News & views

23 January 2012

Tax year end planning

The approach of the tax year end is an ideal time to review clients' tax situations and lifetime financial plans. This News & Views update sets out the main areas to be considered.

Tax-efficient investment opportunities

Where appropriate, make full use of tax-free investment opportunities:

• Use the 2011/12 £10,680 stocks and shares ISA allowance in full.
• Make arrangements to use the £11,280 2012/13 allowance as early as possible in the new tax year – to maximise the benefits throughout the tax year.
• National Savings: no tax free products currently available (but see investing for children and grandchildren below).

Think about whether tax-favoured investments are suitable:

• If suitable, investing in a Venture Capital Trust (VCT) or Enterprise Investment Scheme (EIS) offers relief against a 2011/12 income tax bill of 30% of the amount invested (assuming tax payable of this amount).
• Maximum investment: £200,000 VCT; £500,000 EIS.
• Income and capital gains generated within a VCT are tax-free.
• Under an EIS, capital gains are tax-free.
• An EIS also offers the opportunity to defer or claw-back tax on capital gains realised in the past three years or to anticipate a chargeable disposal in the next twelve months.

Consider investments for children/grandchildren:

• National Savings Children's Bonus Bonds are still available for children under age 16. The limit is £3,000 for each child, currently 2.5% AER compound guaranteed over the first 5 years, then a fixed rate notified at each 5th anniversary to age 21 and a final bonus on the 21st birthday; they are tax-free even if the funds are provided by the child's parents.
• Consider if cash-only ISAs for 16 and 17 year olds (maximum £5,340 in 2011/12) are suitable (NOTE: if funds are provided by the child's parents, income may be taxed as income of the parent).
• Consider if Junior ISAs or topping up a Child Trust Fund for children under age 18 (maximum £3,600) is appropriate.
• Funding a stakeholder pension plan can be a very effective way of providing for children or grandchildren. No access is possible until age 55, which may be a desirable outcome; a gift of £2,880 is grossed up for basic rate tax to a contribution of £3,600 and the investment is in a near-gross fund. Younger generations may well have less generous pension arrangements than their parents/grandparents and will have to wait longer for state or occupational pensions to kick in. The individual may also benefit from reducing the taxable estate potentially subject to inheritance tax each year.

Review investments held by couples:

• If one partner pays tax at a higher rate than the other, consider if income-producing investments should be held in the name of the partner paying tax at the lower rate.
• This is especially important where total income is just over a threshold (see income tax planning below).

Review investment structures:

• The current personal tax regime favours returns from growth over returns from income.
• Moving from a typical stockbroker managed portfolio to a portfolio managed within a tax-efficient structure (such as Towry's Independent Investment Management service) may significantly reduce taxable income.

Retirement planning

Fixed protection:

• The Lifetime allowance on pension savings is to reduce from £1.8m to £1.5m from 6th April 2012. Individual retirement plans should therefore be reviewed to decide if it is appropriate to apply for fixed protection, thus preserving a £1.8m lifetime allowance and the opportunity to take a larger tax-free sum. This has to be balanced against the requirement that in order to qualify for fixed protection there can be no further contributions or benefit accrual after 5 April 2012.

Make the most of current tax reliefs:

• There is political pressure to remove pensions' tax relief at the higher rates and it is clear that Government finances are still severely stretched. The official position is that the Government remains committed to providing pension saving incentives and has no current plans to restrict tax relief on contributions. However, changes next year in Budget 2012 are always possible and if relief at 40% or 50% is available now on contributions to an existing pension scheme, it may be sensible to maximise this tax benefit as soon as possible.
• Use the 'carry forward' rules to maximise tax-relieved contributions above the normal £50,000 annual allowance in the current year, especially for clients who were subject to the anti-forestalling rules in the past three tax years. An unused annual allowance from 2008/09 will be lost if not used by 5 April 2012.
• Recent HMRC clarification of the carry forward rules may mean that some clients have greater scope to contribute in the current year, or to make further contributions. Spreading contributions over two pension input periods is also possible.

