01 April, 2011
From 6 April 2011, as previously announced, the Personal Allowance for those aged less than 65 will increase by £1,000 to £7,475 and so that higher rate tax payers do not benefit from this increase the basic rate limit will be reduced to £35,000. The Chancellor has announced for 2012/13 the Personal Allowance will increase to £8,105 and the basic rate limit will reduce to £34,370.
The Chancellor reiterated that the 50% rate of income tax is only a temporary measure. He has therefore asked HMRC to confirm how much revenue this 50% rate has raised once the self assessment returns have been filed.
The Government has also announced that it will consult on reforms to integrate the operation of income tax and national insurance contributions (NICs). These reforms are not about taxing more but instead simplifying the current system and reducing the burden on businesses. NICs will not be extended to individuals above State Pension age or to income such as pensions, savings and dividends. Due to the complexity involved in this change it will be a number of years before this reform will be introduced. An initial consultation document outlining the differences in the current income tax and National Insurance systems and options to address these will be published later this year.
With the reduction in the basic rate threshold potentially more people will become higher rate tax payers and will consequently be requiring advice on planning strategies to keep tax to a minimum. The most widely applicable strategies include:
Some investors will be drawn to investing for capital growth, in particular, maximising use of the capital gains tax annual exemption of £10,600. With gains in excess of this amount being taxed at 28% for higher rate tax payers rather than income taxed at 40%, 50% or effectively 60% for those with income just over £100,000 where they have lost some if not all of their Personal Allowance. The appropriateness of the investment portfolio, and in particular the degree of risk being assumed will always be capable of overriding the pure tax advantages.
For higher rate tax payers an insurance-based investment bond may well represent a more tax attractive home for reinvested income. Inside a UK life fund dividend income would bear no further tax and other income would be subject (broadly speaking) to a 20% tax rate. There would be a 20% tax credit when a chargeable event gain was realised and tax effective withdrawals using the "5% rule" would be possible.
For those with investment income which causes their gross income to be just over the basic rate threshold, they could consider reinvesting into capital growth oriented investments, investments that defer tax (eg investment bond) or investments that produce tax-free income (eg ISAs). Obviously, the investment risks need to be considered as do the capital gains tax implications on reinvestment.
Couples may consider ensuring that they split their investments between themselves to ensure maximum use of their allowances and lower tax rates.
From April 2013 if at least one of a couple in a family is a higher rate tax payer all child benefit will be lost. The reduction in the basic rate threshold will result in more people paying higher rate tax and potentially losing their entitlement to child benefit. For those who are marginally paying higher rate tax making a personal pension contribution and thus keeping their income within the basic rate band may well be a suitable strategy to consider.
The changes to NICs previously announced will commence on 6 April 2011. The changes include an increase for both employer and employee of 1%, and also changes to the thresholds. In summary the new Class 1 contribution rates from 6 April 2011 are as follows:
The thresholds of £136 and £139 for employer and employee respectively are both an increase from £110 in 2010/11 which offsets some of the impact of the 1% rate increase. The upper employee limit of £817 is a reduction of £27 per week (from £844 from 2010/11) and hence NICs are due at 2% rather than 12% on this portion. There will be winners and losers from these changes, but overall more National Insurance will be paid.
As already discussed, a consultation on the merger of Income Tax and National Insurance has been announced and this is expected to take some years before it is introduced. In the meantime salary exchange continues to be a very tax efficient way of arranging contributions to a pension scheme. This is more so from April 2011 with the increases to NICs of 1%
From 6 April 2011 there will be an increase in the Entrepreneurs' Relief lifetime limit from the first £5 million to the first £10 million of qualifying gains in order to promote enterprise. The rate in such cases will remain at 10%. The annual exemption will increase to £10,600 from 6 April 2011 which is in line with statutory indexation.
Investing for capital growth, in particular, regular use of the capital gains tax annual exemption of £10,600 can deliver long term tax efficiency for both individuals and trustees. Although the increase in Entrepreneurs Relief is good news, for those that have planned for 'their business to be their pension' it should be remembered that from 6 April 2011, the ability to make large tax relieved pension contributions in excess of the Annual Allowance in the year in which benefits are taken will no longer be possible. It is therefore imperative that the appropriate plans are put in place sooner rather than later to address the retirement planning needs of business owning clients.
The Inheritance Tax nil rate band remains frozen at £325,000 until April 2015, after this the Chancellor has announced that the consumer prices index (CPI) will be used as the default indexation for future increases. In addition, for deaths on or after 6 April 2012 a reduced rate of 36% will apply if 10% or more of the deceased's net estate (after deduction of exemptions, reliefs and the nil rate band) is left to a charity.
