This Budget was certainly one with few surprises.
As such I am going to take a more oblique view of what some of the changes might mean and what action might be profitable for UK taxpayers in a few selected areas. Namely:
- The children's tax credit
- Inheritance tax
- Capital gains tax
- Life assurance policy taxation
1. The Children's Tax Credit
1. The Children's Tax Credit
As was widely expected the amount of this credit (which takes effect for the first time on 6 April 2001) will be increased above the level at which it was first proposed to give a tax cut of up to £520 per annum.
The Children's Tax Credit (CTC) is payable to families (ie. single parents, married couples or unmarried couples living together) where at least one child under the age of 16 is that of the claimant and living with the claimant, or maintained at the expense of the claimant. The maximum credit is £5,200 per family which gives a reduction in income tax otherwise payable, at the rate of 10%, ie. a maximum of £520.
The relief will be means-tested and will be progressively withdrawn if the claimant is liable to higher rate income tax (ie. has taxable income, on current rates, of at least £29,400 which equates to total income of £33,935 before deduction of the standard personal allowance of £4,375 at present increasing to £4,535 from 6.4.2001). [The relief is then withdrawn at a rate of £1 of credit per £15 of income subject to higher rate tax. This means that where income subject to tax exceeds £37,200 no CTC will be available (£37,200 – £29,400 = £7,800. £7,800/£15 = £520)].
Where the child lives with two persons each person is termed a “partner”. Households where one partner's income which is subject to tax exceeds £37,200, at current rates, will not qualify. Yet where each partner has just under the limit the relief will be due in full even where the joint income is much higher than the £37,200 limit. This is because the legislation requires the “higher-earning” partner to claim. The “higher-earning” partner is the one who has the higher income subject to tax and so where both partners have income subject to tax in excess of £29,400, the one with the higher income will claim. If neither partner has income in excess of £29,400 subject to income tax then they can elect to share the credit equally or allocate the whole to one of them.
Where there is a chargeable event gain for income tax purposes from the encashment of a non-qualifying life assurance policy, e.g. a capital investment bond, a trap could catch the CTC (in the same way as for age allowance). Top-slicing relief does not apply hence the entire chargeable event gain will be treated as income. This will be disadvantageous where a basic rate taxpayer will be taken into the higher rate band by the chargeable event gain.
Another, worrying conclusion that can be drawn from the new system of credits is that where the credit is cut back by the claimant's income exceeding the higher rate threshold the effective rate of tax suffered by virtue of tax and loss of credit can exceed 50%. This in turn means that any qualifying expenditure (such as an allowable pension contribution) that can reduce income falling between £29,400 and £37,200 would both secure tax relief and reinstate the credit so that tax relief at an effective rate of over 50% could be secured.
2. Inheritance Tax
2. Inheritance Tax
Unlike earlier years, the general view ahead of this Budget was that with a General Election pending few, if any, changes would be made to inheritance tax this time around. The general view was proved to be correct.
Although no major changes to IHT have yet been made by this Government, complacency must be avoided. It would, therefore, be prudent (to use the “in” Budget word) to continue planning for the possible changes should the Government be re-elected. Don't forget that some five years ago the Labour Party publicly criticised the lack of bite in the inheritance tax regime.
In very brief terms the main advantages of the current inheritance tax regime are as follows:-
an increased a nil-rate band of £242,000 (meaning that potential savings for a couple could be up to £96,800) with a flat rate of tax on death (40%)over that amount
the potentially exempt transfer rules
a 100% maximum level of business property relief and agricultural property relief
planning using deeds of variation
lump sum inheritance tax schemes that avoid the gift with reservation rules
advantageous rules for excluded property trusts.
All of these are areas that may well be targeted for harsher treatment under Labour in the future.
- Capital Gains Tax
The main changes announced here was an easy to understanding increase in the annual exemption from £7,200 in 2000/2001 to £7,500 in 2001/2002 for individuals and personal representatives, and (in most cases) from £3,600 to £3,750 for trustees.
This exemption remains as one of the most important but woefully underused weapons in an individuals capital gains tax (CGT) planning armoury. Each individual in a family (this means a separate CGT exemption for each spouse and each child) can realise gains each tax year within his/her CGT exemption tax free. A simple way for parents and grandparents to facilitate use of the exemption by children is for investments, such as unit trusts, to be held for the designated benefit of the child. All capital gains would then be assessed on the child not the nominee.
Transfers between spouses remain 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 use of the familys annual exemption. However, following the changes in 1998, it is much harder to use up the annual exemption through "bed and breakfast" transactions without the required 30 day “break period” between disposal and reacquisition.
The annual exemption is applied after taper relief. This can have the effect of "stretching" the annual exemption. For example, if gains on an investment were, say, £7,500 and the investment had been held (or treated as held) for 10 years of ownership qualifying for taper relief, then taper relief at 40% would reduce the gain to £12,500 which would be wholly exempt within the annual exemption at its new level. It may well be higher in ten years time!
4. Life Policy Taxation
4. Life Policy Taxation
Life policy taxation is perhaps one of the most enigmatic areas of taxation. Fortunately for most investors they do not have to worry because personal tax only becomes relevant when the policy is cashed in or a withdrawal is made. For policies issued by UK insurers – only the difference between the higher rate (40%) and the basic rate (22%) ie. 18% is payable and even then only by higher rate taxpayers.
For couples and families where the policy owner is a higher rate taxpayer and there are others (over 18) who are non or basic rate taxpayers an unconditional assignment of the policy for no consideration from the higher rate taxpayer to the non or lower taxpayer would not of itself give rise to a chargeable gain but then the policy could (in most cases) be encashed with no tax liability for the non taxpayer.
These strategies are most effective and beneficial for investments in single premium bonds where the gains tend to be largest. However, complications and tax liabilities can arise where the policy is jointly owned by other than a married couple and an assignment for no consideration is made of a part interest eg. from a higher rate paying joint owner to a non or lower rate taxpaying joint owner.
In the Budget notes it is made clear that, like assignments of the whole of a policy, there will now be no income tax charge on part assignments – this will be a relief for those otherwise affected and prevented from benefiting from what could be a very effective and simple piece of tax planning.