Review existing arrangements where the tax-free lump sum has been taken but no income is currently drawn down:

• Unless the remaining fund is used to provide an annuity or drawdown for a surviving dependant, a 55% tax rate would apply to any lump sum payment on death.
• Income could be gifted to reduce the taxable fund on death or reinvested tax-efficiently.

For younger clients, consider the impact of the planned rises in State Pension Age:

• The State Pension Age rises to age 66 in 2020, and rises again to age 67 from 2026.

Income tax planning

Avoid the loss of the income tax personal allowance:

• If 'net adjusted income' exceeds £100,000, the personal allowance is reduced by £1 for every £2 of the excess. In 2011/12 this means that the personal allowance is lost in full where net adjusted income is £114,950 or more.
• A pension contribution reduces net adjusted income and can result in an effective tax relief rate of 60%.
• A gift aid payment to a registered charity can also mean that the personal allowance is restored.
• A salary exchange arrangement to reduce net adjusted income below £100,000 (including arrangements where the employer makes a pension contribution) will also mean national insurance contribution (NIC) savings.
• Check that gains or excesses under investment bonds do not impact on the personal allowance (even if no further tax is payable on the gain or excess itself).

Check whether total income in 2012/13 will be close to a relevant tax threshold (£34,370, £100,000 and £150,000).
• Transferring savings investments by outright gift to a partner who pays tax at a lower rate could keep total taxable income below the threshold (note: consider the capital gains tax implications if not to a spouse or registered civil partner with whom the client is living).

• Consider pension contributions, gift aid payments and salary exchange arrangements as above.

Capital gains tax planning

Make full use of the annual exempt amount - £10,600 in 2011/12 and remaining at this level in 2012/13:

• On chargeable assets, realise gains within the exemption before 6 April 2012.
• Avoid a repurchase of shares or units of the same class within thirty days of the sale (otherwise the disposal is matched with the repurchase and is not effective for capital gains tax purposes).
• Consider bed and ISA or bed and pension planning to avoid the thirty-day matching rule from applying.
• Consider no gain/no loss transfers between spouses/civil partners who are living together so as to able to use two annual exempt amounts.
• Consider whether to crystallise losses to be set off against current year gains on other chargeable assets.

Where a business interest or asset may be sold within the next two years:

• Check whether the disposal will qualify for entrepreneurs' relief (reducing the capital gains tax rate from 28% to 10% up to a lifetime limit of £10m of gains).
• Carry out an entrepreneurs' relief audit to advise on dressing the business for sale.

Wealth protection and estate planning

Review life insurance and pension arrangements:

• In a typical year, 4% of all inheritance tax paid relates to life insurance policies not written in trust.
• Consider whether lump sums payable on death before pension benefits are crystallised should be held within or paid to a suitable trust, instead of being simply accumulated in the estate of a surviving spouse or civil partner (with an exempt benefit then becoming taxable on the second death).

Maximise use of exemptions and reliefs:

• Use the £3,000 annual exemption (and any unused exemption carried forward from 2010/11).
• Make small gifts within the £250 exemption – a possibly apocryphal case involved a wealthy woman gifting £250 each Christmas to her 27 grandchildren and great grandchildren; if true, this would mean an inheritance tax saving of £13,500 over five years.
• Note that gift aid payments can be carried back to 2010/11 if taxable income in 2011/12 has reduced and would fall within a lower tax band.
• Where charitable gifts on death are contemplated, consider whether clients need to review their will. This needs to be undertaken now to take into account the reduction in the inheritance tax rate that is intended to apply for deaths on or after 6 April 2012 where 10% or more of the net estate is left to charities.
• Where there is surplus income, consider gifts using the normal expenditure exemption. There is no limit on the amount which qualifies for this exemption provided the gifts are made from income, that taking one year with another the gifts represent normal expenditure and that the gifts do not reduce the donor's normal standard of living. Documentation of the intention and commitment to make regular gifts is essential – although there is no requirement to make gifts of exactly the same amount at the same time to the same person or persons; for example, the client could simply document that he or she has resolved to give away 10% of income or all investment income.

