The run-up to the tax year end is a good time to consider tax planning to maximise the use of an individual’s allowances, reliefs and exemptions for the current tax year, some of which will be lost if not used before the tax year end.
As well as last minute tax planning for 2012/13, now is also a good time to put in place strategies to minimise tax throughout 2013/14.
In this article all references to married couples include registered civil partners.
1. INCOME TAX
There are four main income tax factors that are relevant for 2012/13:
- The basic personal allowance of £8,105. (This is due to substantially increase to £9,440 in 2013/14).
- The threshold for the start of higher rate tax is £34,370 (which reduces to £32,010 in 2013/14 but this is counterbalanced by the increase in the personal allowance).
- A 50 per cent tax rate applies to taxable income that exceeds £150,000 (reducing to 45 per cent in 2013/14).
- People with income of more than £100,000 lose some or all of their basic personal allowance. The reduction is £1 for every £2 of income above £100,000.
People with income falling within (iii) or (iv) above pay marginal rates of income tax of up to 60 per cent on some of that income.
Increases in the amount of tax payable can be combated in a number of ways including:
- Maximising use of a couple’s allowances, reliefs and exemptions.
- Using tax-efficient investments.
We will now look at these in more detail.
1.1 MAXIMISING THE USE OF ALL OF A MARRIED COUPLE’S ALLOWANCES, RELIEFS AND EXEMPTIONS
Planning to maximise the use of a married couple’s allowances, reliefs and exemptions is very important for those whose top rate of income tax is 50 per cent (reducing to 45 per cent from 6 April 2013). For such people who are married, the tax savings available by diverting income into the lower income earner’s name will be substantial.
The tax savings that can arise from such planning can be just as important for the higher rate (40 per cent) taxpayer who is married to a lower rate or non-taxpaying spouse. Diversion of any income must be on an outright basis, with “no strings attached”.
Similar planning may be appropriate for couples where one has income between £100,000 and £116,210. Where an individual’s adjusted net income is above the income limit of £100,000, the basic personal allowance will be reduced by £1 for every £2 above the income limit.
Based on the basic personal allowance of £8,105 for 2012/13, an adjusted net income of £116,210 or above would mean that no personal allowance is available and non-dividend income in that £16,210 band is effectively being taxed at 60 per cent.
Most of these strategies need a full tax year to deliver maximum effect so these suggestions may serve more as a reminder to plan ahead for the coming tax year than as a “last minute” means of saving tax this year.
The appropriate type of tax planning to adopt will depend on the type of income a person enjoys ie. earned/business income or investment income.
(i) Earned/business income
Individuals who have earned/business income falling into the £100,000 – £116,210 band could consider reducing this by paying a pension contribution or arranging for a salary sacrifice.
With the marginal rate of tax in the £100,000-£116,210 band of earned/business income being 60 per cent it may thus be possible to obtain 60 per cent tax relief on some pension contributions.
(ii) Investment income
Where an individual has investment income that causes their adjusted net income to fall into the £100,000-£116,210 band then, depending on their circumstances, any of the following may be appropriate strategies:
Redistribution of investment capital to a spouse with a lower income so that the income generated is taxed on them instead.
Reallocation of dividend income for couples who run their business through a company.
Reinvestment in tax-free investments, such as an ISA, so that taxable income is replaced with tax-free income.
Reinvestment in tax-efficient investments that generate no income and so will not impact on the loss of the personal allowance. Such investments would include:
(i) Unit trusts/Oeics geared to producing capital growth.
(ii) Single premium investment bonds from which a 5 per cent tax-deferred withdrawal may be taken each year, for 20 years, without affecting the personal allowance calculation.
Where possible, a couple should try to ensure that they both have pension plans that will provide an income stream in retirement which will enable them to both use their personal allowances.
Clients should make maximum use of all personal allowances available to them and their family. A husband and wife each have their own personal allowance.
