Louis Baker's blogs

In his November Autumn Statement, chancellor George Osborne confirmed the difficulties the economy faces and effectively emphasised the need for partners to reappraise their financial planning and the tax-efficiency of their finances. There is no better time to do this than at the start of the new year! Here are some strategies and points to keep in mind:

Pension contributions 2011/12

Pension contributions are one of the most tax-efficient long-term investments partners can make, and the rules for the maximum contributions that can be made tax-effectively changed from 6 April 2011.

Tax relief is now restricted to pension contributions of up to £50,000 a year (the new Annual Allowance (AA)). This figure is the gross equivalent. Contributions are paid net of a deemed withholding of 20% basic rate tax. The tax relief available is confirmed to be at your marginal rate.

Any unused AA is carried forward for up to three years for future use as long as you had a fund in existence in the earlier years. The three-year carry forward rules mean that some partners might be able to invest up to £200,000 (gross) into their pension arrangements and obtain 50% income tax relief thereon.

Lifetime allowance change and election

A lower lifetime allowance (LTA) of £1.5m (reduced from £1.8m) will apply from 6 April 2012. Partners have until 5 April 2012 to make an election for the old £1.8m LTA to continue to apply - this election can only be made if you then cease to make any further pension contributions.

Pension Input Periods (PIPs) - important hidden detail

The AA applies to contributions paid in a pension scheme’s PIP, which ends in the tax year. Each of your pension arrangements will have their own PIP and their annual period end may not be 5 April each year. If they have a different end date this may give rise to problems.

Unfortunately, many don’t know the annual year-end of date of their PIP, and the immediate concern is that your scheme PIP which ends in 2011/12 may have already ended! So, contributions you make between now and 5 April 2012 may use your 2012/13 AA rather than your 2011/12 AA. You really do need to know your PIP when determining your contributions over the next few months - particularly if you are looking to use your three-year brought forward capacity.

Other tax-favoured investments - ISAs, EIS and VCT

Each adult is able to invest up to £10,680 into an ISA (Individual Savings Account) each tax year. There is no tax relief on the investment. The attraction is that any growth is Capital Gains Tax (CGT) free and income in the fund is exempt from income tax, as are dividends or interest distributed out. Subscriptions into EIS (Enterprise Investment Scheme) qualifying shares are tax-favoured investments. 30% income tax relief is available on such investments of up to £500,000 each tax year. There are also CGT and Inheritance Tax (IHT) benefits. Investments in Venture Capital Trusts (VCTs) of up to £200,000 each tax year generate 30% income tax relief.

Gift Aid - are you getting your full tax relief?

Many know that charities get basic rate tax relief refunded from the government on donations made via the Gift Aid scheme. What seems less well known is that partners are entitled to higher rate tax relief on their Gift-Aided donations (when claimed via their tax return). High-earning partners can thus get 50% tax relief on their donations, which might motivate some to be more generous, and others to be better at recording the Gift-Aided donations they make.

Partners retiring shortly

Partners about to retire should pay particular attention to whether their tax rate will be lower in retirement or in the lead-up to retirement. This may provide added incentive to increase pension contributions and to accelerate Gift Aid contributions, before their income level and marginal tax rate falls.

Spouse planning

This relates to financial planning within the family structure, rather than relationship planning. Where one spouse has a lower tax rate than the other, then investment income (interest or dividends) suffers less tax if the asset is held in the name of the spouse with the lower tax rate. Conversely, Gift Aid donations are more tax-efficient if made by the more highly taxed spouse.

Use of the annual CGT exemption

Each of us has an annual CGT allowance of £10,600. This enables us to realise gains of £10,600 in 2011/12 tax free. As spouses can transfer assets between themselves CGT-free in most instances, it can be possible to realise gains of £21,200 tax free between them.

CGT main residence elections

A capital gain on selling your sole home is tax free if it and its grounds do not exceed half hectare. Where you own two residences, for example a holiday home or midweek flat together with the main home, the main home will continue to be exempt. However, dual exemption for a period can be engineered on more than one residence where an election is made within two years of acquiring the second home. If this might apply to your circumstances, speak to your tax advisor.

Non-domiciliaries

The chancellor confirmed in November that the charge for a non UK-domiciled individual to be assessed to tax on the ‘remittance basis’ would increase to £50,000 (from £30,000) once they have been resident in the UK for 12 of the previous 14 years. This change will be effective from 6 April 2012.

Statutory residence test

Early in 2011 the chancellor announced that he would consult on the introduction of a statutory residency test from April 2012. The proposals in the consultation document were generally well received, but it has been concluded that due to drafting difficulties, the introduction will be delayed until 6 April 2013.

Louis Baker, head of professional practices group at Crowe Clark Whitehill

Late last year new rules were announced relating to tax relief on pension contributions from 6 April 2011.

