In this bulletin all references to married couples include registered civil partners.
1. Income tax planning
Income tax rates are currently 10% (on certain investment income), 20% and 40%. Four key changes will take place from 6 April 2010:
(i) the standard personal allowance will be frozen at the 2009/10 rate (£6,475)
(ii) the threshold for the start of higher rate tax will be frozen at £37,400
(iii) a 50% tax charge will apply to taxable income that exceeds £150,000
(iv) those with an income of more than £100,000 may find that they will lose some or all of their standard personal allowance.
The impact of (i) and (ii) will mean that even more people will fall into the higher rate tax band – some purely down to a standard pay increase.
The impact of (iii) and (iv) will mean that people with income of more than £150,000 and £100,000 respectively will pay even more tax, sometimes at an alarmingly high marginal rate.
There are a number of ways in which tax increases can be mitigated:
(i) Maximising use of a couple's allowances, reliefs and exemptions
(ii) Utilising tax exemptions and allowances
(iii) Using tax efficient investments
We deal with each of these in more detail below.
1.1 Maximising use of a couple's allowances, reliefs and exemptions
Planning to maximise the use of a couple's allowances, reliefs and exemptions has become much more important following the Chancellor's announcement that the top rate of income tax will increase to 50% for those with taxable income of more than £150,000; and the introduction of an effective rate of 60% on income between £100,000 and £112,950 caused by the withdrawal of the personal allowance. For such people, who are married or have a registered civil partner, the tax savings available by ensuring that income arises in the lower income partner's name will be even more substantial. But don't forget the tax savings are still attractive for the increased number of people who will be 40% taxpayers if they have a spouse who is a basic, lower or nil rate taxpayer.
Most of these strategies need a full tax year to deliver maximum effect so these suggestions may serve more as a reminder for planning for the coming tax year than as a means of saving tax this year. The appropriate type of tax planning to adopt will depend on the type of income a person enjoys i.e. earned/business income or investment income.
(A) Earned income
(i) Employment income
(a) Employers could pay bonuses before 6 April 2010 to take advantage of existing tax rates
(ii) Owner/directors of a private limited company
Points to consider for 2010/11 for these people are:
(i) Where married couples run their business through a company, it will be sensible for salary payments or dividends to be shared as evenly as possible. Following the taxpayer's success in the case of Jones v Garnett (2007) - the so-called "Arctic Systems" case - the Government's income-shifting proposals have been put on hold for the time being.
(ii) In the run up to next year's tax increases, owner/directors will no doubt consider the benefit of salaries and dividends being paid from the business before 6 April 2010, thereby paying tax at 40% and 32.5%, rather than at 50% on income and 42.5% on dividends over £150,000 after 5 April 2010.
(iii) Pension contributions are still a very tax efficient way to extract funds from the business however the reliefs available have been restricted for those with high incomes. As such professional advice should be sought before making any employer contributions for high earning directors/business owners/ employees – see section 3.
(B) Investment income
Where a higher rate taxpaying spouse owns investments, income from these may suffer tax at a rate of up to 40% or 32.5% (if dividends). These rates could be as high as 50% and 42.5% respectively from 6 April 2010. Therefore, subject to practical considerations, the transfer of investments to a lower or non-taxpaying spouse can save tax and increase overall net of tax investment returns. To be effective, such transfers must be outright and unconditional.
1.2 Utilising tax exemptions and allowances
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Where possible, a couple should try to ensure that they both have pension plans to provide an income stream in retirement that will also use their personal allowances, rather than all pension income being weighted towards one individual which is still a very common occurrence.
- Older married couples benefit from an increased age-related personal allowance. It may be advisable to transfer income-producing assets between couples where one would otherwise exceed the age allowance limit of £22,900 (2009/10 and 2010/11) and start losing this valuable benefit.
1.3 Using tax efficient investments
With the rates of tax effectively increasing for all from 6 April 2010, it is important that people invest in the most tax efficient way possible.
(a) ISAs
The ISA is still the main method of investing savings with freedom from income tax and capital gains tax. There are still two types of ISA – a cash ISA and a stocks and shares ISA. The overall annual contribution limit is £7,200 of which no more than £3,600 can go into cash. The balance can be invested in a stocks and shares ISA. This means a couple could invest £14,400 between them. Those investors aged over 50 in this tax year can currently invest up to £10,200 into an ISA - £5,100 of which can be in a cash ISA. For somebody over age 50 who has not yet used all of their increased ISA allowance of £10,200, now could be the time to do this. From 6 April 2010, the increased ISA investment limit applies to all qualifying individuals irrespective of age.
The announcement by the Government in the 2009 Budget that the annual Individual Savings Account (ISA) subscription limit was to increase to £10,200 (from £7,200) for those aged at least 50 in tax year 2009/10 may not have seemed much of a concession – especially given the current low dividend and interest yields. However, in a climate where people need to take more personal control over their retirement provision, this can be a useful long-term concession. For example, for somebody aged 45 now who plans to retire in 20 years' time, this will mean that an extra £60,000 can be saved into an ISA over that 20 year period. And as this will be accumulating in a highly tax efficient environment, this will provide an opportunity for better investment returns, particularly for the higher rate taxpayer who will not then pay higher rate tax on dividend income or interest.