This is particularly relevant where one spouse pays tax at a lower rate than the other. A non-working spouse with no investment income will be able to receive income of £8,105 for tax year 2012/13 (£9,440 for 2013/14) before they pay any tax.
Older married couples benefit from an increased age-related personal allowance.
It may be advisable to transfer income-producing assets between couples where one would otherwise exceed the current age allowance income limit of £25,400 (£26,100 for 2013/14).
1.2 USING TAX-EFFICIENT INVESTMENTS
For 2012/13 the annual contribution limit is £11,280 of which no more than £5,640 can go into cash. This means a couple could between them invest £22,560.
For 2013/14 the annual contribution limit rises to £11,520. A child aged 16 or over can invest £5,640 into a cash Isa in 2012/13 and £5,760 in 2013/14.
No tax relief applies on an investment into an Isa but income and capital gains are free of tax. As the dividend tax credit is not recoverable, for the basic rate taxpayer an ISA invested in equities gives no income tax advantage.
However, for a 40 per cent taxpayer, tax freedom means the net dividend income yield improves by 33.3 per cent and for a 50 per cent taxpayer by 56.5 per cent. Investors who are 50 per cent taxpayers are more likely to be utilising their annual CGT exemption on a regular basis and so, for them, investment in an Isa is almost essential.
(b) Junior Isas (JISAs)
Broadly speaking, JISAs are available to any UK resident and ordinarily resident child, under age 18, who does not have a child trust fund. Any individual may contribute, the maximum contribution is £3,600 this year (£3,720 in 2013/14) and the tax benefits are the same as for Isas.
Children with a CTF do not qualify for a JISA but, given its tax free status, consideration should still be given to paying further contributions to that CTF. The maximum contribution is also £3,600 this year.
(c) Growth-oriented unit trusts/Oeics
Given the relatively high rates of income tax as compared to the current rates of CGT, it can make sense from a tax perspective to invest for capital growth as opposed to income.
Although income on collectives is taxable – even if accumulated – if this can be limited so can any tax charge on the investment.
Instead, with emphasis on investing for capital growth, not only will there be no tax on gains accrued or realised by the fund managers, it should also be possible to make use of the investor’s annual CGT exemption on later encashment (or both annual CGT exemptions for couples).
(d) Single premium investment bonds
Continuing pressure on the Government to maintain high tax rates means that deferment represents an important tax planning strategy and single premium investment bonds can deliver this valuable tax deferment for a higher/additional rate taxpayer.
This is because no taxable income arises for the investor during the “accumulation period”. In particular, it should be borne in mind that any UK dividend income accumulates without corporation tax within a UK life fund.
Realised capital gains (after indexation allowance) suffer corporation tax at 20 per cent. An investor in a UK bond will receive a basic rate tax credit for deemed taxation in the fund meaning that, on eventual encashment, a tax charge will only arise if the investor (after top-slicing relief) is then a higher rate or additional rate taxpayer.
More tax efficiency at fund level can be achieved via an offshore bond because there is no internal tax charge on investment growth. However, there is no tax credit for a UK resident investor.
(e) Maximum investment plans (MIPs)/ Qualifying savings plans (QSPs)
Although the underlying fund of the MIP/QSP is taxed, the proceeds at maturity (usually after 10 years) are generally completely tax free for the investor, irrespective of amount.
However, the funds are not easily accessible before the expiry of 10 years.
The scope to pay substantial premiums to MIPs/QSPs has been dented by Government proposals to introduce, with effect from 6 April 2013, a limit of £3,600 per annum on payments to qualifying policies that commenced on or after 21 March 2012.
(f) Enterprise Investment Scheme (EIS)
For tax year 2012/13 an investment of up to £1m can be made to secure income tax relief at 30 per cent, with relief being restricted to the amount of tax otherwise payable.
Unlimited CGT deferral relief is available provided some of the EIS investment potentially qualifies for income tax relief.
