The end of the tax year on 5 April is once again looming large on the horizon. It is important to ensure that, if we have not done so already, we take the time to carry out a review of our tax and financial affairs to identify any tax planning opportunities and take action before it’s too late.
There are a number of significant tax changes coming into effect from 6 April, including:
- A divergence in the threshold at which Scottish resident taxpayers will be liable to pay the higher rate of income tax.
- Restrictions for higher rate taxpayers for interest relief on the financing of residential property investments.
- The introduction of the residence inheritance tax nil rate band.
- Extension of the UK inheritance tax regime to foreign owned, indirectly held UK residential property.
- The introduction of a new Lifetime ISA for first time buyers.
This article provides a summary of the main tax reliefs, exemptions and allowances on offer, together with some planning tips that could help you protect your wealth by maximising the tax benefits available to you.
- Higher (40%) and additional rate (45%) taxpayers should consider reviewing their own personal tax position with that of their spouse/civil partner (for convenience, referred to throughout as “spouse”) and/or other family members.
- Everyone earning less than £100,000 currently receives a tax-free personal allowance of £11,000. Taxpayers should ensure that the personal allowance of a non-taxpaying spouse is fully utilised. The personal allowance will increase to £11,500 in the 2017/18 tax year.
- Individuals earning more than £100,000 per year should be aware that their personal allowance is reduced by £1 for every £2 that their taxable income is above £100,000. Where this reduction applies, the effective rate of tax is up to 60%. Steps can be taken by careful use of, for example, tax relievable pension contributions or gift aid donations to charity to avoid this.
- The transfer of certain income-producing assets to other family members may be attractive if they are non-taxpayers, are subject to lower rates of income tax or have available personal savings allowance or dividend allowance (see below). This strategy could result in an income tax saving of up to 45%. If, for example, a spouse has a lower rate of income tax, savings accounts could be placed in joint names in order to share the income tax liability on the interest. Parents will still, however, be subject to income tax on income arising from assets gifted by them to their minor children (subject to a de minimis limit of £100). Income arising from assets gifted by grandparents to grandchildren, however, would be subject to income tax in the grandchildren’s hands.
- The transfer of income-producing assets from one spouse to the other may also enable both spouses’ taxable income to stay below the High Income Child Benefit Charge threshold of £50,000.
- Family businesses provide a number of opportunities to control the income tax exposure of both owners and employees. Family members could be introduced to the family business as co-owners and/or employees and be provided with income in some form. Salary, profit share or dividends may then be taxable at lower rates of tax. It is important that any remuneration is justifiable and genuine.
- Owners of family companies can consider declaring a dividend rather than taking additional salary in order to minimise their income tax and NIC exposure.
- The tax regime for dividends changed with effect from 6 April 2016, resulting in the tax rates on dividends not covered by the new £5,000 tax-free dividend allowance being 7.5% greater than in the previous tax year. The effective rate of tax for a basic rate taxpayer is 7.5% and for higher rate taxpayers 32.5%. Those paying tax at the highest rate and trustees pay income tax on dividends at 38.1%. It was announced at the Spring 2017 Budget that the dividend allowance will be reduced to £2,000 from 6 April 2018.
- Salary sacrifice schemes may enable employees to make tax-efficient pension contributions (see below) and potentially protect their personal allowance.
- Under the current tax rules landlords can claim a full income tax deduction for allowable finance costs (e.g. mortgage loan interest, arrangement fees, repayment fees, etc..) relating to buy-to-let residential property. Tax relief on all allowable finance costs will be restricted to the basic rate of income tax (currently 20%) for landlords of residential property by 6 April 2021. The new rules will be phased in over 4 years from 6 April 2017. The restrictions will apply to individuals, partnerships and trusts.
- It is important to consider the other tax implications on any proposed transfer of assets (e.g. capital gains tax and inheritance tax) and also the fact that you no longer have ownership or control of those assets in the future.
- Donations to charity can be used to reduce a higher or additional rate taxpayer’s income tax bill by allowing the income tax paid above the basic rate to be reclaimed.
- Beneficiaries of discretionary trusts can recover income tax on distributions of income by trustees, by virtue of their individual personal allowances and basic and higher tax bands.
Capital gains tax (CGT)
- Individuals currently receive an annual CGT exemption on the first £11,100 worth of chargeable gains arising in the 2016/17 tax year. Anyone who has not used up their exemption for the year should consider whether they wish to sell or otherwise dispose of assets in order to obtain up to £11,100 of tax-free gains.