The 2011 Finance Bill, which includes these rules, is due to be enacted by late June/early July 2011, so partners have just a few short weeks to act in order to make the most of the changes.

The new rules include changes to the annual allowance (AA), which has been reduced to £50,000 with tax relief on contributions being available at the marginal rate of tax.

The rules also give the ability to carry forward unused AA for up to three years, as long as you had a pension policy in existence in the earlier years.

Furthermore, it is being deemed that the £50,000 AA will apply to 2008/09, 2009/10 and 2010/11 to determine any unused AA to bring into the new regime.

There is, therefore, an opportunity to catch up with additional contributions now with tax relief at current marginal rates.

However, there is a catch – the AA applies to contributions paid in a pension scheme’s Pension Input Period (PIP) which ends in the tax year.

The PIP may not be coterminous with the tax-year end.

Each pension scheme will have its own PIP, but they are not currently in the habit of advising policyholders of the year-end date. If you would like to find this out, the administrator will be able to confirm the PIP year-end date for a policy.

If the PIP year-end date is 5 April, then this keeps the position simple, particularly if there are several pension policies in existence.

However, when considering making contributions to utilise carry forward of unused pension relief, it is very complex if there are different PIP year-end dates for policies.

A few examples will help illustrate this:

Example 1

• Mr Butcher is earning more than £200k
• PIP date is 5 April 2012
• Pension contribution of £50,000 made on 1 October 2011

The pension contribution will receive tax relief at 50% in 2011/12 and completely utilises the AA in respect of 2011/12.

Example 2

• Mr Baker is earning more than £200k
• PIP date is 30 September 2011
• Pension contribution of £50,000 made on 1 October 2011

The pension contribution will receive tax relief at 50% in 2011/12 and completely utilises the AA in respect of tax year 2012/13 (as the contribution is into a PIP period ending on 30 September 2012 in 2012/13).

Example 3

• Mr Candlestickmaker is earning more than £250k
• PIP date for a pension policy 1 is 5 April
• PIP date for pension policy 2 is 30 September
• Under the new rules there is unused pension relief from 2008/09 brought forward of £50,000
• Pension contributions are made as follows:

o Policy 1 - £30,000 made on 31 March 2012
o Policy 2 - £20,000 made on 30 September 2011
o Policy 2 - £50,000 made on 31 March 2012

The pension contributions will receive higher rate tax relief in 2011/12 on £100,000 and utilise the AA in respect of tax year 2011/12 (payments into policy 1 and first payment into policy 2) and 2012/13 (second payment into policy 2).

The unused AA from 2008/09 will not be utilised and will be lost.

If, however, the PIP year-end date for policy 2 was changed to 5 April then the position would be different.

The AA for 2011/12 and the unused pension relief brought forward from earlier years would all be fully utilised.

The AA in respect of 2012/13 would still be available to utilise in the tax year ending 5 April 2013.

Higher rate tax relief is still due on the £100,000 in 2011/12.

Changing the PIP year-end date

If you want to simplify your pension planning, you currently have a brief opportunity to retrospectively nominate for the PIP date for all your policies to be 5 April. (If you or the pension company have already changed the PIP year-end date to a date other than the 5 April, this will not be possible.)

Until the 2011 Finance Bill receives royal assent (anticipated to be late June/early July), it is possible to nominate retrospectively a change to the PIP year-end date all the way back to when PIPs were introduced in 2006/07.

To do this, simply send a nomination to the administrator of the scheme.

Once the Bill is enacted you will not be able to nominate a change to the PIP year-end date retrospectively.

Thereafter, a change to a PIP date can only be affected in advance of the existing PIP date occurring and the following rules are also met:

• The policy can only have one PIP year ending in any tax year;
• A policy’s PIP can only be changed once in a tax year.

Louis Baker is head of professional practices group at Crowe Clark Whitehill

A few weeks ago, I addressed the topic of year-end personal finance planning, with a specific focus on pension contributions and tax relief.

There are, however, several additional considerations that partners should also bear in mind as this tax year winds down and planning for the tax year ahead becomes a top priority.

Holding cash, shares and rental property

One key element of any partner’s financial planning should include examining ways to hold cash and share savings more tax efficiently in the future.

The 40% higher tax bracket kicks in when income totals £43,875 and the 50% tax threshold is £150,000. If your spouse’s tax rate is lower than yours there is a tax benefit in holding bank deposits in your spouse’s name and transferring shares into their name. It is relatively easy to effect such transfers.

Alternatively, if you want to maintain some control of the cash funds, transferring your bank account into joint names will reduce the tax on half of the annual interest income.

For those partners who own rental property there are a few tax planning opportunities available. For example, if your spouse pays tax at a lower rate, hold the property in joint names to improve tax-efficiency.

Alternatively, in some instances you can withdraw equity in the rental property and replace it with debt on which you can obtain tax relief on the interest payments.

