Year-end tax planning is even more important in the current financial climate as a means of minimising tax payable and maximising net income, capital growth and wealth. As well as last-minute tax planning for 2008/09, now is also a good time to put in place strategies to minimise tax in 2009/10.
Of course, tax planning is an important part of financial planning but it is not the only part. It is essential therefore that any tax planning strategy being considered also makes commercial sense.
Please note that in this article references to married couples include registered civil partners.
1.1: Independent taxation
Significant changes to the rates of income tax occurred on April 6, 2008, in that the 10 per cent rate of income tax no longer applies to earned income and basic-rate income tax was reduced from 22 per cent to 20 per cent.
Income tax saving opportunities still exist for married couples who carry out appropriate planning. 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 year.
Where a higher-rate taxpaying spouse owns investments, income from these may suffer 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 lower or non-taxpaying spouse can save tax and increase overall investment returns. Such transfers must be outright and unconditional.
Where possible, a couple should try to ensure that they both have pension plans to provide an income stream in retirement that will also use their personal allowances (see below).
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 £6,035 for tax year 2008/09 (£6,475 for tax year 2009/10) before he or she pays 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 age allowance limit of £22,900 (2009/10).
Business owners may consider 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 up to the NIC free limit (currently £105 per week) that would still attract contributory State benefits and give the ability to pay additional pension contributions.
1.2: Investment planning
The Isa is still the main method of investing savings, with freedom from income tax and capital gains tax. Improvements to Isas were made from April 6, 2008.
Although the rules have recently changed, there are still two types of Isa – a cash Isa and a stocks and shares Isa.
The overall annual contribution limit is £7,200, of which no more than £3,600 can go into cash. The balance can be invested in a stocks and shares Isa. This means a couple could invest £14,400.
Money that has been invested in a cash Isa can be transferred to a stocks and shares Isa. However, a transfer from a stocks and shares Isa to a cash Isa is not permitted.
A child aged 16 or over can invest £3,600 in a cash Isa.
Enterprise Investment Scheme
An EIS offers tax relief on an investment in new shares of an unquoted trading company which satisfies certain conditions. For tax year 2008/09, an investment of up to £500,000 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 in an EIS provided some of the EIS investment potentially qualifies for income tax relief.
For those who have disposed of assets before April 6, 2008 which has resulted in a CGT liability at a rate of more than 18 per cent (after taper relief), investment into EIS shares within three years of the disposal would mean that the original gain will be taxed at 18 per cent (and not some higher rate) when the EIS shares are realised.
However, careful calculations will need to be carried out for disposals before April 6, 2008 as the applicable CGT rate could be as low as 5 per cent (business assets) or 12 per cent (investment assets) because of taper relief. Deferral of a capital gain means taper relief is lost.
Venture capital trusts
The VCT offers income tax relief for tax year 2008/09 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 ability to defer CGT as with an EIS investment but dividends and capital gains generated on amounts invested within the annual subscription limit are tax free.
For both the EIS and the VCT, it is essential that would-be investors are aware of the likely greater investment risk and lower liquidity that will have to be accepted in return for the attractive tax relief.
1.3: Gifts for children
Bare trusts for children
The benefit of a parent establishing a bare trust for the benefit of a minor unmarried child not in a civil partnership is that all capital gains of the trust will be taxed on the child beneficiary. Thus, it is possible for the child to use his/her annual CGT exemption of £9,600 for tax year 2008/09.
The potential downsides are:
Subject to these potential downsides, bare trusts can be useful planning mechanisms for an investment into unit trusts or Oeics that are geared towards capital growth so that the child’s annual CGT exemption can be used.
If more control over trust assets is desired, then a discretionary trust may be more appropriate. There may also be income tax benefits. The first £1,000 of gross income in a tax year falls within the trustees’ standard rate tax band and is taxed at the basic rate. Income in excess of this will be taxed at the normal trust rates of 40 per cent or 32.5 per cent (for dividends). The trustees of a discretionary trust are entitled to an annual CGT exemption of normally £4,800 for 2008/09.
It is important that careful thought is given to the investments underlying a discretionary trust to maximise tax efficiency and enhance the benefits available for the beneficiaries. This is particularly the case as the top rate of income tax on discretionary trusts may increase to 45 per cent in tax year 2011/12.
In theory, there is no limit to the amount of contributions that can be paid by an individual or an employer on behalf of an employee.
