The past few weeks have seen much activity on the pension front with more detail on Nest, proposals for radical change to the state pension and even calls in some quarters to end higher-rate tax relief on pensions.
Many were expecting further tax-related activity in the spending review but this was not forthcoming – not that we are not having to endure some serious tax changes introduced in 2010/11.
There has been a focus on income tax and, in particular, the new additional rate of tax and withdrawal of the personal allowance for those with taxable income exceeding £100,000.
But we have also had a pretty serious change to capital gains tax in the shape of the introduction of the two-rate system from June 23 (ignoring the 10 per cent rate when entrepreneurs’ relief applies). This should cause financial planners to reconsider staple tax planning strategies in relation to CGT. Investing time in this knowledge, even at a relatively high level, should prove worthwhile.
The five obvious things to consider in the light of the two rates are:
- maximising use of the annual exemption for individuals, couples and families;
- spreading gains to maximise the benefit of the 18 per cent tax rate, both across tax years and taxpayers (especially married couples);
- minimising income or extending the basicrate band for higherrate taxpayers;
- using losses against higher rate (28 per cent) gains where possible; and
- deferring gains through the use of the various reliefs.
Maximising the use of the annual exemption and lower (18 per cent) CGT rate
Subject to investment and commercial considerations, the annual exemption should be used each year, especially by higher rate taxpayers. The annual exemption can represent a useful means of avoiding tax on simple portfolio rebalancing exercises.
Spousal transfers will also be well worth consideration from a tax planning perspective. For the last couple of years, pre-sale transfers have not had much benefit (a maximum saving of £1,818 (£10,100 at 18 per cent for 2009/10) but for 2010/11 there could now be a maximum benefit of £6,568 (£10,100 at 28 per cent plus £37,400 at 10 per cent).
HM Revenue & Customs will only look to dispute a pre-sale transfer of an asset where it is clear the recipient spouse never had a beneficial interest in the asset and that the transfer instead amounts to a gift of the sale proceeds. There is guidance on this point in HMRC’s published Capital Gains Manual at CG18171 that demonstrates the limited circumstances in which HMRC can look to make a challenge. However, care is required on a transfer of shares where the transferor qualifies for entrepreneurs’ relief.
CGT planning – through income
As the CGT rate is now determined by reference to the taxpayer’s income, some care needs to be taken with income tax planning.
Where possible, advisers should look to minimise an individual’s income in any given year in which capital gains have arisen that fall within the higher-rate tax band.
This could involve changing a business year-end, maximising capital expenditure in the year, choosing an interest payment date for the proceeds on deposit such that it falls into the subsequent tax year or deferring dividend receipts.
Alternatively, the basic-rate tax band could be extended (potentially mitigating tax paid at the higher rate) through pension contributions and/or gift aid payments.
Pension planning could be an attractive option for some individuals to mitigate the higher rate of CGT as the contribution would extend the basic-rate tax band. Gift aid has the same effect and is, in fact, more flexible as it does not have the same restriction as to relevant UK earnings and the payment can be carried back to the previous tax year.
Trusts and the higher CGT rate
All trusts (other than bare trusts) will bear CGT on gains earned in excess of the available (lower) annual exemption (usually £5,050 maximum) at the higher rate of 28 per cent – regardless of the level of their income.
For trust assets with high unrealised gains, a prior transfer by trustees (pre-realisation) to a beneficiary, who is a basic-rate taxpayer, accompanied by a hold-over claim may be worth considering.
The gain (or at least part of it), when realised by the beneficiary, may then be subject to a lower rate of tax. Of course, this strategy needs to be aligned with the non-tax aspects of trust asset management.
Even the most basic steps in CGT planning can sometimes get forgotten. Financial planners advising their clients in regard to any non-Isa, non-insurance and non-pensions investments can substantially (or even partially) increase the net of tax returns by just making sure that the basics are dealt with.
Advisers might like to consider incorporating these checks into an overall personal financial audit, the offer of which can, at the very least, demonstrate that the adviser is thinking of the client and putting them first through a planned and structured process aimed at minimising outflow and, as a result, maximising returns.