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What the Budget means for your clients

John Woolley of Technical Connection delves into the Budget in detail.

Having inflicted substantial pain on the electorate through the introduction of a number of austerity measures in the June 2010 emergency Budget and offered a Budget for economic growth in 2011, this year the Chancellor announced his intention to offer a Budget to meet Adam Smith’s stated requirements that an effective tax system needs to (article continues below) :

-give greater rewards for work

-reduce rates of tax

-be fair and

-be simple

Some categories of taxpayer – most notably the retired person – may query whether this Budget achieves all these objectives.
As ever, there was considerable pre-Budget speculation and much of it turned out to be well founded. The main headlines were:

a reduction in the top rate of income tax to 45 per cent from April 6, 2013

-a substantial increase in personal allowances by £1,100 from April 6, 2013

-a gradual phasing out of the entitlement to age allowance

-a gradual reduction in corporation tax over the next three years

-a relaxation to the previously proposed rules on the removal of child tax benefit for higher-rate taxpayers

-a step-up in the tax avoidance rules, particularly in the area of stamp duty

-and, of course, no change in the rules that apply to tax relief on registered pension schemes.

There were also a couple of changes to the rules on the taxation of life policies that will be of particular interest to financial advisers and, no doubt, some of their clients.

Although the Government’s plans appear to be to cut tax at the top end, rates of tax are still relatively high and so many clients will have a need for advice on how they combat the continued relatively high level of personal taxes and ongoing impact of the significant changes to the pension rules announced in the last quarter of 2010.

This means the financial adviser should still have a number of high-net-worth clients interested in tax-efficient solutions and, where relevant, financial products.

Let’s look at some of the changes and resulting opportunities.

3: Savers/investors

Higher-rate taxpayers and those with taxable income of over £150,000 need to consider tax-efficient savings. Mainstream tax-efficient investments, such as registered pensions, Isas (increase in annual limit to £10,680), offshore bonds and new-style qualifying savings plans are very important. These are the type of person who will probably be interested in the tax benefits of the VCT and EIS.

Over the last few years, provisions have been introduced to restrict the relief to schemes that are truly risk investments but the rate of tax relief on EIS investments remains at 30 per cent and, with effect from April 6, 2012:

  • the permitted maximum investment to an EIS doubles to £1m from April 6, 2012 and
  • certain restrictions are being lightened for both VCTs and EISs, in particular the number of permitted employees and permitted gross annual value of the company concerned.

Life insurance policies
i: Single -premium bonds

The taxation of life insurance policies came in for some unexpected attention from the Government. Proposals were made to prevent the use of single-premium bonds in the following circumstances:

  • to create chargeable-event gain credits (at no tax cost) while the policyholder is abroad with the intention of creating a deficiency on a later encashment of the bond when the policyholder is UK-resident and so claiming tax relief against other income
  • that are issued as a series of individual policies with each policy offering benefits that are not commercially justified by the premiums that is paid to it and thus makes tax planning (largely founded on the “accelerated” deferment of tax on amounts taken from the investments before final encashment) possible.

These rules apply to plans effected on or after March 21, 2012

ii: Qualifying life insurance policies
Following the opportunity for non-pension but still tax-effective investment created by the reduction of the annual allowance for pension plans and the increase in the top rate of income tax, more interest has been shown in the use of a qualifying policy as a tax-effective method of saving providing completely tax free benefits after seven-and-a half years or 10 years – depending on the policy structure.

In this respect, the maximum investment plan had sprung back into life. These plans offer scope to save on a regular basis in a UK taxed fund and receive tax-free proceeds after 10 (or seven and a half) years.

Somewhat surprisingly, the Chancellor has acted to cut back use of qualifying policies such as Mips. In broad terms:

  • in order to qualify for tax freedom on the proceeds, payments in all new policies effected on or after April 6, 2013 (with transitional provisions in respect of post-March 21, 2012 but preApril 6, 2013 policies) must not exceed £3,600 a year (in total)
  • the benefits of existing (that is, pre-March 21, 2012) plans are not affected, provided these policies are not assigned, used as a security for a debt or have their terms extended. It is hoped and expected that policyholders of existing policies will be protected if they merely continue to pay the original premium. Unfortunately, this point is not crystal clear from the HMRC press release and so caution should be exercised for the time being. It would seem that premiums on existing policies that are paid after April 5, 2013 will count for the purposes of the £3,600 limit that applies to post-March 20, 2012 policies.

Cap on income tax reliefs for other uncapped investment

The Government will, from April 6, 2013, introduce a new cap on income tax reliefs to ensure that those on higher incomes cannot use income tax reliefs excessively. For anyone seeking to claim more than £50,000 of relief, a cap will be set at 25 per cent of income (or £50,000, whichver is greater).