- Gains realised by higher rate taxpayers in excess of their annual exemption are currently subject to CGT at a rate of 20% (28% for capital gains on residential property).
- Gains realised by basic rate taxpayers are subject to CGT at a rate of 10% (18% for residential property gains) if the gains fall within their available basic rate band once their taxable income has been taken into account. Gains in excess of the basic rate band limit are taxed at 20% (28% for residential property gains).
- Splitting disposals over two tax years or delaying triggering gains until the next tax year may enable you to benefit from two CGT annual exemptions and/or delay the payment of CGT by another 12 months to 31 January 2019 for disposals after 5 April 2017.
- Transfers between spouses are CGT-free. Spouses should therefore consider making transfers between each other prior to any planned disposals in order to take full advantage of available CGT exemptions, capital losses and/or a lower rate of CGT.
- If you are a higher or additional rate income taxpayer, it may be advantageous to invest in assets which produce capital growth, rather than income. This could result in gains taxed at 20%, rather than income at 40% or 45%.
- Losses can be set off against an individual’s chargeable gains. Taxpayers with a considerable CGT liability for this tax year could consider if they would wish to dispose of any loss-making assets which have decreased in value enough to produce a loss to set off against the capital gains for the year.
Inheritance tax (IHT)
- An individual can make annual IHT-exempt gifts of up to £3,000 with any unused relief being carried forward for one year (e.g. up to £6,000 may be available in the 2016/17 tax year if no gifts were made in the 2015/16 tax year).
- There are also a number of other forms of IHT-exempt gifts including small gifts of up to £250 to any one person and gifts to charities.
- Gifts out of your surplus income will also qualify for IHT-exemption if you satisfy certain conditions.
- Gifts above the annual exemption can be made to family members and other persons. No IHT is chargeable if the donor survives at least seven years after the gift.
- Transfers to a spouse are exempt from IHT. This allows assets to be transferred free from IHT between spouses to take advantage of each spouse’s income tax and CGT position.
- The residence IHT nil rate band will potentially be available for deaths on or after 6 April 2017 where the deceased leaves an interest in property which at some point has been their main residence. This top-up relief will initially be set at £100,000 and will rise to £175,000 by 6 April 2020. Restriction to the relief will apply where the net value of the deceased’s estate is over £2 million.
- The Government is introducing legislation with effect from 6 April 2017 to bring the value of UK residential property held indirectly (e.g. through an overseas company or trust) into the UK IHT regime. This measure is designed to target non-UK domiciles. Where property is held this way a review of how ownership is structured is recommended.
- The end of the tax year can be an ideal time to review an individual’s will to ensure that it allows assets to be passed on in the most tax-efficient manner.
- The Government provides income tax relief on pension contributions within an individual’s annual contributions limit.
- The lifetime allowance for pension savings was reduced to £1 million with effect from 6 April 2016. The annual pension contributions limit of £40,000 is reduced by £1 for every £2 of earnings in excess of £150,000. Anyone funding their pension based on the previous higher lifetime limit of £1.25 million should take advice to ensure the value of their pot is protected from a tax charge on any excess.
- Pension contributions can be made on behalf of anyone of any age, including children and grandchildren. Contributions of up to £3,600 (gross) per year can be paid on behalf of non-earners. This would require a contribution of £2,880 net of income tax relief, with a 20% contribution from HMRC.
- If you earn more than £3,600, you can pay up to the whole of your earnings into a pension scheme, but the relief is capped by the annual allowance of £40,000. Any unused annual allowance in the previous three tax years can also be brought forward to obtain tax relief on contributions provided you have the required level of earnings in the year you make the payment.
- Non and basic rate taxpayers should receive 20% income tax relief on their pension contributions. Higher or additional rate taxpayers may be able to claim tax relief of at least 40% or 45%.
- Income and capital gains arising within pension funds are generally tax-free.
- Sweeping changes to pensions were introduced from 6 April 2015. Most taxpayers aged 55 and over now have much greater flexibility going forward when looking to draw down their pension savings. It is important to take specialist pension advice prior to making any pension contributions or decisions relating to accessing your pension fund on retirement.
Individual Savings Accounts (ISAs)
- An ISA as an investment vehicle offers a range of benefits including tax-free income and capital gains, easy access and encashment.
- An individual can currently invest up to a total amount of £15,240 in an ISA in the 2016/17 tax year. Any unused annual allowance cannot be carried forward and should be used within the tax year. The ISA limit will increase to £20,000 in 2017/18.
- The ISA allowance can be split between stocks and shares, and/or cash, according to the preference of the taxpayer.
