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Pet shop ploys

The end of the financial year is looming and this is a good opportunity for advisers to help clients consider what tax planning activities should be undertaken before April 6.

The first type of planning to be considered is income tax planning. Given the level of advertising across almost every type of media, it would be difficult not to be aware of the benefits of Isas. You can invest a maximum of £7,000 each year in this wrapper which keeps the underlying assets free of income tax or capital gains tax liabilities.

As well as using current allowances to place capital into an environment with permanent tax advantages, any review of an individual&#39s affairs should cover the question of whether their investments could be structured in a way which would lower that their future annual income tax bill.

There are two typical situations where using a life insurance bond might help achieve lower ongoing tax bills.

The first example of this is where the individual is over 65. This is because older taxpayers qualify for an additional personal income tax allowance, usually known as “age allowance”.

This gives the claimant additional tax-free income as long as their taxable income does not exceed a particular threshold. For the current tax year, full age allowance is available to an unmarried individual when his or her taxable income is less than £17,000, with the allowance amounting to £1,405 for individuals aged between 65 and 75. The extra allowance rises to £1665 at 75.

Where an individual has income in excess of the £17,000 limit, the additional allowance reduces by £1 for every £2 of this excess.

This means the allowance disappears altogether for a claimant between 65 and 75 when their income reaches £19,810, with older taxpayers losing the allowance altogether where income exc-eeds £20,330.

This effect, where rising income leads to disproportionately high tax liabilities, is known as the age allowance trap.

One tactic to avoid this is to move capital from investments from which income is taxed annually, such as bank deposits, to investments where the point at which tax is charged can be chosen by the investor, such as life insurance bonds.

Not only do such bonds allow taxable gains to be deferred as opposed to arising annually, they have the additional advantage that annual withdrawals of up to 5 per cent of the premiums invested can be taken without the withdrawal affecting the calculation of taxable income or available age allowance.

The second situation where a life bond can be used to achieve lower ongoing tax liabilities is where the investor is a higher-rate taxpayer at present.

The investor may chose to move capital from investments taxed annually at a current rate of 40 per cent to a life bond where higher rate liabilities will be deferred until a taxable event is triggered, perhaps on final encashment. This has the advantage that taxable gains may be deferred until the point where the individual is no longer a higher rate taxpayer, perhaps in retirement.

As well as income tax planning, the individual may want to consider whether anything can be done to mitigate current or future CGT liabilities.

For the tax year 2000/01, they may realise capital gains of up to £7,200 tax-free. Someone with large accrued gains might want to take advantage of this allowance to rebase some assets in his or her investment portfolio, giving lower eventual liabilities.

The CGT regime now disallows rebasing of shares via the mechanism of a sale and repurchase within 30 days (bed and breakfasting).

This is usually dealt with either by waiting for the 30 days to elapse before the repurchase or by investing into a different holding with the same sort of risk profile.

Using up the annual allowance is a common technique in CGT planning and is useful where no gains have already arisen.

The other form of planning that may occur before the end of the tax year is action to shelter a gain that has already arisen and would otherwise give rise to a tax charge.

Investments in venture capital trusts, and in shares qualifying for relief under an enterprise investment scheme can be useful in this context since they allow the original gain to be held over, delaying payment of tax indefinitely.

The final tax which should be considered in the end of the tax year review is inheritance tax. Again, there is an annual allowance to be utilised. The allowance is £3,000 per person and this is the amount that can be gifted and fall outside the scope of inheritance tax.

As well as using up the allowance for the 2000/01 tax year by making a gift before April 6, someone who has not used up the 1999/2000 allowance can carry this forward and take advantage of both years&#39 allowances, allowing a tax-free gift of £6,000.

IHT planning might go beyond using the annual exemption and the individual may decide that wider estate planning activities might be considered.

There are obscure activities which might be considered, such as the purchase of woodlands or significant works of art, but, more commonly, the planning will involve making gifts to other individuals or to certain types of trust.

Assuming that the person making the gift (the donor) has given up the right to benefit from the asset, such gifts will generally be potentially exempt transfers and will pass outside the IHT net as long as the donor survives the gift by seven years.

Pets are a particularly generous feature of the UK tax system and there is often speculation in the run-up to the Budget in March that this advantage might be withdrawn in favour of some lifetime gift tax.

This year, the political situation makes such a radical change an unlikely feature of the Budget but it is still worth contemplating such planning as part of the year-end review.

This is partly because the earlier a gift is made, the more likely it is that the seven-year Pet period will be survived.

In addition, while it may be unlikely that Pets will vanish in this year&#39s Budget, the current generous IHT regime could be a casualty of a second term of Mr Brown as Chancellor.

If such planning is considered and trusts identified as a suitable mechanism for the making of a gift, a life bond may be considered as a good asset to gift. This is because of the tax flexibility associated with bonds as well as the simplicity of administering bonds as trust assets.

As the end of the tax year looms, this is the time to be considering using tax allowances and reliefs, some of which can be lost if not used by April 5.

As well as using the tax-year-specific products such as Isas, the planning activities may give advisers opportunities to promote investment bonds for ongoing planning.


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