Tax Year Planning

Child Benefit and Personal Allowance

The two common strategies to ‘adjust’ income downwards include pension contributions and gift aid payments. This adjusted net income can mean no High Income Child Benefit charge is applicable nor Personal Allowance is lost.

Incomes over £123,700

Receiving income well above £100,000, i.e. over £123,700, should not be seen negatively by tax payers. While it is true that there is a higher effective rate of tax applicable between £100,000 and £123,700, on a percentage basis, the reduction in the tax free allowance is not as bad as one might imagine.

For example:

An investor receiving non-savings income of £50,000 per annum from, for example, a pension and dividends of i) £45,000, ii) £60,000 and iii) £85,000, the tax payable would be: Once total gross income reaches £150,000, Additional Rate of tax is paid on this marginal income. As above, non-savings and savings income is taxed at 45% whilst dividend income is taxed at 38.1%.

Once total gross income reaches £150,000, Additional Rate of tax is paid on this marginal income. As above, non-savings and savings income is taxed at 45% whilst dividend income is taxed at 38.1%.

Dividends:

Dividends benefit from a lower rate of tax than savings and non- savings income, such as wages or pension income.

	Income from Employment, Property, Trusts, Savings, Chargeable Event Gains	Dividends from Shares
Income Tax within the Basic Rate band	20%	7.5%
Income Tax within the Higher Rate band	40%	32.5%
Income Tax within the Additional Rate band	45%	38.1%

Capital Gains Tax

Capital gains tax (CGT) is a tax charged if you sell, give away, exchange or otherwise dispose of an asset and make a profit or 'gain'. It is not the amount of money you receive for the asset but the gain you make that is taxed. Broadly, to calculate a capital gain, you compare the sales proceeds with the original cost of the asset.

However, CGT rules can be complicated and specialist advice may be required from a Tax Adviser. You may have to pay CGT when you give an asset as a gift to someone. CGT rules may vary depending on who you give the gift to and what the asset was. There are special reliefs for gifts of business assets.

There are some assets which are free of CGT. The most common examples are:

— Main residence

— Private motor cars, including vintage cars

— Gifts to UK registered charities

— Some Government securities

— Personal belongings (or ‘chattels’) where the sale proceeds are less than £6,000

— Prizes and betting winnings

— Cash

— Assets held in ISAs

— Foreign currency held for your own use.

Annual exemption

Each tax year, most UK residents are allowed to make a certain amount of capital gains before they have to pay CGT. This is because they are entitled to an annual tax-free allowance, called the annual exemption or annual exempt amount. For 2018/19 you may make gains of £11,700 tax free. Any unused exemption cannot be carried forward or back.

Rates of CGT

The rate of CGT you pay depends partly on what type of chargeable asset you have disposed of and partly on the tax band into which the gain falls when it is added to your other taxable income.

From April 2017, CGT is charged at the rate of 10% (or 18% on residential property) for gains falling in the Basic Rate band. For gains falling into the Higher Rate band or Additional Rate band, the rate is 20% (or 28% on residential property). For example, if you are normally a Basic Rate taxpayer but when you add the gain to your other taxable income you are pushed into the Higher Rate threshold, then you will pay some CGT at both rates. There is a special rate of 10% (entrepreneurs' relief) that applies on the sale of certain business assets.

Spouses and civil partners could transfer investments to the lower taxpaying spouse, so that when they are eventually sold part of the gain may be charged at 10% and not 20%. This could be combined with an income tax election if one spouse wished to receive and be taxed on most of the income. They would also be taxed on part of the gains, which might be useful in ensuring their annual CGT exemption is not wasted.

The historically low CGT rates may provide an opportunity for investors who have undiversified portfolios to reduce stocks they have proportionately too much of. This could be particularly pertinent in light of the current uncertainty in British politics as a new government could be inclined to increase CGT rates. A balanced, well diversified portfolio will help minimise the risk of loss. For example, if one investment performs poorly over a certain period, other investments may perform better over the same period.

Pension planning

As discussed above, individuals may be able to recover part of the income tax paid through tax-efficient pension planning.

— Pension contributions are paid net of 20% tax, meaning for each £80 paid to the scheme HMRC matches that with a £20 rebate to the pension company, topping the investment up to £100. Higher Rate and Additional Rate taxpayers can claim tax rebates at their marginal rates. However, the maximum annual allowance for pension contributions is £40,000. This is gradually tapered down to a minimum of £10,000 once a person’s gross income reaches £210,000.

Share investors

Where dividends are received, either through traditional investments or a family company, there are a number of options available for shareholders:

— Spouses and civil partners can transfer investments between each other free of CGT. The transferee is taxable on dividends declared after the transfer. The transfer will be in the form of a gift.