- Junior ISAs are available to those under age 18 who do not already have Child Trust Funds and up to £4,080 can be paid into a Junior ISA in the 2016/17 tax year. The Junior ISA limit will increase to £4,128 in 2017/18. For children with Child Trust Funds, the same level of contributions can also be made.
- A new Lifetime ISA will be introduced from 6 April 2017 into which individuals aged between 18 and 40 will be able to pay up to £4,000 every tax year. The Government will pay a 25% bonus (i.e. £1 for every £4 invested) into the ISA at the end of each tax year. The Lifetime ISA can be used as deposit by a first time buyer.
Enterprise Investment Scheme (EIS)
- The EIS offers attractive tax breaks for investment in new shares of qualifying unquoted trading companies.
- Income tax relief is given at 30% on qualifying investments of up to £1 million in the 2016/17 tax year (i.e. a potential tax saving of up to £300,000).
- The income tax relief on the cost of shares acquired in 2016/17 can be carried back to the 2015/16 tax year to provide relief against the income tax liability for that year.
- CGT on gains arising on the disposal of any asset can be deferred through investing in shares that qualify under the EIS.
- There should be no CGT on gains arising from the disposal of qualifying EIS shares after 3 years of ownership.
Seed Enterprise Investment Scheme (SEIS)
- The SEIS operates in a similar manner to the EIS, but instead applies to small, early-stage companies which satisfy certain qualifying criteria.
- Taxpayers can invest in the SEIS and claim income tax relief on 50% of the cost of a qualifying investment up to £100,000 in the 2016/17 tax year (giving a potential maximum tax saving of £50,000).
- There should be no CGT on gains arising from the disposal of qualifying SEIS shares after 3 years of ownership.
- A CGT exemption is available for chargeable gains which have arisen on the disposal of assets during the 2016/17 tax year, but which are then reinvested into shares which qualify for SEIS income tax relief. Capital gains of up to £50,000 (i.e. 50% of the annual investment limit) can qualify for this re-investment relief resulting in a CGT saving of up to £14,000 (£50,000 @ 28%).
Venture Capital Trusts (VCT)
- VCTs are a form of investment trust that invests in a range of relatively small trading companies.
- Income tax relief is given at up to 30% on qualifying investments of up to £200,000 in the 2016/17 tax year in a VCT (e.g. a potential saving of up to £60,000).
- Dividends on VCT investments are tax-free.
- There is no CGT deferral relief available into VCTs for gains arising on other assets, but capital gains arising on the disposal of VCT shares themselves should be CGT-free if the shares have been held for a minimum period of 5 years.
- It is important that potential investors in EIS, SEIS, and VCTs are aware that these investments are generally favoured by higher risk investors, who are prepared to tie their money up for a number of years in exchange for attractive tax reliefs.
Social Investment Tax Relief (SITR)
- Similar in many ways to EIS relief, income tax relief is given at 30% on the acquisition of shares or qualifying debt instruments in social enterprise activities of up to £1 million per tax year through to 5 April 2019.
- CGT on gains arising on the disposal of any asset in the period to 5 April 2019 can be deferred through investments that qualify under the SITR rules.
- There are no tax reliefs for income arising from SITR investments. Dividends and interest are taxed in the normal manner.
- Capital gains arising on the disposal of the SITR investments themselves are CGT-free if the investments have been held for a minimum period of 3 years.
- Land and buildings transaction tax (LBTT) replaced Stamp duty land tax (SDLT) for property transactions in Scotland with effect from 1 April 2015.
- A supplementary 3% LBTT/SDLT charge is applied on the acquisition of “additional” residential properties (e.g. second homes, buy-to-lets, etc...) with effect from 1 April 2016.
- The 10% wear and tear allowance previously available to reduce taxable rental income for furnished property was abolished from 6 April 2016. Taxpayers are now only able to claim the actual cost of replacing furnishings.
- The income tax “rent a room relief” available for taxpayers letting out rooms in their own home increased to £7,500 from 6 April 2016.
- Individuals with gross income arising from property of under £1,000 in a tax year will no longer be subject to income tax or have to report the income to HMRC with effect from 6 April 2017.
- Residential property worth more than £0.5 million and owned by a “non-natural person” (e.g. a company) is subject to an Annual Tax on Enveloped Dwellings (“ATED”). If you hold or are planning to hold property through a holding company, consider whether this ownership structure is still tax-efficient for you.
- The Government is introducing new tax rules from 6 April 2017 to bring the value of foreign owned UK residential property held indirectly (e.g. through a company or trust) into the UK IHT regime.