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The late shift

In all the preand post-Budget excitement over capital gains tax, non-domiciliaries and inheritance tax, some of you may have forgotten that there are some income tax changes taking effect from April 6.

The starting rate of 10 per cent for 2008/09 applies to the first £2,320 of taxable savings income after allowances and reliefs. This is a change from previous tax years when the 10 per cent rate applied to all types of income. The fact that the 10 per cent will only apply to savings income is a subtle change from last year’s proposals which merely excluded earned income from being taxed at 10 per cent.

The result is that if an individual’s taxable non-savings income is more than £2,320, then the 10 per cent savings rate will not apply. This is because in calculating tax, savings income sits on top of non-savings income. If, for example, taxable non-savings income were £1,500, then £820 of savings income (the savings rate limit of £2,320 less non-savings income of £1,500) would benefit from the 10 per cent rate.

For 2008/09, basic-rate tax reduces to 20 per cent and the higher-rate threshold has been increased to £36,000. The basic rate will apply to income in the band £1 to £36,000, subject to what is said above in connection with the 10 per cent rate.

The basic rate of tax is relevant to:

  • Individual contributions to registered pension schemes which operate tax relief at source. This means that to keep the same level of gross contributions, net contributions will have to be increased or the gross amount will reduce.

  • Charitable covenants and Gift Aid. For qualifying Gift Aid donations made before April 6, 2011, the Government will make an additional repayment to the charity so that the overall effect is that the 22 per cent basic rate still applies for repayment purposes.

  • Annual payments.

    For those interested in trust taxation, it should be noted that discretionary trusts and accumulation and maintenance trusts will generally qualify for a £1,000 standard-rate tax band for 2008/09.

    So what planning opportunities should be considered in the light of these changes?

    By allocating income and possibly gains between spouses, particularly where the income is currently concentrated in the hands of one spouse and especially where that spouse pays income tax at a higher rate than the other, it is still possible to save tax. This reallocation can be achieved by unconditionally transferring assets from one spouse or registered civil partner to the other. No CGT or IHT liability will arise on such transfers. There is no better time than the start of the tax year to implement income-splitting plans.

    Following HMRC’s loss in the Jones v Garnett (Arctic Systems) case in December 2007, it issued a consultation paper on income shifting, draft legislation and guidance. The legislation was due to come into effect from April 6, 2008. Instead, there will be a further period of consultation and any resulting legislation will be introduced through the Finance Bill 2009.

    The purpose of the proposed legislation is to counteract income shifting, where one individual redirects part of their income to another individual who is subject to a lower rate of tax, by counteracting the tax advantage gained through the use of non-commercial arrangements by partnerships and companies.

    The legislation as it was proposed was to apply to income that would be subject to tax in 2008/09 and later. It will apply when income is shifted from one individual (Individual 1) to another (Individual 2) provided that four conditions are satisfied:1: Individual 1 is party to or has power over the relevant arrangements. A relevant arrangement is one which is not a genuine commercial arrangement and, in all the circumstances, it is reasonable to conclude that the purpose or one of the main purposes of the arrangement is the avoidance or reduction of income tax.

    As would be expected, “arrangement” is widely defined to include “any agreement, understanding, scheme, transaction or series of transactions (whether or not legally enforceable)”. A genuine commercial arrangement is broadly defined as one that would have been made by individuals acting on an arm’s-length basis.2: Individual 1 forgoes income and any of that income would be income of Individual 2. Income is forgone if Individual 1 does not receive the income he or she is entitled to or, with regard to work done by Individual 1, he or she might reasonably expect to receive but does not.3: Individual 1 has the power to control or influence the amount of income shifted.4: The shifted income must consist of distributions from a company (most likely to be dividends) or profits of a partnership (including a limited liability partnership).

    If the above four conditions are satisfied, then the shifted income is treated as the income of Individual 1 for the tax year in question and will not form part of the income of Individual 2. However, this rule will not apply in a situation where the total amount of tax due from Individuals 1 and 2 is equal to or less than it would be were it treated as not being shifted. In other words, for the legislation to apply, a tax advantage must be secured. The income is not recategorised so if dividend income is forgone, that dividend income is assessed on Individual 1.

    It is intended that the liability for Class 4 National Insurance contributions, payable by the self-employed, will follow the shifted income, so the liability for NICs on shifted income will fall on Individual 1 as well as the income tax liability.

    For the time being, the guidance issued by HMRC following the decision in the House of Lords should be followed.

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