(g) Venture Capital Trust (VCT)
The VCT offers income tax relief for tax year 2012/13 at 30 per cent for an investment of up to £200,000 in new shares, with relief restricted to the amount of tax otherwise payable. There is no ability to defer CGT but dividends and capital gains generated on amounts invested within the annual subscription limit are tax free.
2 CAPITAL GAINS TAX
Four very effective forms of CGT planning are set out below.
Using the annual CGT exemption
For individuals, the annual exemption is £10,600 for 2012/13. For higher and additional rate taxpayers use of the annual exemption can save up to £2,968 in tax. For a basic rate taxpayer the tax saving is worth up to £1,908.
As far as possible it is important to use the annual exemption each tax year because, if unused, it cannot be carried forward.
Unfortunately, a gain cannot simply be crystallised by selling and then repurchasing an investment – so-called bed-and-breakfast planning – as the disposer must not personally reacquire the same investment within 30 days of disposal. However, there are other ways of achieving similar results such as bed-and-ISA, bed-and-Sipp and bed-and-spouse.
Maximising the use of a couple’s exemptions and lower tax rates
As the value of the annual CGT exemption depends on whether an individual is a higher rate taxpayer or not it makes sense for an individual who is a higher/additional rate taxpayer to transfer assets into their spouse’s name to utilise that spouse’s annual exemption on subsequent disposal.
This can be achieved by an outright and unconditional lifetime transfer. This should not normally give rise to any inheritance tax consequences or CGT implications.
Indeed, it may even be worthwhile transferring an asset showing a gain of more than £10,600 if the result would be for the surplus capital gain to be taxed at 18 per cent rather than 28 per cent.
Pension contributions to reduce the tax on capital gains
Those who are realising a taxable gain may have taxable income around the basic rate limit (£34,370 for 2012/13). This means that a significant part of any taxable gains is likely to suffer CGT at a rate of 28 per cent. By taking action to increase the basic rate limit, it is possible for such a person to save CGT. One method of achieving this is to pay a contribution to a registered pension scheme as the gross contribution is treated as increasing the basic rate limit.
If a person is contemplating making a disposal it may be worthwhile, if possible, spreading the disposal across two tax years to enable use of two annual exemptions to be made. Alternatively, the disposal could be delayed until after 5 April 2013 to defer the payment of CGT until 31 January 2015.
Pensions have always formed a key part of tax year end planning and 2012/13 is no different. Indeed, the announcements made in the December 2012 Autumn Statement and the pension provisions of the draft clauses of the Finance Bill 2013 only serve to highlight the importance of pension planning before 6 April 2013.
In its Autumn Statement the Government announced that from 2014/15 the lifetime allowance and the annual allowance would be reduced to £1.25m and £40,000 respectively.
Although the present Coalition Government seems highly unlikely to make any further cuts in pension tax reliefs during this Parliament, the Liberal Democrats have made clear their desire to limit contribution relief to the basic rate.
Ed Balls, the Labour Shadow Chancellor, has also talked of restoring the High Income Excess Relief tax charge, which would effectively taper pensions tax relief down to the basic rate at £150,000 of income.
All of these changes and potential further threats to the pension tax reliefs underline the need to take full advantage of current reliefs.
(b) Maximising contributions
Individuals should maximise their pension contributions in the current tax year, where able. In total, pension input (contributions and the deemed value of any increased benefits under a DB scheme) of up to £50,000 can be accrued in pension input periods ending in tax year 2012/13 without resulting in an annual allowance charge.
Advantage can also be taken of the carry forward provisions once the £50,000 annual allowance has been exhausted in the current tax year.
Carry forward is only available for the three immediately preceding tax years, and therefore any 2009/10 unused annual allowance will be lost if not used by Friday 5 April.
Clients should consider paying a contribution that, at the very least, maximises use of their annual allowance for the current tax year and picks up any unused allowance for 2009/10.
