change.
In the meantime, it is possible to plan for the dying months of 2009/10. Here is an outline letter that, hopefully, is a useful starting point for those of you who want to contact clients in this way.
Higher taxes and fewer reliefs
From 6 April 2010, those earning in excess of £150,000 will be subject to a ‘super-tax’ of 50% on income over that threshold.
Furthermore, personal allowances will be restricted for those earning more than £100,000, at the rate of £1 for every £2 of income above that figure. As the current personal allowance is being frozen at £6,475 (with all the fiscal drag that will bring), this means the full allowance will be extinguished at an income level of £112,950.
The gradual tapering of the allowance – within the narrow banding of £100,000 to £112,950 – means that where income falls within these limits, the effective rate of income tax is an
eye-watering 60%.
History shows that the higher a tax rises, the more risks people are willing to take to mitigate the effects. When faced with the possible alternatives of a 50%-plus income tax rate or an 18% capital gains tax rate (or 10% if entrepreneurs’ relief applies), one does not need to be a rocket scientist to work out how clients will prefer to be taxed.
There was a lot of speculation that the pre-Budget report last December would include sweeping anti-avoidance rules to prevent the move from income to capital, but these did not arise.
The overriding difficulty was probably how hard it would be to draft something that caught the extreme measures but not the sensible and the commercial. This means, as is shown below, that in some cases it is possible to arrange a capital rather than an income effect.
We did, of course, see a renewed effort to upgrade the disclosure of tax avoidance scheme (DOTAS) rules. The ongoing consultation in this area will be looking to batten down the hatches on more aggressive tax planning.
Anyone looking to enter into any planning that falls within the DOTAS rules needs to think very carefully about how robust the idea is technically, and about the implications if that planning is challenged.
Dividends, trusts and NICs
Still on the subject of tax increases, from 6 April 2010 there will be three rates of tax on dividend income. Where income falls within the basic rate band, the 10% tax credit will extinguish any liability, as before. The equivalent rate for 40% taxpayers remains at 32.5%, but a new rate of 42.5% will be introduced where income will be taxed at the new rate of 50%.
Trusts, of course, are not left alone, and from the same date the additional rate of tax for trusts will also rise to 50% with a new higher trust rate of tax on dividends of 42.5%.
Last, but certainly not least, National Insurance contributions (NICs) are due to rise from April 2011 (a further year on), but if these go ahead as planned they will add another 1% to the rate, which is a significant uplift and may be a very sobering thought as people look ahead.
It will be interesting to see if this year brings a change of government and if it chooses to go ahead with this NIC increase. The Conservatives have shown no willingness to publicly support change to the uplift in income taxes for the wealthy, but did make noises about NIC increases for those on lower incomes.
However, given the poor state of the economy, choices for any government may be limited.
Starters for ten
Let’s consider some planning points for individuals. These are only as good as the facts: i.e. they simply are not relevant for everyone and as always they might come with some downsides that need to be considered before proceeding.
Tax alone is rarely the only consideration to take into account when deciding a course of action. Space constrains a detailed examination of every single point, so they are covered in outline only as follows.
- Employers could consider making advance payments to their employees, such as advancing bonus payments into the current (2009/10) tax year to reduce the overall tax bill. Could this see the advancement of bonuses for the next year or more? The downside for the employer is that this makes tax and NICs due earlier. The bigger downside is how can you be sure that the employee will still be around to do the work on which the bonus is predicated?
- Owner-managed business owners could opt to pay dividends before 6 April 2010 to take advantage of the current, lower tax rates.
- Claims for tax relief could be made post-5 April 2010 to obtain tax relief at the highest possible level (for example, gift aid relief).
And what about the old, tried and tested methods of reducing tax? These become perhaps even more helpful than before. A simple income balancing exercise among spouses (or civil partners), even those who are higher-rate taxpayers themselves, can produce tax savings.
Consider the spouse whose income is £80,000 and one whose income is £110,000. An effective tax saving of 20% on the amount exceeding £100,000 can be achieved by balancing income.
However, income balancing is still an area of contention as far as HMRC are concerned, so it is important to proceed with care. First, it is vital to get the formalities right: for example, are income producing assets really held by the right person?
Second, issues still remain around the settlements legislation that can deem the passage of income from one to another to be ineffective. Despite the endorsement of the taxpayers’ action in Jones v Garnett [2007] STC 1536, the success of the case in the House of Lords was based upon specific facts; not all forms of income shifting will work.
For example, the couple had ordinary shares that dictated the spread of dividends. The use of preference shares does not bring the same results.
It is difficult (although not impossible) to convert income into capital to move from a 50%-plus to a charge of 18% or less. It is far easier to structure sensibly to get a capital effect rather than an income effect.
This may be an ideal opportunity to remind employers of the various share incentive schemes that can give employees a capital receipt in the future.
From 6 April 2010, the long-standing furnished holiday letting (FHL) rules are abolished. From that date all lettings will be treated under one set of rule: those of the property business.
The implications of this have been covered in past issues of Taxation, but there are planning opportunities to consider in advance of this deadline, especially around losses and capital allowances. In particular, should the client accelerate expenditure into 2009/10 where the individual would be able to use the loss against general income?
Partnerships and pensions
There are a few specific issues that are relevant to partnerships. These include the following.
- Withdrawing capital and reinvesting it as a loan to give tax relief. Careful structuring is required to meet the legislative requirements, but after 5 April 2010 the loan could give tax relief at 50%.
- Introducing a spouse to a partnership, subject to
- anti-avoidance provisions.
- Accelerating income to take advantage of lower rates by changing the accounting year end.