The Treasury has confirmed this rule will not apply to those reliefs that are already capped, as to do so would reduce the amount of support the tax system gives to, for example, enterprise and pension contributions. Further precise details of this measure are awaited through the consultation and draft legislation

Investing for children

The new junior Isa is now up and running and can be used for investors under age 18 who do not have a child trust fund. The maximum annual investment is £3,600 and the full benefit of the plan will be accessible to the child at the age of maturity.

While on the subject of investments for children, many parents and grandparents will still be worried about the future cost of a university education and how a child can raise sufficient funds to get into the housing market.

In such circumstances, and provided they are happy that only the child in question will benefit, the early implementation of a bare trust to hold growth collectives or offshore bonds will offer a mechanism to provide for the tax-efficient funding of the costs of educating children/grandchildren and helping them through university. The earlier that a start is made on such planning the better.

Alternatives delivering greater investor control include offshore bonds held by the investor and later assigned once the child reaches maturity and collectives held on discretionary trusts.

4: Pensions

The good news here was the lack of substantive changes despite the rumours. In particular:

  • the lifetime allowance remains at £1.5m
  • the annual allowance is £50,000
  • there is no further restriction on tax-free cash, and
  • contributions from tax relief at the investor’s marginal rate of tax on earned income

A technical change was made to prevent a particular scheme that manipulated the tax rules. This would involve an employer paying a contribution on behalf of the spouse or child of a (senior) employee. In such circumstances, it seemed there would be no benefit-in-kind charge on the employee. This position is to be rectified.

The ability to carry forward unused annual allowance (based on the notional £50,000 limit) from tax years 2009/10, 20010/ 11 and 2011/12 will help many pension scheme members to maximise contributions.

This will be particularly relevant for people who were caught by the anti-forestalling rules in tax year 2010/11, many of whom will only have paid a contribution of £20,000 for that year and so have unused annual allowance available for carry-forward.

It should be borne in mind that in order not to lose carry-forward annual allowance from 2009/10, the full £50,000 plus an amount in respect of carried-forward annual allowance from that tax year will need to be paid to pension arrangements with an input period ending in 2012/13. Given the general speculation on a cutback of the tax reliefs on pension plans, it is thought that changes cannot be ruled out in the future and so full advantage should be taken of these reliefs while still available.

With the lifetime allowance set to reduce to £1.5m on April 6, 2012, clients with pension funds approaching that value will need immediate advice on whether to elect for fixed protection or not. The downside is that, having made the election, no further contributions can be made to a registered pension from April 6, 2012 onwards.

5: Estate planning

The four main changes on inheritance tax were:

  • confirmation that the nil-rate band of £325,000 will increase by CPI from April 6, 2015
  • measures to prevent the avoidance of IHT by people buying an interest in an excluded property trust (which is exempt from IHT)
  • consultation on whether an increase should be made to the limited £55,000 spouse exemption on transfers from a UK-domiciled to a nonUK-domiciled spouse (and whether a non-UK-domiciled spouse should be allowed to elect for UK-domiciled status) and
  • consultation on whether the IHT tax treatment of discretionary trusts (that is, periodic and exit charges) should be simplified.

The outlook for financial planning in relation to inheritance tax planning continues to look bright.

The freezing of the nil-rate band at £325,000 until April 5, 2015 means that for most couples with assets of more than £650,000, they will need to consider the impact of IHT on their death.

It is also important to note that the freezing of the nil-rate band (with a then increase by CPI) dilutes the effective value of a transferable nil-rate band from a deceased spouse to a surviving spouse.

For this reason, we may see a re-emergence of interest in the nil-rate band discretionary will trust which will enable the first to die to put assets in trust which will accrue in value outside the taxable estate of the surviving spouse.

The financial services industry has a number of solutions. For those with cash/investments who want to make a gift, yet control the destination of the benefits, a discretionary gift trust works well.

For couples who want to gift, yet enjoy some form of income, the discounted gift trust and loan trust can work well and for those who want to cover the inheritance tax liability on a property – say, a private residence – a joint-lives last-survivor policy in trust can work well. Also do not forget the use of spousal by-pass trusts for death benefits under pension schemes – an easy way to keep assets outside the surviving spouse’s taxable estate, yet still give the surviving spouse access via the trustees.

Last year, a new provision was announced so that, taxpayers who are prepared to make a substantial bequest to charity (equal to at least 10 per cent of their net estate) qualify for a 36 per cent IHT rate on the rest of their estate. This provision has not been brought into effect.

Finally, some expected changes were introduced to apply a 15 per cent stamp duty land tax charge on £2m-plus properties bought by companies, a 7 per cent SDLT charge on any sale of a residential property and consultation on the introduction on an annual charge on residential properties valued at over £2m owned by other than individuals – a kind of corporation-owned mansion tax.

Advisers need to be at least aware of these rules when advising their wealthier clients.

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Comments

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  1. Tyburn Asset Management 29th March 2012 at 4:44 pm

    Thank you. Great article.

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