— Where investments are owned jointly by spouses or civil partners, for income tax purposes they are taxed equally on the income irrespective of their underlying interest in the investments. Often, equal taxation is acceptable, but in cases where one partner wishes to transfer income to another who pays tax at a lower rate there must be a genuine transfer of the underlying capital. It is then necessary to make a formal election on HMRC Form 17 to be taxed on the new unequal basis.

Property investors

Landlords can enjoy similar flexibility with land ownership that investors do with shares.

Spouses and civil partners can hold the land in unequal shares and can therefore share rental profits in unequal proportions to benefit partners with unused lower tax bands. Again, HMRC have to be notified and there should be a Declaration of Trust to confirm this ownership which will be as ‘tenants-in-common’.

Individual Savings Accounts (ISAs) It is always worth mentioning ISAs

(including Junior ISAs and Lifetime ISAs) as we approach the end of the tax year. The standard ISA allowance for 2018-19 is £20,000 per adult. The gains on which are tax-free – and income is also exempt from income tax.

Parents and even grandparents can fund Junior ISAs on behalf of younger generations. The annual subscription limit for Junior ISAs for 2018/19 is £4,260. From age 16, a child can also have an adult cash ISA alongside their Junior ISA. They can still only save £4,260 per tax year in the Junior ISA, but they could also save up to £20,000 extra in an adult cash ISA between age 16 and 18.

The Lifetime ISA (LISA) can be used to fund the purchase of a first home or save for later life. Investors must be 18 or over but under 40 to open a Lifetime ISA. LISA holders can put in up to £4,000 each year, until their 50th birthday. The government will add a 25% bonus to your savings, up to a maximum of £1,000 per year.

ISAs provide a good opportunity to create tax-free capital gains by setting aside relatively modest sums. If it is the older generation in a family that has the money, funding these investments out of surplus income or capital has useful inheritance tax benefits.

Inheritance tax

Inheritance tax is paid on death and occasionally on gifts into trust where the value exceeds £325,000. The rate of tax applicable is 40%. There are a number of things that individuals can do on an annual basis when looking to reduce the amount of tax HMRC may be due on death.

— Regularly update values of assets and consider if there is any scope to give away surplus assets based on reasonable life expectancies. This avoids surplus wealth continuing to accumulate unnecessarily and being exposed to the 40% charge on death.

— Divestment can take many forms, but usually capital gifts are made either outright to individuals or into a family trust. The latter is useful if the intention is to build up some wealth in a trust that can be responsive to the needs of younger individuals such as assistance with education of adult children, house purchases or funding their early careers or business start-ups.

— An annual review of wealth and income, particularly for those aged over 60, can indicate whether a range of different types of gift can take place. Normally, a donor has to survive seven years before the gift is treated as being outside of their estate. However, the following are never included once made:

— Annual gifts of £3,000 in total per donor.The annual gift exemption can be carried forward one year if not used, so in appropriate cases there may be a £3,000 allowance from 2017-18 and also an allowance of £3,000 from 2018-19.

— Small gifts of £250 to any number of individuals. This relief is to ensure that on death, modest gifts such as birthday presents do not have to be accounted to HMRC. However, the relief cannot be used in conjunction with another gift – i.e. it is not possible to make a gift of £3,250 to one individual and on death claim both the annual gift exemption and the small gift exemption, if the donor dies within seven years.

— Gifts made out of ‘normal income’ can avoid double taxation. Suppose a person’s net annual income from pensions, work and investments were £48,000 a year but they only needed £36,000 to live on, year in year out, and this could be demonstrated by looking at current account statements each year. If the surplus income of £12,000 were accumulated into savings there would be double taxation because that net income having suffered income tax at rates as high as 45% is then exposed to a further 40% inheritance tax on death. The combined effective tax rate could be as high as 67%. By arranging and documenting regular gifts of this surplus income to family beneficiaries or their executors (of their estate), and proving that it was genuinely not needed each year, the gifts will not count as capital on death. Gifts of surplus income can be made to beneficiaries outright or into a wider family trust.

— In addition to the above annual gift reliefs, a donor may wish to make ad-hoc larger capital gifts. These are called ‘potentially exempt transfers’, which means they gain full exemption only when the donor survives seven years. They are one of the most common form of gifts, used in addition to the annual gifts referred to above, and when integrated into other forms of tax planning can be quite powerful.

— Relatively modest amounts can therefore be transferred away, which combined with other tax-efficient savings investments, can produce material returns and make a difference for the younger generations.

The information provided in this article is of a general nature. It is not a substitute for specific advice with regard to your own circumstances. You are recommended to obtain professional advice from a professional accountant or solicitor before you take any action or refrain from action.

To meet one of our Chartered Financial Planners to discuss tax and estate planning, please contact your investment manager who will be happy to arrange a meeting.