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Cause and effective

Applying a form of wrapper allocation when determining wrapper choice may help to deal with future tax risk

Last week, I looked again at the contention of Warren Buffett that very-high-net-worth individuals pay too low an effective rate of tax.

Even a superficial appreciation of the way UK taxation works will deliver an appraisal that through the use of allowances, reliefs and the management (to the extent that such management is possible) of where the flow of your income and gains comes from, the legitimate achievement of a low overall effective rate of tax is entirely possible. It should also remind us that the consequence of a lack of advice and consequent action is likely to be a higher than necessary effective tax rate.

The point that the super-rich should pay more tax is borne out of the feeling that they are better equipped economically to shoulder the burden of the higher tax necessary to enable government debt to be repaid.

But, as I said in the first of these articles, any higher “headline” rate of tax that may be applied to high income needs to be effective. This explains why, to complement higher rates of tax, there is continuing strong attention paid to the prevention of what HM Revenue and Customs sees as unacceptable avoidance.

The labyrinthine provisions, explanatory notes and the draft provisions for the Inspectors’ Manual (over 200 pages of them) on disguised remuneration are evidence of this intent.

So how about we look at the taxation of land? Apparently, the richest 10 per cent in the UK own 44 per cent of the country’s £9,000bn of assets – much of which is property.

It is the view of Vince Cable (and other LibDems) that some of this vast amount of value could be put to better use, namely, helping to “repay” government debt.

The basic premise is that it is better to tax expensive homes and land, an unproductive asset that benefits few, than the incomes of high-earners who create wealth, ideas and businesses that benefit everyone.

There are a number of ways in which expensive homes and land could be taxed. One proposal that is apparently being floated by the Liberal Democrats is to apply capital gains tax to gains made on the sale of principal private residences worth more that £1m. A more radical alternative would be to apply an annual wealth tax on the owners of homes worth more than, say, £2m.

At a “high level” the idea seems relatively unobjectionable. However, it could not be without its complications. What new tax is? You would need to consider which gains from which date are brought into account. Would there be a need for a start date and a valuation at that point or would there be some form of time apportionment to exclude “past gains”? To what extent would expenditure on improvements be allowed – although there is an existing body of law on this point in relation to property that is not the taxpayer’s main residence.

The latest variation on the tax real property idea is a land tax at around 0.5 per cent of the capital value of the land subject to certain exemptions for lower values and lowerincome owners. There is no official detail though, only rumour. This has to be carefully borne in mind.

For any land or property-based tax, there would also be the worry of the stealth tax effect. A £1m property may seem out of the reach of many currently but if that threshold value is not increased, then, over time, more properties will, by stealth, be brought into the net. I could go on. Whatever we think about the merits or otherwise of applying higher tax rates to the very-high-net-worth/ super-rich, Mr Buffett’s statement in relation to his low effective rate of tax should serve as a reminder to us all that, with a little application, lower effective rates of tax on income (investment and earned) and capital gains would also be available to most of us.

Last week, I looked at how the simplest investment management in relation to wrapper choice for an investment portfolio could substantially reduce the effective rate of tax – with a focus on capital gains.

Well, the same is true for income. All other things being equal, if the portfolio produces high yield and the investor is a higher or additional-rate taxpayer, then, over time, and all other things being equal, that income would better accumulate inside an insurance product than a collective. I am assuming that all Isa/pension capacity had been used.

For a relatively small investment and for a short term, the difference would not be great but for longer periods and bigger investments it could.

With this in mind, it does not take long to appreciate how important that wrapper selection can be in the process of determining suitability. And with the importance attached to strong, consistent yields as a key factor in justifying investment in equities, this should not be underestimated.

With a little more thought, you can consider wrapper choice for particular parts of the portfolio (rather than as a whole) to optimise tax minimisation.

Unfortunately, (although I do accept the difficulties), we do not have any kind of rollover or deferment provisions allowing tax neutral movement of funds between wrappers where no investor withdrawal is made.

Given this, applying a form of wrapper allocation when determining wrapper choice at outset might go some way to anticipating and dealing with future tax risk.
The greater the potential saving and resulting bottom line improvement from wrapper choice the greater the value of informed advice. And let’s not forget, it seems that tax planning and tax reduction is something that investors value and are more likely to be willing to pay for.


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