TAX NEWS - JUNE 2010

Britain Tax: Easing the tax rise burden by making shrewd investments

02 June 2010 -- With increases in taxation expected in the new Chancellor's emergency budget on June 22 following on from the tax increases for high earners and trusts introduced by the previous Government, it is now more important than ever to take advantage of tax efficient savings and investment opportunities.

The Labour Government introduced the 50 per cent rate of income tax for individuals with income of more than £150,000 and also brought in measures to be effective from next April, to restrict the tax relief they receive on pension contributions.

Anyone likely to be affected by the restriction on tax relief may wish to bring contributions forward and pay them during this tax year.

However, "anti-forestalling" regulations mean that if individuals whose income exceeds £130,000 (not £150,000) pay contributions exceeding certain limits, a "special annual allowance tax charge" may be payable. Careful planning and professional advice is needed for people in this category.

It is not only individuals with income of more than £150,000 (or £130,000) who will, potentially, suffer a greater tax burden.

Introduced on April 6, individuals with "adjusted net income" of more than £100,000 will lose their personal allowance, currently £6,475 at the rate of £1 for each £2 of income more than £100,000. This means that someone with adjusted net income of £112,950 will lose the allowance completely and, as a result, will pay extra tax of £7,770, an effective marginal tax rate of 60 per cent on the top £12,950 of income.

Adjusted net income is, essentially, taxable income less certain deductions such as trading losses, the gross amounts of personal contributions to pension schemes and grossed-up gift aid payments.

In simple terms, this means an individual with gross taxable income of £112,950 might pay a gross pension contribution of £12,950 thereby reducing their adjusted net income to £100,000 and restoring their full personal allowance. In so doing, they would reduce their tax bill by £7,770 providing an effective rate of tax relief on that particular contribution of 60 per cent.

As an alternative to paying the pension contribution personally, it may be appropriate to enter into a salary sacrifice arrangement with their employer, reducing gross salary (and adjusted net income) by £12,950.

The employer could then pay an employer pension contribution of £12,950. The salary reduction would also produce a saving in employer national insurance contributions, which could be used to boost the pension contribution by a further £1,657.60.

The impact of the new 50 per cent tax rate will not be restricted only to high earners.

Introduced from April 6, discretionary trusts will also suffer tax at 50 per cent (or 42.5 per cent in respect of dividends) on income in excess of £1000 per tax year which is retained in the trust.

The basic rate band of £1,000 assumes there is no more than one trust created by the same person otherwise it is divided between them, subject to a minimum of £200 per trust.

Consequently, trustees who do not wish to distribute income to a beneficiary have a greater incentive than ever to review the trust's investments and to consider switching to non-income producing assets such as insurance-based investment bonds.

Although onshore bonds are taxed at source, credit is given for tax paid at the savings rate with any assessment to additional tax deferred until a "chargeable event" occurs, eg partial or full encashment or the death of the life or lives assured.

Trustees may choose to assign ownership of a bond to one or more beneficiaries prior to an encashment with the tax assessment falling on the beneficiaries when the encashment is made. Where the beneficiaries are liable for tax at a rate which is lower than the trust rate, there can be an appreciable tax saving.

There has been much speculation in the media that the June emergency budget will see an increase in the rate of Capital Gains Tax (CGT) from the present rate of 18 per cent and a reduction in the personal Capital Gains Tax allowance. If either of these were to happen, owners of assets with gains assessable to Capital Gains Tax will need to take even greater care regarding how and when to dispose of the assets.

Investors may also wish to review their investment strategy, e.g. with regard to the relative merits for their circumstances of securities such as unit trusts and OEICs, versus both onshore and offshore investment bonds.

The message from all of this is that it will become more important than ever to be aware of your tax position and to take advantage of tax favoured investments such as ISAs and pension plans.

The media tells us every day that the Government will have to raise taxes to reduce the budget deficit. The only way it can do this is by taxing more heavily those who are fortunate enough to be in work or own capital.

The issues involved are complex and proper professional independent advice is needed to ensure you do not pay more tax than you should.