This year, year-end planning will be all the more important, given the major changes to capital gains tax that are scheduled to take effect from April 6.
As well as last-minute tax planning for 2007/08, now is also a good time to put in place strategies to minimise tax in 2008/09. Of course, tax planning is an important part of financial planning but it is not the only part. It is essential that any tax planning strategy being considered also makes commercial sense.
INCOME TAX PLANNING
There are identical taxsaving opportunities available for married couples and civil partners. Accordingly, throughout this article, references to spouses and married couples include registered civil partners.
The main tips for saving tax for married couples are set out below. Most of these need a full tax year to operate to give 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 tax year.
Where a higher-rate taxpaying spouse owns investments, income from these may suffer income tax at a rate of up to 40 per cent or 32.5 per cent (if dividends). Therefore, subject to practical considerations, the transfer of investments to a spouse who pays tax at lower rates can save tax. Such transfers must be outright and unconditional.
Where possible, a couple should try to ensure that pension plans are made for each of them. This is especially important where one of them is likely to have an available personal allowance or be subject to a lower rate of tax than the other (see also below).
You should try to make maximum use of all personal allowances available to you and your family – as mentioned immediately above, eve in retirement.
A husband and wife each have their own personal allowance. This is particularly relevant where one spouse is a non-taxpayer or 10 per cent/basic rate taxpayer and the other is a higher-rate taxpayer.
A non-working spouse can receive income of £5,225 for tax year 2007/08 before he or she pays any tax and the next £2,230 is taxed at only 10 per cent. It should be noted that from tax year 2008/09 the 10 per cent rate will only apply to unearned income.
Older married couples benefit from an increased age-related personal allowance. However, this is cut back if the total income of a particular spouse exceeds £20,900 for tax year 2007/08. This limit applies separately to each of a married couple.
In the right circum-stances, careful planning by transferring investment capital to rearrange income between spouses can improve tax efficiency.
If you are engaged in a business, it can sometimes be worth considering the payment of a salary to a lower or non-taxpaying spouse, provided, of course, he or she performs work for the business that fully justifies the payment.
This could be at such a level as to ensure it is free of income tax and National Insurance,that is, currently up to £100 a week (£105 a week for 2008/09), assuming this is the taxpayer’s sole source of income.
As mentioned above, if pension contributions are made, this tax efficiency can continue into retirement.
Individual Savings Accounts (Isas)
The Isa is still the main method of tax-free investing. Up to £7,000 a year (£7,200 from April 6) can be contributed by each of a couple, regardless of the source of the funds. This means that a couple could save up to £14,000 a year. If the £7,000 allowance is not used in one year it will be lost. Currently, up to £3,000 can be invested in cash, £3,600 from April 6.
Enterprise Investment Schemes
The EIS offers tax relief on an investment in new shares of an unquoted trading company which satisfies certain conditions. For tax year 2007/08, an investment of up to £400,000 can be made to secure income tax relief at up to 20 per cent, with relief being restricted to the amount of income tax otherwise payable.
Unlimited capital gains tax deferral relief is also available on an investment into an EIS, provided that some of the EIS investment potentially qualifies for income tax relief.
If you have disposed of any assets and this has resulted in a taxable gain arising which will incur a capital gains tax liability, payment of tax on such a gain can be deferred if you reinvest an amount equal to the untapered gain in an EIS within three years of the disposal.
Venture capital trusts
The VCT offers income tax relief for tax year 2007/08 at up to 30 per cent for an investment of up to £200,000 in new shares with relief being restricted to the amount of tax otherwise payable. There is no CGT deferral, but dividends and capital gains generated on amounts invested within the annual subscription limit are tax-free.
GIFTS FOR CHILDREN
Bare trusts for children
It is possible to make use of children’s and grandchildren’s income tax personal allowances by establishing suitable trusts to hold investments. In particular, provided the donor is happy that the child/grandchild will be absolutely entitled, a bare trust could be considered.
Remember, however, that where a parent creates a trust for a minor unmarried child not in a civil partnership, under which that child is entitled to the income (for example under a bare trust), and the income exceeds £100 gross in a tax year, it will be assessed on the parent, regardless of whether it is distributed or accumulated.
The CGT upside of a bare trust is the ability to offset the child’s annual CGT exemption against capital gains – see later. However, the bare trust strategy works best when the trust is established with cash or “gains-free or low-gain” investments as the transfer to the trust of chargeable assets will be a disposal for market value.
Discretionary trusts for childrenWhile a bare trust has its attractions, a discretionary trust would give more control over the assets gifted and secure an income tax benefit.
Provided that income is not taxed on the settlor, that is, where neither the settlor nor the settlor’s spouse can benefit, income will be taxed on the trustees. This means that the normal trustee rates of 40 per cent or 2.5 per cent will not apply to the first £1,000 of such income each year.
