Over the next few weeks, I will look at some of the key proposals in the pre-Budget report and consider what they could mean to those in the business of giving financial advice. I will start with income tax.
The Chancellor gave details of the main personal allowances applicable for 2004/05. There were no real surprises, with all the main allowances maintained and increased by the expected amount.
It would be easy to pass by all this fairly mundane stuff but it is worth reminding you that, bearing in mind that each of a couple have their own personal allowance, more tax can be saved with planning. Both personal allowances should be used in full if possible, particularly where only one spouse is a higher-rate taxpayer.
As well as a transfer of investments, considerable scope may exist for a business owner to employ his or her spouse and possibly provide a pension for her or him. With the alignment of the standard personal allowance with the primary threshold (the level of earnings at which employees start to pay Class 1 National Insurance contributions) and the secondary threshold (the level of earnings at which employers begin to pay National Insurance contributions), earnings of up to £91 a week in 2004/05 should attract neither income tax (assuming this is the taxpayer's sole source of income) nor National Insurance contributions, which makes planning much easier.
Care should be exercised to ensure all payments made are a deductible expense for the payer. The greater the remuneration, the greater the care.
Special care needs to be taken by those considering taking their spouse into partnership or paying dividends to a non-working spouse who is also a shareholder, particularly in view of the Inland Revenue's current attitude to this. In April Tax Bulletin No 64, the Revenue set out its views on the application of the settlements legislation to various aspects of spousal remuneration, including partnership profits and some dividends.
In this connection, the settlements legislation may be applied where profits are transferred from the partner or shareholder responsible for most of the profits of a business to, say, a spouse or other family members who pay income tax at a lower rate. If the settlements legislation applies, then profits attributed to a spouse, etc, will be assessed to tax on the settlor, that is, the partner or shareholder responsible for most of the profits. This risk will be minimised when the lesser partner's share of profits is commensurate with that partner's contribution to profit generation.
The Revenue has recently expanded on the views expressed in the earlier Tax Bulletin and these will be republished in the February Tax Bulletin. It makes it clear that each case will depend on its own facts and if there is bounteous intent – an arrangement that yields benefits to a party, for example, a non-working spouse, that would not have been received in an arm's length arrangement – then the settlements legislation could apply.
Age allowances apply separately to a husband and wife, as does the total income limit of £18,900 for 2004/05 above which the allowance reduces. By careful planning, both spouses can qualify for age allowance. When investment income is in the age allowance trap, it can suffer an effective tax rate of between 30 and 33 per cent so reinvestment in non-income-producing assets should be considered. Capital investment bonds, capital growth-oriented unit trusts and Oeics may be attractive as “income” by way of capital withdrawals can be taken without loss of age allowance, subject to guarding against capital erosion. Income and capital from an Isa is tax-exempt in any event.
With a bond, “income” will commonly be in the form of utilisation of the 20-year 5 per cent annual withdrawal facility. In some cases, more than 5 per cent can be taken provided the first withdrawal is made in the second policy year.
Under current rules, care must be taken on final encashment of the bond or part-encashment over the cumulative unused 5 per cent allowances as the entire chargeable event gain, without topslicing relief, counts as income for age allowance purposes. Careful planning can help to reduce this problem substantially.
In the case of unit trusts and Oeics, units or shares can be encashed regularly to make use of the annual capital gains tax exemption, after due allowance for any taper relief and the exercise of care over capital depletion.
Still on personal tax but this time looking at capital gains tax, it is expected that the annual exemption will increase to £8,200 for 2004/05 for individuals and personal representatives and £4,100 for trustees in most cases. We will have to wait until the Budget for confirmation of these figures.
It is worth remembering that taper relief at the ordinary or accelerated business assets rate applies before the annual exemption. This can have the effect for gains arising on the disposal of assets held for three years or more of stretching the amount that is exempt from CGT. For example, if the gains were £13,666, after full taper relief of 40 per cent they would reduce to £8,200, which would be wholly exempt.
A consultation paper on trust reform has been issued and I will comment on this in subsequent articles. It is worth noting that, ignoring settlor-interested trusts (where gains are attributed to the settlor) and bare or absolute trusts (where gains are likely to continue to be attributed to the beneficiary although some change may occur in respect of parental bare trusts), the rate of CGT paid by all trusts rises to 40 per cent from April 6, 2004 .