After a period of consultation, transfers of property into trust will be subject to the Disclosure of Tax Avoidance Schemes. From 6 April 2011 a report will have to be made if a scheme involving a transfer into a trust avoids or reduces the lifetime Inheritance Tax Charge. This will only apply to new and innovative schemes. Schemes already available on 6 April 2011 and new schemes that are substantially the same as existing schemes do not have to be reported, thus discounted gift schemes and loan schemes need not be disclosed unless they have some innovative feature that gives an additional entry charge advantage.
The freezing of the nil rate band makes it important to review nil rate band/transferable nil rate strategies. It cannot be assumed that all couples affected/potentially affected by Inheritance Tax will have already put in place and updated their estate destination and Inheritance Tax/Long term care reduction plans. Reviewing existing Wills also gives the opportunity to consider bequests to charity with a view of benefiting from the new reduced rate of inheritance tax that will apply for deaths after 6 April 2012.
The changes to pension legislation from April 2011 are substantial, and have been subject to considerable discussion in consultations from July, October and December 2010. The following is a very brief summary of the changes:
The Government has confirmed its intention to review the state pension system. The aim is to make the whole system simpler, and this will involve a new 'simple, contributory, flat-rate support above the level of the means-tested guaranteed credit'. Current estimates are that the new pension will be around £140 per week. A change to a flat rate system would mean the end of contracting out for defined benefit schemes. It should be noted that the changes will affect new pensioners only, with benefits earned under existing earning related schemes being protected. Further details are expected in a forthcoming Green Paper.
Finally, anti-avoidance legislation is to be introduced to prevent employers, directors and employees who use third party arrangements to avoid restrictions on pensions tax relief. The Government confirmed that the scope of the legislation will include Employer Financed Retirement Benefit Schemes (EFRBS). The new rules are effective from 6 April 2011, although anti-forestalling provisions also apply between 9 December 2010 and 5 April 2011. In general, it means that when contributions are made to an EFRBS which are earmarked for an individual, they will be subject to both Income tax and National Insurance.
For those caught by the anti-forestalling provisions (relevant income of £130,000 and above), there may be an opportunity to pay additional contributions after 5 April 2011. The anti-forestalling provisions limited pension contributions to £20,000 (up to a maximum of £30,000) or protected pension inputs. The introduction of carry forward from 6 April 2011 will allow those who have made contributions of less than £50,000 in the last 3 tax years to carry forward this relief subject to them having been a member of a Registered Pension Scheme at some point in each of the relevant carry forward years.
The increase to the recovery charge on specific lump sum death benefits from 35% to 55% for members who die on and after 6 April 2011 is likely to increase the attractiveness of monthly phased drawdown compared to the standard and annual alternatives.
For tax year 2011/12 the annual investment limit for adults will be £10,680, up to £5,340 of which can be saved in cash. In line with the Government's intention to move the underlying indexation assumptions for direct taxes to CPI future increases in the ISA limits will be by reference to this instead of the retail price index. In October 2010 the Government announced it would introduce a Junior ISA for UK resident children who do not hold a Child Trust Fund. Legislation will be introduced in the Finance Bill and it is expected that Junior ISAs will be available from the autumn of 2011.
Investors should be encouraged to maximise their ISA limits. Especially those who will be (or could be) affected by the 50% additional rate and/or removal/reduction of personal allowances. With the reduced Annual Allowance for pension contributions ISAs represent a very tax efficient pension alternative. With the cost of university education, house prices and the high cost of weddings, it has never been more important to begin a programme of savings for children and grandchildren. The new Junior ISA gives the opportunity to discuss with clients and implement a simple tax efficient investment solution for children.
For the 2011 Financial Year the small companies' rate will reduce to 20%. In addition, the main rate will reduce to 26%. The main rate will then be subject to three further one per cent cuts to 23% by the Financial Year beginning April 2014
Giving consideration to corporation tax rates is essential when advising companies on tax planning, especially where the planning incorporates tax deductible pension contributions.
For sole traders and partners who are likely to be affected by the 50% additional rate the appeal of incorporation may be considered, especially where a substantial amount of business income may be retained.
For existing company owners, the extent that they do not need to pay out funds, interest in fund retention and reinvestment in the company is likely to increase. This will be especially so if there is the future
opportunity to benefit from the increased Entrepreneur's relief at £10 million and CGT rates at 10%,18% and 28%.
For further information or advice on any of the above issues contact a member of the Financial Services Team on 01772 220022.