Practical Tax Planning Strategies

26 May, 2009

In his budget, the Chancellor has not only brought forward tax proposals which were due to take place in 2011, he has also made changes to his original announcements. To ensure you keep as much of what you earn as possible, we have examined the opportunities for practical tax planning that exist.

Read on to find out how we can help reduce your tax bill…

From 2010, the personal allowance on incomes over £100,000 will be reduced by £1 for every £2 of income over the limit. Incomes over £150,000 will also be subject to a top rate tax of 50 percent – a double whammy for higher earners.

So what opportunities exist to claw some of that tax back?

If you are part of couple with one higher-tax payer and one lower paying one, you can benefit from transferring any assets from the higher payer to the lower one. It does, however, require a full transfer of ownership, with no way for the original owner to take the income from the assets.

Overseas investments may seem like a good idea, but these have always been taxable in the UK unless you are foreign. Changes to the budget this year now ensure most offshore funds are taxed in pretty much the same way as if they were UK-based investments.

For non-UK nationals, the rules changed in 2008. Once you have been a UK tax-paying resident for seven years, you will be charged tax on all global assets. To avoid this, you need to pay £30,000 to ensure offshore income not brought into the UK is not taxed. If you have been resident for less than seven tax years, then you automatically qualify for this. Additionally if your income and gains left overseas are less than £2,000, you can bring income into the UK indirectly.

You should also consider whether the high tax charges make your company car worthwhile. For 2009/10, the tax charge will stay the same, with a generous low rate for cars with emissions less than 120g of CO2 per km. If you have free private fuel, it is almost certainly worth changing your package to give this up.

It is also worth looking at Venture Capital Trusts and the Enterprise Investment Scheme (EIS). Investments in these qualify for income tax relief of 30 and 20 percent respectively, as well as possible Capital Gains Tax (CGT) exemption. Reinvesting in EIS companies enables you to defer paying CGT, and such investments qualify for Inheritance Tax exemption after two years.

Let’s now consider CGT a little further:

The CGT exemption for 2009/10 is set at £10,100. After this, most capital gains will be taxed at 18 percent. However, for gains made on the disposal of a business, Entrepreneurs’ Relief can bring the tax rate down to 10 percent for the first £1 million of gains.

What ways are there to make the most of your CGT exemption?

Let’s start by considering your property and garden. Selling a garden of less than half a hectare is exempt from CGT, but if you sell your house first, then you lose the exemption. The property will also qualify for CGT exemption, even if you have lived elsewhere or let it. If you have a second home, consider carefully which property counts as the main house and there may be benefits in ensuring both properties count at some point.

Transfers between spouses and civil partners are also exempt from CGT, even if you have separated. They remain exempt until the divorce has been finalised.

Any assets you give away are treated as if you have sold them. In some cases you can pass the tax over to the recipient along with the gift, to be dealt with at a future sale. This normally only applies to gifts of certain business assets and to trusts.

If you have a large share portfolio, it can be worth realising gains to use up the annual CGT allowance. You will have to wait 30 days to buy the shares back again, or buy them using a different name, such as that of your partner.

So how can you ensure you don’t pay back all these savings when you die?

For Inheritance Tax (IHT), the most well known way of avoiding paying is by giving assets away at least seven years before your death. However, putting these into trusts can be beneficial, as this also takes them out of the estates of your beneficiaries.

This also applies to lump sums paid out from pensions. Although these are currently considered outside your estate, by naming a trust as the beneficiary, you could keep the proceeds out of the estates of beneficiaries.

Income from a pre-1986 trust could be subject to IHT of 40 percent, so it could be worth passing these on to the next generation.

For certain assets, the seven year rule above doesn’t apply. If you set up a regular pattern of giving away surplus income, then those gifts would be outside your estate even if you didn’t survive for seven years afterwards.

Other investments are exempt from IHT. We have already mentioned EIS companies above, but commercial woodlands and some farmland also count, as long as you hold on to them for two years.

Taper relief is also available if you die between three and seven years after making the gifts. This isn’t as good as it sounds, however, as tax is only paid on gifts if they exceed the nil-rate band – currently £325,000 and increasing to £350,000 in 2010/11. The main effect of gifts is to use up some of the nil-rate band of the estate.

As surviving spouses now inherit any unused nil-rate band from their deceased partner, leaving everything to your spouse is not as tax-inefficient as it used to be.