The amount taxed at the reduced rates is reduced if the settlor has created more than one trust.
Care would need to be exercised if income is distributed where the settlor was the minor unmarried beneficiary’s parent and capital gains would be assessed on the trustees.
The pension rules introduced in April 2006 have made pension saving a lot easier for almost everyone.
There are now two key limits when you are making pension savings – the annual allowance, which is an annual limit on how much can be input to all your pensions during the year, set at £225,000 for tax year 2007/08; and the lifetime allowance, which is a limit on the total amount that can be accumulated within all your pensions and is set at £1.6m for the 2007/08 tax year.
In order to be eligible for tax relief, you can pay the higher of £3,600 and your total UK earnings. Contributions are normally paid net of basic rate tax and, if you are a higher rate taxpayer, further tax relief can be obtained through your self assessment tax return. Your employer can also pay contributions.
CAPITAL GAINS TAX PLANNING
The new flat rate
The proposed introduction from April 6 of a flat rate of 18 per cent for CGT and the withdrawal of the indexation allowance and taper relief will have a big effect on year-end CGT planning. Individuals must determine the different tax outcomes of making a disposal before and after April 6 before making any decisions as to whether to sell now or wait.
Matters to take into consideration include:
These considerations will also have to be taken into account by those holding shares or loan notes from an earlier disposal of their business.
Such considerations may also have an impact on the planning points given below.
The annual exemption
The annual exemption for individuals is £9,200 for 2007/08 and £4,600 for most trustees. The annual exemption cannot be carried forward. If you have investments with inherent gains, you should consider making disposals to realise any gains within the annual exemption. You must not personally reacquire the same shares within 30 days of disposal.
The annual exemption is available to both a husband and wife and so, between them, capital gains of up to £18,400 in tax year 2007/08 can be realised without any capital gains tax 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.
With a flat rate of 18 per cent from April 6, the maximum CGT saving on such a transfer will be capped at 18 per cent of the annual exemption.
Capital losses could also be crystallised for tax purposes if gains in excess of the annual exemption have arisen in the same tax year.
If you are contemplating making a disposal in the near future which will trigger a capital gain in excess of £9,200, it may be worthwhile, if legally and practically possible, spreading the disposal across two tax years.
Alternatively, if the disposal cannot be spread or is very substantial, you could delay the disposal until after April 5 to defer the payment of capital gains tax until January 31, 2010 but, of course, you would then be subject to the rules that apply under the new CGT regime and that will need to be considered.
If you have realised a capital gain within the last three years, consider taking advantage of the deferral relief available on investments into an enterprise investment scheme (see above).
Gains under a bare trust (even for a minor unmarried child not in a civil partnership) will be treated as having been made by the beneficiary regardless of who the settlor is. Thus, that beneficiary’s annual exemption will be available on gains made on trust assets.
Consider realising losses on investments to offset against capital gains. Don’t cause net capital gains to fall below £9,200 or part of the annual exemption will be wasted. Carried-forward losses can be offset to the extent they reduce current year capital gains to £9,200.
Maximising the use of exemptions
One of the simplest methods of inheritance tax planning is to make full use of this year’s annual exemption (£3,000) and any unused exemption from the previous year.
It is important to remember that it is necessary to use the current year’s exemption before using any of the previous year’s available exemption. The exemption is available to both a husband and wife.
Unconditional transfers between spouses can facilitate maximising the use of the exemption for a family.
The normal expenditure out of income exemption can also be useful. To use this exemption, gifts must be:
Premium payments to a life insurance policy under trust will often be a simple, economic and acceptable way of providing cash on death that is free of IHT and using the annual and normal expenditure out of income exemptions.
Pre-March 22, 2006 trusts
For trusts in existence on March 21, 2006, the changes made to the IHT trust regime on March 22, 2006 mean that April 5, 2008 is the last day that:
From April 6, UK-resident but non-UK-domiciled or non-UK ordinarily resident individuals, who have been resident in the UK for not less than seven of the last 10 tax years and have unremitted foreign income or gains of more than £1,000 in a tax year, will be taxed on the arising basis unless they pay an annual charge of £30,000 to remain on the remittance basis.
Such individuals currently taxed on the remittance basis should consider realising gains on offshore investments (including gains on non-distributor funds taxed as income) by selling them so as to crystallise the gains before the new rules come into effect on April 6.
Alternatively, if it is desired to retain the assets but crystallise the gain, assets can be transferred to a trust under which the settlor is a beneficiary.
If the settlor is non-domiciled for inheritance tax purposes, then the trust should constitute an excluded property trust and, provided the assets remain non-UK-sited, they will be free of IHT.
It is important to note that the changes affecting non-domiciliaries do not directly change the inheritance tax rules for this category of individual.