Where appropriate, and within the context of a lifetime financial plan, consider larger gifts:

• The March 2006 changes to the taxation of trusts mean that clients generally need to start planning at an earlier age. Consider using the nil rate band (£325,000), with further gifts then being possible on survival for seven years. A couple in their early 60s could reasonably expect to be able to reduce their taxable estates by nearly £2m using this simple planning strategy.
• Lifetime gifts will necessarily require consideration of the financial position, circumstances and, possibly, the business interests of family members and/or whether an outright gift or a gift to trust is appropriate and/or whether a packaged solution such as a loan trust or discounted gift trust would best meet the client's needs and objectives.
• Where the gift would involve the disposal of a chargeable asset, consider whether the potential inheritance tax saving outweighs any immediate charge to capital gains tax.
• In some circumstances, accelerated estate planning using a tax-led investment qualifying for 100% business property relief after two years ownership would be appropriate. Tax-led investments can also be the basis for transferring assets valued at greater than the available nil rate band to a discretionary trust with (a) an improved wealth preservation position – as compared to outright gifts – in the event of divorce, insolvency or premature death within the beneficial class, (b) no immediate charge to inheritance tax at the lifetime rate and, (c) no concerns about the tax disclosure rules.

Use a life insurance policy subject to trust to cover the potential liability of death:

• Temporary cover can provide time to implement longer-term planning.
• The Office of Tax Simplification is undertaking a thoroughgoing review of inheritance tax (and by implication, capital gains tax). This could prompt the acceleration of some lifetime planning if it is feared that exemptions and reliefs may be curtailed (with life cover to protect against death within seven years) but could equally mean that planning is delayed (with life cover to protect the current liability).

Directors and owner-managed businesses

Review remuneration arrangements and dividend policy:

• Many small companies (probably the majority) have an accounting period ending 31 March. Under a tax regime where personal tax and NIC rates remain high and corporation tax rates are reducing, remuneration strategies need to be considered very carefully. This might also include, for example, employing a spouse or partner or other family member in the business.
• Profits paid out as salary or bonus could be subject to income tax at up to 5O% + employers and employees NIC. Profits paid out as dividends could be subject to income tax at up to 36.11% of the net dividend. On the other hand, pension planning can still be a highly tax-effective way of extracting profits (subject to the limitations of the annual allowance and any carried forward allowance).

Where profits are retained within the company structure for a longer-term business purpose:

• Investing on a discretionary management basis using a wide range of asset classes and with a relatively low natural yield and control of the tax point on gains will be as valuable for corporate investors as for individuals.
• Companies also continue to qualify for indexation relief on realised gains, so that inflation gains are not taxed.
• A tax-efficient investment structure giving control of the tax point on gains means that gains could be realised in an accounting period when there are trading losses, thus offsetting the gain against the loss.
• Where trading companies hold funds on deposit or in investments, there should be a regularly updated board minute or a note in the accounts confirming the specific business purpose for which the funds are held – to avoid prejudicing a claim for business property relief by the executors of the business owner on death or the availability of entrepreneurs' relief on a sale.

Family trusts

Reviewing investments:

• Trustees have a legal obligation to review, from time to time, trust investments and to do this on the basis of proper  investment advice from a suitably qualified person or firm.
• Given recent market volatility, it is especially important that trustees also have regard to the suitability of the trust investments and the need for diversification of trust assets.
• Life tenant trusts may need review to consider if the investments made mean that the trustees are maintaining a fair balance between the interests of life tenant, entitled to trust income, and those ultimately entitled to trust capital.

Where an inheritance tax periodic charge would be payable on the next 10-year anniversary, forward planning using tax-led investments can reduce or eliminate the tax charge where such investments would be appropriate as part of the overall trust portfolio (subject again to the same point regarding authorisation to advise trustees on these investments).

Looking forward

Lifetime financial planning is a continuous 'looking forward' process:

• Is a suitable plan in place, so that any tax planning is undertaken within the right context?
• Does any existing lifetime financial plan need review to take account of new circumstances?
• A Towry Financial Review Service agreement is a very cost-effective way of keeping plans under review and in implementing routine planning.

If you would like to learn more, please speak to your usual contact at Towry.

Disclaimer
For Professional Adviser Use Only

 

Download PDF

Disclaimer
For Professional Adviser Use Only