For the 50 year olds who can now invest £10,200 in an ISA, up to £5,100 of this can be invested in a cash ISA. From 6 April 2010, these limits will apply to everyone who is eligible, irrespective of age.
Action
ISAs can be used for a number of tax planning reasons. Call us for information on the most appropriate ISA solution for your clients.
(b) Other tax efficient investments
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Growth-orientated investments
Given the relatively high rates of income tax compared to the current rate of capital gains tax (CGT), it makes tax sense to invest for capital growth as opposed to income. Whilst we mustn't forget that CGT rates may well increase in the future – especially after the forthcoming General Election – based on the current rules, growth-orientated investments look tax attractive for the higher rate taxpayer.
Income (dividends and interest) on collectives is taxable – even if accumulated. Therefore, if the emphasis is placed upon generating capital growth, it should also be possible to make use of the investor's annual CGT exemption (currently £10,100), with excess gains only suffering tax at 18% currently. For couples, it makes sense for them both to invest in order to be able to use both annual CGT exemptions.
- Single premium investment bonds
Because single premium investment bonds are deemed as non-income producing assets, no taxable income arises for the investor when holding this type of investment. Not only that, any dividend income accumulates without corporation tax within a UK insurance company's investment funds. However, investment bonds are not so tax efficient from a CGT standpoint with capital gains (after indexation allowance) realised by the UK life fund suffering corporation tax of up to 20%. The investor policyholder will receive a basic rate tax credit for deemed taxation in the fund meaning that, on eventual encashment, a tax charge will only arise if the investor (after top-slicing relief) is then a higher rate or additional rate taxpayer.
Ways in which this tax charge may be mitigated involve the following strategies:
(i) defer encashment of the bond until a year in which the investor is a basic rate taxpayer – say after retirement. In the meantime, if cash is required use the 5% tax-deferred withdrawal facility.
(ii) assign the bond to an adult basic rate or non-taxpaying relative (say spouse or children) prior to encashment. The assignment will therefore not trigger a tax charge and tax should be avoided on subsequent encashment.
Of course, more tax efficiency at fund level can be achieved via an offshore bond because there is no internal tax charge on investment growth. However, there is then no tax credit for a UK-resident investor.
Action
Whether a UK or offshore bond is best for any particular investor will depend on their individual situation and correct advice in this area is essential.
(c) Enterprise Investment Scheme (EIS)
The EIS offers tax relief on an investment in new shares of an unquoted trading company which satisfies certain conditions. For the tax year 2009/10 an investment of up to £500,000 can be made to secure income tax relief of up to 20% on investments held for three years, with relief being restricted to the amount of income tax otherwise payable. Unlimited capital gains tax deferral relief is also currently available on an investment into an EIS provided some of the EIS investment potentially qualifies for income tax relief.
(d) Venture Capital Trust (VCT)
The VCT offers income tax relief for tax year 2009/10 at up to 30% for an investment of up to £200,000 in new shares held for five years, with relief being restricted to the amount of income tax otherwise payable. There is no ability to defer capital gains tax as with an EIS investment but dividends and capital gains generated on amounts invested within the annual subscription limit are tax free.
For both the EIS and the VCT it is essential that would-be investors are aware of the likely greater investment risk and lower liquidity that will have to be accepted in return for the attractive tax reliefs. However there are some newer schemes coming to market that manage the risk much more carefully than the traditional unlisted equity investments associated with these type of funds. They can therefore offer a viable alternative for those who seek tax relief but have been restricted in the more traditional areas such as pension contributions.
Action
As ever it is critical that advice be sought to make sure that the correct investment is selected for the specific individual concerned. Contact us for further information on our preferred VCT and EIS schemes as well as other types of investment as set out above.
2. Dealing with the loss of the personal allowance
From 6 April 2010, the standard personal allowance will be subject to a single income limit of £100,000. Where an individual's "adjusted net income" is below or equal to the £100,000 limit, they will continue to be entitled to the full amount of the standard personal allowance.
Where an individual's adjusted net income is above the income limit of £100,000, the amount of allowance will be reduced by £1 for every £2 above the income limit. The personal allowance can be reduced to nil from this income limit. For example, based on the personal allowance of £6,475 for 2010/11, an adjusted net income of £112,950 or above would mean that no personal allowance is available.
A number of people may have adjusted net income of just over £100,000 which will cause them to lose their personal allowance. How can they plan for this forthcoming tax change? Well, much will depend on the type of income that causes the cut back.
Earned income
Where it is earned income that takes the individual into the £100,000 - £112,950 income bracket they should seek to reduce this by either
- paying a pension contribution or
- arranging for a salary sacrifice
Investment income
Where it is investment income that causes an individual's adjusted net income to fall into the £100,000 - £112,950 band then, depending on their circumstances, any of the following may be appropriate strategies:
- redistribution of investment capital to a spouse with a lower income so that the income generated is taxed on him/her instead,
- reinvestment in to tax free investments, such as an ISA, so that taxable income is replaced with tax free income,
- reinvestment in to tax efficient investments that don't generate an income and so will not impact on the loss of the personal allowance. Such investments could include:
- certain National Savings products.
