Over the last two weeks, I have looked at income-splitting between a couple where the means of producing earned income is capable of being influenced by one or both of the couple.
I would like to turn to tax-planning opportunities that may exist for a couple in relation to capital invested to produce income. Some of these opportunities are so obvious that they may not be raised as regularly as they should be.
Perhaps the most obvious of tax-efficient investment wrappers available to individual investors is the Isa. Each individual can contribute up to £7,000 a year to an Isa. Thus, for those couples with more than £7,000 to invest, an Isa for each is an essential piece of planning.
The combined Isa limit for a couple is obviously £14,000 a year.
Gifts between spouses to facilitate Isa investment are exempt for both inheritance tax and capital gains tax purposes. This is not the case for transfers between an unmarried couple. But, if the asset transferred is cash, there will be no CGT issue and it may well be that this year's and last year's IHT exemptions come to the rescue on the IHT front.
Once the Isa limit has been reached, if there are still funds to invest, then serious thought should be given to maximising the annual CGT exemption and taper relief, especially where the aim is capital growth. Even if we take into account the fact that it is now harder to use the annual exemption on a year-on-year basis through bed and breakfasting, investing for the long term can enable substantial tax-free growth to be realised.
For example, a lump sum of £10,000 invested for 20 years at 6 per cent annual growth after charges would grow to about £32,000. If encashment of the investment were made at the end of the 20-year period, the gain would be about £22,000. Taper relief would be applied at 40 per cent so that the chargeable gain would be reduced by £8,800 to about £13,200. If the annual exemption increased at the rate of 3 per cent a year from the current £7,500, it would be worth about
£13,500 in 20 years, which would mean that the entire gain would be tax-free.
Of course, each of a couple is entitled to the annual exemption so that planning on this basis, in addition to the combined Isa allowance of £14,000, could take place to the extent of £20,000 each year
based on this example and a wholly or substantially tax-free gain could be realised through the impressive but simple combination of taper relief and the annual exemption.
It is important to remember that, if this type of planning takes place regularly each year, the identification rules for capital gain tax would need to be taken into account. Broadly speaking, where shares (including units) of the same class are held by an investor and part of the holding is realised, the last in, first out rules are applied.
Of course, these rules would not apply if the investor invested in shares or units of a different class so that each year's investments were identified separately. Regardless of the identification issues, the tax attraction of long-term investment to maximise the benefits of taper relief and the annual exemption for each of acouple are well worth considering so as to extend the amount of the tax-free gain potential once the Isa limit is reached.
Interestingly, if a couple invested £14,000 a year into Isa funds which grew at the rate of 6 per cent a year after charges, a fund of just under £450,000 would be available in 20 years. If, in addition, each of the couple invested £10,000 a year into growth-orientated
collectives which also grew at the rate of 6 per cent a year after all charges, then the emerging non-Isa fund at the end of 20 years would be worth around £640,000.
For £34,000 a year, a fund that had the capability of producing substantial tax-free additions to income and which gave the investor complete access to capital at any time could be built up. Some couples may be attracted by this proposition once they have put in place pension provision to ensure that a reasonable level of spendable income is secured in retirement.
Before leaving the subject of simple but effective tax planning between couples, it is worth remembering that bank accounts should be owned so that interest falls into the lowest tax environment. Where the recipient is a non-taxpayer, then it is possible to certify for gross payment of interest by completion of form R85.
Unfortunately, this opportunity is not available when it comes to the receipt of dividends. Even if a higher-rate taxpaying recipient of dividends transfers the shares or other investments giving rise to the dividends to a non-taxpayer, it is not possible for the non-taxpayer to reclaim any of the tax credit. Of course, if the recipient is other than a higher-rate taxpayer, no further tax liability will arise on the dividends received and this itself will generate a saving for the couple because the dividend, if received by a higher-rate taxpaying individual, would have borne tax at 32.5 per cent on the grossed-up dividend with a 10 per cent tax credit available.
Finally, and back to capital gains tax, it is worth remembering that even if a chargeable gain arises on an investment held by a basic-rate taxpayer (because a gain is still left after applying taper relief and the annual exemption) the CGT rate for basic-rate taxpayers is 20 per cent and not the full basic rate of 22 per cent.