The approach of the end of the tax year provides opportunities for taxpayers to maximise the use of personal allowances, reliefs and exemptions for the current year.
Now is also a good time to lay plans for tax reduction over the coming tax year, at least to the extent that the tax rules are not expected to change.
This is particularly relevant this year, following the announcement by the Inland Revenue that, from April 2003, more people will be taxed than ever before and there will be more than three million higher-tate taxpayers. Do not forget that those higher-rate taxpayers will be paying an effective rate of 41 per cent as the additional 1 per cent National Insurance charge will then apply on all earnings over £89 a week.
As ever, lots of tax planning opportunities exist and, with the prospect of stealth taxation being used again to raise funds in the Government's spring Budget to shore up depleting Treasury coffers, individual taxpayers should do as much as possible to harness these opportunities. But most taxpayers will need advice to make the most of them.
It is also worth remembering that, in a time when many clients will be investing cautiously, for example, in guaranteed funds or cash, one of the most important and effective ways of securing improved returns is through effective tax planning. After all, £1 extra is £1 extra, whether it comes from investment performance or tax saving.
In this Special Report, we will cover the main income tax, capital gains tax and inheritance tax planning opportunities open to UK-resident individuals for 2002/03.
Some of these opportunities involve investments, insurance and pension products and, where relevant, these are highlighted. All of them will be better exploited with advice than without it.
Personal Pensions/ Retirement Annuities
Contributing to an approved pension plan is one of the few remaining ways that an investment can be made that qualifies for higher-rate income tax relief.
A self-employed person or someone who is employed but not a member of an occupational scheme should maximise contributions to a personal pension/stakeholder scheme or retirement annuity policy.
Being a member of an occupational scheme for death benefits only will not stop a contribution being made to a personal pension/stakeholder scheme or Rap.
Carry back of retirement annuity contributions
Contributions to Raps must be paid no later than April 5, 2003 if they are to be eligible to be carried back and relieved against earnings subject to tax in 2001/02. An election can be made as late as January 31, 2004 but it is sensible to make the election when the contribution is paid if it is not to be made in the 2002/03 tax return.
Rap contributions continue to be paid gross, with the member claiming appropriate relief.
If a person with a Rap had no net relevant earnings in 2001/02 and did not pay the maximum allowable contribution in 2000/01, a contribution paid on or before April 5, 2003 can exceptionally be carried back to 2000/01. Tax relief will be at the appropriate rate(s) of tax paid in that tax year.
Carry forward of unused relief
Carry forward of unused personal pension relief was abolished from April 6, 2001. A basis year now exists and planning can be implemented using this.
Carry-forward relief remains available for Raps. If a person had net relevant earnings in all or any of the past six tax years and did not pay the maximum contributions permissible, they can carry forward this unused relief. This means a contribution can be paid now that could have been paid in any of the last six tax years.
Relief is given in the tax year the contribution is paid or treated as paid if carried back, not the tax year in which it could have been paid. It is necessary to have paid the maximum contribution for the tax year in which the contribution is paid or treated as being paid before unused relief can be utilised.
Combining carryback relief with carry-forward relief will allow unused relief to be picked up in the six tax years prior to the tax year to which the contribution is carried back, which will be 2001/02 in most cases. By so doing, unused relief can be picked up in respect of 1995/96 (and exceptionally 1994/95), earliest years first, which would otherwise be lost.
Using the new tax rules
Tax rules introduced from April 6, 2001 opened up a number of opportunities.
Where an individual is resident and ordinarily resident in the UK and under 75, it is no longer necessary to have net relevant earnings to contribute to a personal pension/stakeholder scheme. A contribution of up to £3,600 gross may be paid each tax year.
Where the individual is a member of their employer's occupational scheme and not otherwise eligible for a personal pension/stakeholder scheme, they can contribute up to £3,600 in 2002/03 only if:
Their P60 earnings amounted to £30,000 or less for 2000/01 or 2002/02 and
They were not a controlling director in 2000/01, 2001/02 and 2002/03.
Shareholding directors of a private limited company will have serious interest in extracting profits by use of dividend payments. Some interesting possibilities exist here.
While a dividend offers avoidance of NI contributions (and possible cashflow advantages) and can be an attractive way of extracting funds for shareholding directors of private companies liable to corporation tax on profits at less than the main rate, it can have drawbacks. Perhaps the most important is that the dividend will not be pensionable.
But, by using a personal pension/stakeholder scheme, it is possible to base a contribution on one tax year's evidenced earnings for up to the next five tax years. This applies irrespective of whether the director has earnings in those later five tax years. For example, a director may choose to take a high level of salary in 2002/03. Then, in 2003/04 to 2007/08, they may take remuneration largely in the form of dividends, with only a modest salary of around the level of the threshold for paying tax (£4,615 in 2002/03).
By so doing, the salary drawn in 2002/03 can be used as the basis for contributions to the personal pension/stakeholder scheme not only in 2002/03 but also in 2003/04 to 2007/08. Thus, in 2003/04 to 2007/08, the director can benefit from taking dividends without adversely affecting his ability to pay pension contributions.