The following points need to be reviewed where a client wishes to maximise pension contributions in 2012/13:
It will only be pension input in pension input periods that end in tax year 2012/13 that will be tested against an individual’s annual allowance in 2012/13. It is therefore essential to establish the pension input period of any arrangement to which contributions are paid or accrue.
Will the contribution be tax relievable? An individual can only obtain tax relief on a personal contribution where this does not exceed the greater of 100 per cent of his relevant UK earnings and £3,600 gross. Even if such a contribution is fully relievable it may, in certain cases, be seen as advantageous to split the contribution between the current and next tax year to maximise the amount of tax relief.
It is important to note that any personal contributions will be relievable for tax purposes in the tax year in which they are paid, irrespective of whether these are paid to an arrangement with a pension input period ending in the following tax year.
Where the contribution is paid on the individual’s behalf by their employer, it will normally be tax relieved, provided it is regarded by the employer’s local inspector of taxes as having been paid ‘wholly and exclusively’ for the purposes of the trade.
There will usually be no problem where the employer contribution is in respect of an ordinary employee, although the local inspector will look more closely at a contribution paid in respect of a controlling director or one of their relatives.
- The extent to which any contribution is likely to result in the individual exceeding their lifetime allowance. Further contributions are unlikely to be an option for an individual who has any form of transitional protection. The payment of such contributions would result in the loss of enhanced or fixed protection. Under primary protection, further contributions are in theory possible but, in practice, may well mean that the uplifted lifetime allowance is exceeded.
Personal contributions in 2012/13 may be particularly attractive for additional rate taxpayers as it will be their last opportunity to obtain 50 per cent tax relief.
The payment of pension contributions could be especially valuable to individuals who are able to reduce their ‘adjusted net income’ by means of a pension contribution, and so reduce or eliminate the new high income child benefit tax charge, or restore their personal income tax allowance in full or in part.
(c) Family pension arrangements
Following the earlier reduction of the lifetime allowance and annual allowance, family pension plans became increasingly popular for those individuals whose pension benefits already exceeded, or were likely to exceed, their lifetime allowance or whose contributions would otherwise breach the £50,000 limit.
Under a family pension arrangement an employee arranged for their employer to pay pension contributions into family members’ registered pension schemes as part of their flexible remuneration package.
Section 308 of the Income Tax (Earnings and Pensions) Act 2003 currently provides that no liability to income tax arises in respect of earnings where an employee’s employer makes contributions under a registered pension scheme.
This means that the employee pays neither tax nor NI contributions on the pension contribution paid by their employer to the registered scheme of one or more of their relatives. An added advantage will be that such a contribution will not be set against the employee’s lifetime allowance or annual allowance.
In order to stop this, legislation will be included in the Finance Bill 2013 to amend section 308, restricting the employee’s income tax exemption to employer pension contributions paid to the employee’s registered pension scheme, rather than contributions made to any registered scheme. This change will be effective from 6 April 2013.
The deferral of this change to 6 April 2013 means that such arrangements can continue to operate until then.
Of course, care will need to be taken to ensure that any contribution falls into tax year 2012/13 but, in theory, there would be scope for an employer contribution of up to £250,000 for an employee’s relative (assuming full advantage can be taken of the annual allowance carry forward rules and pension input period end date provisions).
It should also be remembered that the employer pension contribution will only be tax relieved where the local inspector regards it as having been paid ‘wholly and exclusively’ for the purposes of the trade.
Where it is intended to undertake any such exercise prior to 6 April 2013 it would be prudent to discuss the implications of this with the employer’s accountants.
4. INHERITANCE TAX
The tax year end is a good time to generally consider a client’s IHT position with a view to making larger gifts.
Where ongoing control of the assets gifted is required, a discretionary trust will be useful but care should be exercised not to exceed the available nil rate band. If the investor needs access and IHT efficiency, a loan trust or discounted gift trust should be considered.
All those who are concerned about IHT should seek to use their available £3,000 annual exemption(s) before the end of the tax year. Any unused amount can be carried forward for one year only.