OK, the changes do not take effect until April 6, 2010 but that means that there is a reasonable amount of time to carefully consider what action may be taken and to put plans in place to take effect from the beginning of the next tax year. As for most tax planning, strategies evolved other than hastily will stand a greater chance of being fully effective.
Couples have a number of opportunities to maximise the use of allowances and exemptions, as well as the lower rates of tax, and these independent taxation strategies will now be even more worthwhile reviewing – if only because 50 per cent and 60 per cent are both higher than 40 per cent.
I should explain (although most are likely to know this already) that the stepped reduction in the standard personal allowance (and the resulting effective 60 per cent tax rate) for those with income over £100,000 is achieved by reducing the standard personal allowance by £1 for every £2 over the £100,000 limit.
If the standard personal allowance were to remain at its present level of £6,475, then it would be lost completely when income reaches £112,950.
This means that income of £12,950 above £100,000 that would otherwise have been charged to tax at 40 per cent effectively suffers tax at 60 per cent. This is because each £2 above £100,000 generated a tax liability of 80p and causes another £1 to lose the shelter of the personal allowance resulting in another 40p being payable. A total liability then of £1.20 caused by £2 of taxable income.
Given these upcoming tax changes, what can be considered to reduce the soon to be increased tax burden? Let us look first at planning with investments. There are a number of possibilities for couples to minimise their overall tax liabilities. Here are four of them:
1: Invest where the income (and gains) is tax-free
The most obvious investment here is the Isa. From April 6, 2010, each of a couple will be entitled to invest a maximum of £10,200 per annum. For older couples (over 50 in 2009/10), this higher amount can be invested from October 6, 2009.
2: Invest in assets that produce capital gains rather than income
The rate of capital gains tax is now only 18 per cent and each individual (regardless of age) is entitled to an annual exemption of, currently, £10,100, meaning net gains of £10,100 can be generated in a tax year free of tax.
Suitable investments for this purpose would be growth-oriented collectives. However, despite the tax attraction, one would need to carefully consider the investment appropriateness of such a strategy. Portfolios heavily focusing on growth rather than income usually carry a higher investment risk.
Structures purporting to convert “natural income” to emerging gains taxed as capital gains need to be considered with care. HM Revenue & Customs is likely to take an even greater interest in such structures.
3: Invest in assets that defer the tax charge or additional tax charges
UK investment bonds suffer an internal rate of tax of 20 per cent or less (depending on the make up of the fund). On encashment, a 50 per cent taxpayer would currently have an additional 30 per cent tax to pay and a full 50 per cent if the gain is realised from an offshore bond.
However, it may be that encashment can be deferred until the investor is retired, possibly paying tax at a lower rate.
Alternatively, the bond could be transferred to a spouse or grown-up child who does not pay tax at 40 per cent or 50 per cent. The transfer would count as a potentially exempt transfer for IHT purposes but would not give rise to an income tax charge as no chargeable event occurs. This is so regardless of whether the transferor is married to the transferee. On subsequent encashment, any gain would be assessed to income tax on the transferee.
4: Transfer income-producing assets from the spouse in the higher tax bracket to the spouse in the lower tax bracket
Such assets can include bank deposits, stocks and shares, collectives, investment bonds and rental property.
For new investments, subject to non-tax considerations, thought could be given to joint ownership. There would be no adverse CGT consequences as a transfer between spouses living together would be on a no gain/no loss basis.
We have looked at some planning strategies that couples could employ to maximise the use of exemptions and minimise taxable income. It is felt that interest in these strategies could increase with the approach of 50 per cent and 60 per cent rates of tax. We have looked at investment in an Isa (obviously), focusing on capital growth as opposed to income, tax deferment strategies (on the basis that tax deferred represents tax saved) and, of course, asset transfer strategies.