If this approach is being considered, it may be attractive to pay the high Schedule E remuneration this tax year, as this will avoid the 1 per cent increases to employer and employee NI contributions from April 6, 2003.
This pattern could be repeated every six years to ensure the director retains substantial net relevant earnings in each tax year on which his personal pension/stakeholder scheme contributions can be based. Of course, if the proposed changes to the pension tax rules are implemented, this facility will no longer be available.
A member of an occupational pension scheme could, provided benefits are not overfunded, make any additional voluntary contributions before April 6, 2003 in order to obtain relief against income tax for 2002/03.
AVCs receive income tax relief by being deducted from pre-tax earnings.
Although AVC arrangements which started on or after April 8, 1987 do not permit direct commutation of pension for cash, for payments in relation to schemes established after March 13, 1989, or scheme members who joined such schemes on or after June 1, 1989, the additional pension secured by the AVCs can be taken into account for the purpose of calculating the tax-free cash that can be taken from the employer's occupational pension scheme.
Moreover, if the Government's proposals for a new simplified tax regime are implemented, it now appears that any “noncommutable” in-house AVC funds can form part of the proposed 25 per cent of fund tax-free cash limit.
The Isa is the main method of investing savings free of income tax and capital gains tax. The main features are:
An annual limit of £7,000, of which no more than £3,000 can go into cash and £1,000 into life insurance. The balance can be invested in stocks and shares, unit trusts, investment trusts, corporate bonds and certain other investments. These limits apply until April 5, 2006.
In 2006/07, the annual limit reduces to £5,000, of which no more than £1,000 can go into cash and £1,000 into life insurance.
The 10 per cent tax credit on UK dividends can be reclaimed until April 5, 2004.
Capital from a Tessa can, within the six-month period after maturity, be transferred into the cash component of an Isa or a separate Tessa-only cash Isa.
Any subscription to a Tessa or maturing Tessa capital does not count against the annual Isa limit. For maturing Tessas, an Isa can be a useful way of securing ongoing tax-free savings.
Venture capital trusts can provide immediate 20 per cent income tax relief for 2002/03 for investments of up to £100,000 in new shares, coupled with CGT deferral relief (restricted to the lesser of the amount invested and £100,000) if some income tax relief is obtained. But deferral relief is only available if an investment is made within 12 months of the date of the disposal.
Especially now that there should be a greater emphasis on tax minimisation to increase net returns, investment bonds remain worth considering, particularly as a tax shelter for higher-rate taxpayers. As well as income received by the fund being reinvested with no personal tax liability arising (and no life company tax in the case of dividends), gains on policies issued by a UK insurer (without having to be grossed up) are subject to income tax only at the difference between the higher and basic rate, currently 18 per cent. So the effective rate of income tax borne on income and gains generated for a higher-rate taxpayer could be as low as 34.4 per cent, depending on the effective rate of tax borne by the life fund, rather than an investor's normal 40 per cent.
Investment bonds offer another opportunity for higher-rate taxpayers of supplementing income with tax-deferred withdrawals under the well-known 5 per cent rule. This gives investment bonds a boost in terms of being highly tax-efficient vehicles that can provide tax-sheltered growth with regular tax-deferred access for the investor.
The Sandler report made important recommendations on life insurance policy taxation. These were that all new life insurance savings policies should be taxed in the same way and, in particular, that:
The qualifying life policy rules should be abolished for new policies.
The 5 per cent rule for life policies should be abolished for new business.
There is no guarantee these changes will be implemented and it is important to note that Sandler recommends that they only apply to new policies. Investors could continue to invest in investment bonds in the knowledge that the 5 per cent rule is still likely to apply to them, at least in respect of investments made before any new legislation.
The following are the main tips for exploiting the independent taxation of husband and wife. Most of these need a full tax year to operate to give maximum effect, so these suggestions may serve as a reminder for planning for the coming tax year.
A husband and wife each have their own personal allowance. This is particularly relevant where one spouse is a non-taxpayer, 10 per cent or basic-rate taxpayer and the other is a higher-rate taxpayer. A non-working spouse can receive income of £4,615 for 2002/03 before he or she pays any tax and the next £1,920 is taxed at only 10 per cent.
Where a working spouse owns investments, income from these may suffer income tax at a rate of up to 40 per cent or 32.5 per cent for dividends. Therefore, subject to practical considerations, the transfer of assets to a non-working spouse can save tax and increase overall investment returns. Such transfers must, of course, be outright and unconditional.
The married couple's allowance is available where one of a married couple was aged 65 or over on April 5, 2000. For 2002/03, up to £1,055 of the allowance, which is due to the husband, can be transferred to the wife at her request, or £2,110 of the allowance can be transferred to the wife if husband and wife jointly so elect.