- investments geared to producing capital growth.
- single premium investment bonds from which a 5% tax-deferred withdrawal may be taken each year, for 20 years, without affecting the personal allowance calculation.
Action
Advice should be sought to make sure that the individual position in relation to the above rules is fully understood and that the strategy chosen is the correct one. Contact us for further details.
3. Pensions
Any year-end pensions tax planning will need to be made against the backdrop of the restrictions that are being made, to the availability of higher rate tax relief on pension contributions for certain people.
The Government will be introducing a ´high income excess relief´ tax charge, which is designed to restrict the relief available on pension contributions/accrual in respect of high earners, with effect from 6 April 2011. A change was also implemented, with effect from 9 December 2009, to the anti-forestalling provisions designed to stop those individuals likely to be affected by the new rules from April 2011 maximising their contributions in the meantime.
Professional advisers will need to be familiar with the main aspects of these changes, both in terms of the proposed rules to apply from April 2011 and the action that should be taken now by high earners looking to maximise their pension provision. In particular, the following points should be considered:-
- Anyone with "relevant income" of below £130,000 in tax years 2009/10 and 2010/11 should seek to maximise their pension contributions while there is no restriction on their available tax relief. This is particularly important for anyone who is likely to fall foul of the income limits applicable from 6 April 2011.
- Anyone with "relevant income" of £130,000 or more but less than £150,000 should be made aware that they are now potentially subject to the special annual allowance and full advantage should be taken of their special annual allowance (ie. normally £20,000 but potentially up to £30,000 where "infrequent money purchase contributions" have been paid in tax years 2006/07 to 2008/09 inclusive) in both tax years 2009/10 and 2010/11.
- Anyone with "relevant income" of £150,000 or over should take full advantage of their special annual allowance (ie. normally £20,000 but potentially up to £30,000 where "infrequent money purchase contributions" have been paid in tax years 2006/07 to 2008/09 inclusive) in both tax years 2009/10 and 2010/11.
Action
Great care must be taken to avoid falling foul of these new rules and unwittingly contributing too much to a pension plan. The tax consequences of this can be severe and will often not be able to be undone. Therefore advice should be sought in every instance where it is thought that an individual's total income (not just earned income) is getting close to the £130,000 threshold.
4. National Insurance Contributions (NICs)
In the March 2009 Budget the Government announced an increase in NICs of 0.5% for employees and employers and in the surcharge with effect from 6 April 2011. It was announced in the 2009 Pre-Budget Report that these NIC rates are now each scheduled to go up by 1% (instead of 0.5%) to 12% (employee) and 13.8% (employer). Employees will also pay a 2% surcharge on earnings above the upper earnings limit.
For those employees who will be affected by this increased national insurance burden (and are not caught by the new high income excess relief tax charge) salary sacrifice pension arrangements remain attractive. These enable the employee to sacrifice salary (and so save NICs) and, in return, the employer will make a pension contribution of the sacrificed salary plus some or all of the saved NICs.
Action
It is important that the arrangement is established correctly in order to get the desired fiscal consequences. Also it is important to note that the reduction in salary can have other consequences
– for example, the individual's salary is reduced for other purposes including pension benefit entitlement, death in service benefits and calculating the maximum mortgage available. Given the Government's need to produce more revenue, salary sacrifice arrangements may have a limited shelf life so people should make the most of them while they can.
5. Capital Gains Tax
The main planning points to remember in connection with the annual CGT exemption are:
- The annual exemption for individuals is £10,100 for 2009/10 (and £5,050 for most trustees). The annual exemption cannot be carried forward. If an individual has investments with inherent gains he/she should consider making disposals to realise any gains within the annual exemption. To ensure gains are properly realised the disposer must not personally reacquire the same shares within 30 days of disposal.
- The annual exemption is available to each married couple and so, between them, capital gains of up to £20,200 in tax year 2009/10 can be realised without any CGT liability. Transfers between spouses living together are on a "no gain/no loss" basis so, provided any transfer is outright and unconditional, a prior transfer to a spouse could effectively double the potential use of the annual exemption. Since a flat rate of tax of 18% has been introduced the only advantage of such transfers is to use the annual CGT exemption of the transferee spouse.
- In all CGT planning careful thought needs to be given to the possibility of a future increase in the rate of CGT payable.
6. Inheritance tax
Given the changes in the economy, it was no surprise that the inheritance tax nil rate band was frozen at £325,000 in the Pre-Budget Report. The freezing of the nil rate band is clearly bad news for some wealthier clients who have a potential IHT liability on their death but cannot afford to gift capital. For them, insurance-based trust solutions in the shape of discretionary trusts, loan trusts and discounted gift trusts may well be suitable, as well as using insurance policies to provide a lump sum into a trust upon second death.
Action
Please do call us for more information on these type of arrangements and for a discussion as to whether they may be suitable for your clients. There is also the £3,000 per year annual gift exemption for those that wish to make smaller more regular gifts.