However, the individual – and employer – must also be aware of the tax charges applicable should either the lifetime allowance or annual allowance be exceeded and any pension planning must take account of this.
One way to avoid an annual allowance charge is to manipulate input periods.
It is often stated that an individual’s maximum contribution in any tax year is limited to the amount of the annual allowance (that is, £235,000 in tax year 2008/09). However, there is no restriction on the amount of tax- relievable personal contributions to the amount of the annual allowance where the individual’s relevant UK earnings in the tax year in question exceed the annual allowance.
It would normally be unwise to pay a contribution exceeding this level as the excess would be subject to an annual allowance tax charge of 40 per cent and normal tax treatment on benefits.
It is, however, perfectly possible by judicious planning and the manipulation of pension input periods for an individual to obtain full tax relief on a contribution paid in tax year 2008/09 exceeding £235,000 and avoid an annual allowance charge.
For example, an individual with relevant UK earnings of £400,000 could pay a contribution of up to that amount prior to April 5, 2009 and obtain tax relief on this in tax year 2008/09.
If he were, for example, to pay £235,000 to a Sipp on March 2, 2009, he could then elect that the pension input period for that Sipp ends on, say, March 10, 2009. This would mean the pension input period would end in tax year 2008/09 and this would be set against his annual allowance for 2008/09.
He then pays the remaining £165,000 contribution on March 25, 2009. This will fall in the pension input period ending on March 9, 2010 and will be set against his annual allowance for 2009/10 of £245,000.
Therefore, in the above exercise, the member will have received full relief in 2008/09 on his £400,000 contribution but with no annual allowance charge.
However, he will be limited to a £80,000 contribution in 2009/10 unless the process is repeated.
One other aspect specifically needs to be taken into account as the 2008/09 tax year end approaches. Monday, April 6, 2009 is the deadline for any individual who wishes to make an election to HMRC for enhanced and/or primary protection.
Most individuals requiring such protection are already likely to have made such an election but this is something that needs to be checked.
There may also be some individuals who felt they did not need to elect for such protection as they expected the standard lifetime allowance to continue to be increased each year beyond tax year 2010/11.
The announcement of the freezing of the SLA for the five tax years from 2011/12 to 2015/16 at £1.8m may mean that some individuals who had not expected their benefits to exceed the SLA may now find that they are likely to do so and that, where able, they need to elect for enhanced and/or primary protection.
They can only elect for enhanced protection if they have had no relevant benefit accrual since A-Day, while to elect for primary protection they would have needed to have pension benefits as at April 5, 2006 with a value exceeding £1.5m. In practice. primary protection may be of little help, given that the revaluation basis is in line with the growth of the lifetime allowance.
As the election form is quite complex, and requires a good deal of information from the client’s pension providers, any required information should be sought at the earliest opportunity, enabling the election to be made as soon as possible.
2: Capital gains tax
The annual exemption for individuals is £9,600 for 2008/09 and £4,800 for most trustees. The annual exemption cannot be carried forward. If an individual has investments with inherent gains, he/she should consider making disposals to realise any gains within the annual exemption. To ensure gains are properly realised, the disposer 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 £19,200 in tax year 2008/09 can be realised without any CGT 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.
Since a flat rate of tax of 18 per cent has been introduced, the only advantage of such transfers is to use the annual CGT exemption of the transferee spouse.
Consideration could be given to realising losses on investments to offset against capital gains. However, this should not cause net capital gains to fall below £9,600 because then part of the annual exemption will be wasted. Carried-forward losses can be offset to the extent they reduce current year capital gains to £9,600 with any balance losses being carried forward.
If a person is contemplating making a disposal in the near future which will trigger a capital gain in excess of £9,600 it may be worthwhile, if possible, spreading the disposal across two tax years to enable the use of two annual exemptions.
Alternatively, if the disposal cannot be spread or the gain is very substantial, the disposal could be delayed until after April 5, 2009 to defer the payment of CGT until January 31, 2011.
A transfer of an asset showing a loss to a spouse with assets showing a gain can be considered but care should be taken over the CGT anti-avoidance rules that apply.
3: Estate planning
Despite falling property and investment values and the introduction of the transferable nil-rate band for spouses, inheritance tax is still a big problem for many people. There are several effective inheritance tax planning opportunities available, some of which enable a donor to make a gift and enjoy a benefit without being subject to the gift with reservation or Poat rules.