An election must be made before April 6, 2003 if it is to be effective for 2003/04. Relief is given at a flat rate of 10 per cent. This means that if each of a couple are taxpayers, reallocation of the allowance is not going to produce a tax advantage. However, an election will produce a cashflow advantage if a husband is taxed under Schedule D and his wife under PAYE.
If a husband simply has insufficient income to use his allowance, any unused allowance can always be transferred to his wife.
Older married couples benefit from an increased age-related personal allowance. But this is cut back if total income exceeds £17,900 for 2002/03. This limit applies separately to each of a married couple. In the right circumstances, careful planning by transferring investment capital to rearrange income between spouses can improve tax-efficiency. Alternatively, by using suitable investment products, the replacement of taxable income by non-taxable income or non-taxable withdrawals of capital can improve the tax position considerably.
For those engaged in a business, it can be worth considering paying a salary or bonus to a loweror non-taxpaying spouse, provided, of course, he or she performs work for the business that justifies the payment. This could be at such a level as to ensure it is free of income tax and NI, that is, up to £89 a week currently, assuming this is the taxpayer's sole source of income. If a pension payment is made in respect of this salary or bonus, more tax savings are secured now and potentially into retirement.
Full income tax relief on an investment in property in an enterprise zone is available without limit. A pooled investment opportunity is available in the form of enterprise zone trusts. Other advantages are:
An income yield is available in the form of rental income.
Loans can be arranged to facilitate investment. The interest paid can be offset against rental income from the property for tax purposes.
It is important to remember that the investment must be maintained for at least seven or 25 years (depending on the precise nature of the scheme) for full income tax relief to be retained.
The enterprise investment scheme offers tax relief on an investment in new shares of an unquoted trading company which satisfies certain conditions. For 2002/03, an investment of up to £150,000 can be made to secure income tax relief at up to 20 per cent. Certain Alternative Investment Market companies would qualify as EIS companies.
CGT deferral relief is also available. The amount is unlimited provided some of the EIS investment potentially qualifies for income tax relief. If assets have been disposed of, resulting in a taxable gain, payment of tax on such a gain can be deferred if an investment is made in an EIS within three years of the disposal. For a higher-rate taxpayer, this relief, coupled with income tax relief, gives total initial relief of up to 60 per cent.
Capital gains tax
The annual capital gains tax exemption for individuals is £7,700 for 2002/03 and £3,850 for most trustees. The annual exemption cannot be carried forward. It is available to both a husband and wife and so capital gains of up to £15,400 in this tax year can be realised between them without any CGT liability.
A bare trust, regardless of who created it, can facilitate the use of a child's or grandchild's annual CGT exemption. Under any other type of trust, typically, only one-half of the annual exemption would be available to the trustees.
Transfers between spouses are on a no gain/no loss basis so, as long as any transfer is outright and unconditional, a prior transfer to a spouse could effectively double the potential use of the annual exemption.
Capital losses can also be crystallised for tax purposes if gains in excess of the annual exemption have arisen in the same tax year. Remember, losses cannot be used if generated solely by virtue of the indexation allowance, which is frozen at April 1998.
If a disposal in the near future is contemplated which will cause capital gains in excess of £7,700 to arise in this tax year, if legally and practically possible, it may be worth spreading the disposal across two tax years in April. Alternatively, if the disposal cannot be spread or is very substantial, the disposal could be delayed until after April 5, 2003. At least then the payment of CGT will be delayed until January 31, 2005.
Annual exemption Using collectives
For actively managed portfolios, under the current system of identification, it is necessary to carefully track the acquisition history of each parcel of shares. Provided acceptable flexibility and portfolio management can be secured, it will simplify matters if a form of pooled investment is chosen within which share management takes place without triggering chargeable disposals and acquisitions. It may also enable greater taper relief to be secured, perhaps in combination with the use of the annual exemption. Such an investment could be a unit trust, Oeic or investment trust which provides freedom from CGT for the fund manager who realises gains in managing the underlying portfolio.
The following inheritance tax planning points could be considered:
A simple method is to make full use of the annual exemption (£3,000) and any unused exemption from the previous tax year. 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.
Use should be made of the normal expenditure out of income exemption, which cannot be carried forward. To use this exemption, gifts must be regular, made out of income and of such a size as to not affect a person's normal standard of living.
Premium payments to a life insurance policy under trust are an ideal way of :
– Providing cash on death that is free of IHT.
– Using the annual and normal expenditure out of income exemptions.
By using a flexible trust, the benefits secured under policies implemented can be adapted to changing family circumstances.
If control and flexibility over assets to be given is required, a gift to a trust can be useful.
Where it is not possible to make an outright gift, the use of an insurance-based trust arrangement may provide IHT planning combined with future access to regular capital payments, which can be used to supplement income.
All the information given above and views expressed are given strictly for general consideration only. Accordingly, no action must be taken or refrained from based on the content of this Special Report alone. Each case must be considered separately and advice given on the basis of the facts of that case. Neither Money Marketing nor Technical Connection can accept any responsibility for any loss occasioned as a result of any such action taken or refrained from.