Other products worth considering include equity release schemes to pass on some of the value of your home and discounted gift trusts, which enable you to give away cash gifts while keeping the income they generate.

If the deceased’s will is tax-inefficient, it can be rewritten using a Deed of Variation up to two years after the death. However, all the beneficiaries will need to agree to this.

Any gifts to charity in your will are exempt from IHT. However, if you make the gift before your death, you can save the IHT and get Income Tax relief too.

Now we’ve looked at personal tax, let’s consider business tax:

Getting the structure of your business right can save a substantial amount of tax. Making family members shareholders or partners in the family firm will move income from high-rate taxpayers to non-payers. New rules designed to prevent this have, fortunately, been put on hold.

Businesses can also sell shares in subsidiary companies and not pay tax on the gains as long as they remain trading after the sale. This usually means investing the money back into the business.

It is best to buy equipment for your business just before your year-end rather than after, as you receive the tax allowances a year earlier. Most businesses can right off the first £50,000 of expenditure immediately. The latest budget also included temporary first year allowances of 40 percent for the purchase of qualifying plant and machinery.

If your company carries out research and development, then the allowances are now higher than for previous years. Small and medium-sized business can claim 175 percent of what they spend, while larger firms can claim 130 percent.

For firms with a pension scheme that employees contribute to, you can save on National Insurance Contributions by paying the employees’ contributions for them, and reducing their wages accordingly.

A few other issues relating to pensions are also worth noting:

The government will restrict tax relief on pension savings from 6th April 2011 for those with incomes over £150,000. The relief will taper until it reaches 20 percent for incomes over £180,000.

However, the Government is introducing new rules from 22nd April 2009 for those who will be affected by these changes. This will remove the advantage to individuals of increasing their pension contributions in excess of their normal pattern before the relief is introduced in April 2011.

As part of the government’s reform of state pension benefits, people who earn over £40,040 and contract out will pay extra national insurance contributions, but see no increase in the rebate paid into their pension schemes.

Additionally, from April 2009, contracted-out rights awarded as part of a pension sharing order on divorce are treated in exactly the same way as other shared rights. This means they provide the usual 25 percent tax-free lump sum and can be paid out from the age of 50 (increasing to 55 from 6th April 2010).

Finally, the annual allowance, which effectively limits the amount of pension contributions an individual can make has been frozen from 2011/12 to 2015/16 at £255,000 per annum.

It is also worth noting that the annual ISA investment limit has risen to £10,200, of which £5,100 can be saved in cash. These higher limits will be introduced for those aged 50 from 6th October 2009 and apply to everyone from 6th April 2010.

To conclude, we’ll take a look at VAT and the changes being introduced.

At the end of 2009, VAT will revert back to 17.5 percent. Legislation will be brought in to stop companies pre-invoicing at 15 percent for goods or services to be delivered next January.

1st January 2010 will also bring changes to the way VAT is dealt with for cross-border trade. Under the new rules, business to business services will become taxable in the country where the customer is based, rather than the supplier’s country.

Companies engaged in cross-border transactions will also be able to reclaim foreign VAT electronically in their own member state from 2010. You will no longer be obliged to file VAT refund claims in each member state were VAT was incurred.

Two other important measures came into force this April that you need to be aware of to ensure your VAT returns and records are correct.

From 1st April 2009, new penalties for not paying the right amount of tax on time have been introduced. Under the new single penalty system, you will only be charged a penalty if HM Revenue & Customs (HMRC) believes you have not taken reasonable care with your tax returns and documents.

Any penalty charged will be a percentage of the additional tax due, up to 100 percent. The proportion depends on whether the error was careless or deliberate, whether you tell HMRC about the error without them prompting you, and whether you try to conceal the inaccuracy.

From 1st April 2010, the time limit for both HMRC’s ability to make tax assessments and a taxpayer’s ability to make claims is increased to four years. The four-year limit will also apply to Income Tax, CGT and Corporation tax. To ensure a smooth transition, from 1st April 2009, claims and assessments will be able to go back to prescribed accounting periods ending on or after 1st April 2006.

Finally, a few other things to think about. Look at your tax points, bad debt relief and the Cash Accounting Scheme (if your turnover is less than £1.35 million). On purchases ensure that VAT is recovered as early as possible.

If you would like to discuss the above in more detail or to check how the changes may affect you personally, please do not hesitate to contact us.