Looking ahead to 6 April 2011, higher-rate tax relief for pension contributions will be restricted.
Further amendments in the pre-Budget report last December mean that, from 2011/12, relief will be restricted for individuals with taxable income (including employer pension contributions) in excess of £150,000.
There is a ‘floor’ of £130,000, such that an individual with income (excluding employer pension contributions) below this figure will be outside the scope of the rules. The restriction is intended to taper the relief for individuals earning between £150,000 and £180,000 from 50% down to 20%, leaving those with income in excess of £180,000 with only basic rate relief.
However, the legislation on the restriction is still in draft form and subject to change and, given how the pension rules have moved light years from the ‘A-day’ dream of simplification that we talked about only a few years ago, there is no guarantee that this will be the end of the amendments.
To prevent people taking advantage of higher-rate relief in the interim period, the Government has introduced anti-forestalling measures; since the pre-Budget report this includes all of those with income of £130,000 and above.
The anti-forestalling rules are intended to attack individuals making ‘irregular’ contributions in an attempt to take advantage of the higher pension relief prior to 6 April 2011. If the total pension contributions, inclusive of employer or third-party contributions, exceed £20,000 a tax charge will be levied on contributions not classed as ‘regular’.
Where individuals have income around this level and are making pension contributions (especially those who make annual contributions) they will need to look carefully at how the anti-forestalling rules and new restrictions apply, to ensure they do not fall foul of the rules.
Trusts
The introduction of the 50% income tax rate for trusts from 2010/11 will probably result in more trust beneficiaries needing to file repayment claims.
A trust rate of 40% reflects the marginal rate of tax paid by most individuals on high incomes, but currently only 2% of taxpayers are in the £100,000-plus income bracket (according to paragraph 2.48 of the 2008 pre-Budget report), so you would expect significantly fewer to be in the 50% marginal rate band.
Many beneficiaries, such as minors, vulnerable beneficiaries and all those not liable at the new 50% higher rate, who receive payments of trust income, will be able to apply for tax refunds before the trustees have even had to file a tax return and pay tax for the year.
The structuring of trusts also needs consideration. ITTOIA 2005, s 624 contains the settlor-interested rules that provide that where the settlor or settlor’s spouse could benefit under a settlement, all income of the settlement (i.e. the trust) will be taxed as the settlor’s.
These rules were introduced to discourage individuals putting assets in a trust, which they or their spouse could access, at a lower rate than if they owned them personally.
However, this was based on the rate of tax that was paid by the trust being lower than the rates of tax paid by the individual settlor. From 6 April 2010, it is likely that the trust will pay a higher rate of tax than the individual settlor.
Therefore, many discretionary trusts will pay a higher rate of income tax than the individual. Two possible planning opportunities here are to consider converting to a settlor-interested trust or an interest in possession trust, although you will need to think about the broader implications of whether the trust restructuring is the right move.
Changes to time limits
From 1 April 2010, the new time limits for making claims and elections come into force. Previously, individuals had five years from 31 January following the end of the tax year in which to make most claims and elections.
However, from 1 April 2010, individuals will have four years from the end of the tax year to which the claim or election relates.
The first tax year to be affected will be 2004/05, which is subject to the transitional rules. Outstanding claims and elections for this year will need to be made by 1 April 2010 (where previously it would have been 31 January 2011).
This is swiftly followed by the deadline for claims and elections relating to the 2005/06 tax year, which now need to be made by 5 April 2010. The new rules will effect things such as repayment claims, error or mistake claims, loss relief claims, claims relating to remittances, and various capital gains tax claims and elections.
The usual things to consider
As always, there are some standard year-end planning issues to bear in mind:
- Married couples and civil partners should seek to maximise their personal allowances and lower-rate bands by reviewing the ownership of income-producing assets, such as bank accounts. This also applies for the capital gains tax annual exemption, which is £10,100 for 2009/10.
- Where one member of a couple is a basic-rate taxpayer and the other is a higher-rate taxpayer, payments made to charity under the gift aid scheme should be made by the higher-rate taxpayer because they are currently able to claim higher-rate tax relief for the payments.
- Each individual has their own annual individual savings account (ISA) allowance (£7,200 for 2009/10). Unused allowance cannot be carried forward to a future tax year and should therefore be utilised by 5 April 2010 where this forms part of the individual’s investment strategy. The annual allowance will increase to £10,200 from 2010/11 and is already at this level for those born on or before 5 April 1960.
- It is possible to make contributions to a personal pension and contribute up to £3,600 a year (gross) without having any evidence of earnings. This could therefore be a valuable planning opportunity for a non-working spouse, children, or those with only unearned income.
- Remember that the inheritance tax annual exemption still stands at £3,000 and can be carried forward for one year. This exemption is per person and, therefore, where a married couple have not made any gifts in the past two tax years they would have an exempt amount of £12,000 between them. The exemption can only be rolled forward one year. If it is not used in that year it is lost and cannot be rolled forward again.
- Tax-favoured investments, such as in a venture capital trust (VCT) or an enterprise investment scheme (EIS), can be useful tax planning tools where they are appropriate for the investment strategy of the individual. Investments in VCT and EIS companies are a higher risk and, as with any investment, appropriate financial planning advice should be sought before the client makes any decisions.
So, as the old tax year draws to a close, there are plenty of ‘door-openers’ to give you an opportunity to discuss possible future or current planning with your clients and help them make the best of the new tax year.
Francesca Lagerberg is head of tax at Grant Thornton UK LLP, where Amy Read is a manager in the national tax office. Contact them via the company's website.