Capital gains tax

Another straightforward tax planning technique is the use of the annual capital gains tax exemption. It is possible to realise gains of up to £10,100 in total in 2010/11 before CGT becomes payable.

This exemption does not get carried forward if not used, so it is definitely worth reviewing your portfolio to see if some gains can be triggered and realised tax-free within this exemption. To add an element of sophistication, review whether there are any investments standing at a loss, which could be sold to realise the loss and offset against gains beyond the annual exemption.

Your spouse will also have a CGT exemption for 2010/11. You can transfer assets tax-free to your spouse, who can then sell them to use their exemption – doubling the exemption used!

The introduction of the 50% income tax rate emphasises the differential with the far lower capital gains tax rate of 28%. This difference is amplified with an 18% CGT rate for those subject only to the basic rate income tax band.

Where possible, partners should look to structure investments to realise a capital gain rather than income.

Additionally, modest gains beyond the annual exemption are best realised in a spouse’s name if that spouse is only a basic rate taxpayer at most.

Charitable donations

An often overlooked tax relief is charitable donations paid under the ‘Gift Aid’ scheme. Charities are now quite good at getting you to ‘tick the box’ so that they can reclaim basic rate tax relief on your Gift-Aided donations.

But neither charities nor the government are so good at pointing out that higher rate taxpayers are entitled to further tax relief personally on their Gift Aid contributions.

Donors whose taxable income exceeds £150,000 can get 50% tax relief on their donations by using the Gift Aid scheme. Higher rate tax relief is available by claim on your tax return, thus reducing your tax bill.

If your spouse is only a basic rate taxpayer it is more tax-efficient for you to make any Gift Aid charitable donations, as it is only you who is entitled to the higher rate tax relief.

ISAs, EIS and VCT investments

Other tax planning opportunities to take advantage of are specific tax breaks introduced to encourage particular investment behaviour and/or compensate for extra risk. The tax breaks are annual, so there is only a short time left to take advantage of the 2010/11 reliefs. Now is also the time when most of the products are available.

Basic tax planning encompasses ISAs (individual savings accounts). Modest equity savings can be effected by investing up to £10,200 pa in ISAs. An ISA suffers no tax on dividend income, and no capital gains tax on any trading on the underlying funds by the unit manager.

All adults are entitled to invest in ISAs, so you could assist your spouse or adult children in investing in ISAs, should you wish.

You are able to invest up to £500,000 in fresh shares issued by qualifying companies under the Enterprise Investment Scheme (EIS), and obtain 20% income tax relief on the investment.

This income tax relief can be carried back one tax year. EIS investments in 2010/11 can also be used to shelter capital gains made in the period one year before and up to three years after the date of the EIS investment.

Investments in Venture Capital Trusts (VCTs) allow 30% income tax relief. Up to £200,000 can be invested in VCTs in 2010/11.

With a little bit of planning and consideration, tax relief will be ripe for the picking in the year ahead.

On 4 January 2011 the standard rate of VAT will rise from 17.5% to 20% – the third change in the standard rate in the last two years. This impending rise may have prompted some savvy partners to buy their new refrigerators or computers now instead of next year, but major appliance purchases shouldn’t be the only thing on their minds.

The VAT rise will of course impact on legal firms, and planning for the increase should be top of the agenda for partners and firms as the year draws to a close. By now legal firms will be well versed in how the VAT changes work, but nonetheless it is worth highlighting a few important issues.

Back to basics
The basic tax point – or the date when VAT becomes chargeable – for service providers is normally when the service is completed. However, this point in time can be shifted by clients making an earlier payment, or the firm raising an invoice in advance.

Invoices raised ahead of the VAT rate change will trigger the current 17.5% rate instead of the new 20% rate, as long as the amount invoiced in advance does not exceed £100,000 and the terms of the invoice require payment within six months. For clients who cannot fully recover VAT charged to them, this will potentially be an attractive option, so firms should consider accommodating them.

Special rules – apportionment
There are VAT rules in place which enable legal firms to apportion the VAT on services which began before and ended after the VAT rise, if they wish. For example, a legal firm completes its service to a client on 10 February 2011 and the work began on 1 December 2010. The firm can, if it wishes, raise an invoice with a VAT rate of 17.5% for work undertaken in the period 1 December 2010 to 3 January 2011, with the remainder of the work chargeable at 20%. The alternative would be, of course, to invoice all the work at 20%.

Firms should keep in mind that this ‘facilitation’ of apportioning the fee will be especially important to private clients and businesses involved in the VAT exempt sector, such as finance and insurance businesses and charities.

Legal firms are not obliged to operate this apportionment option, but my experience has shown that clients who cannot recover their VAT will probably challenge the VAT rate if you have not followed the apportionment option.

It is important to note that you can only retrospectively amend an invoice charged at 20% VAT to reflect the apportionment option until 21 February 2011. Thereafter the original 20% invoice has to remain unchanged.

The countdown to the VAT rise has begun – best to end the year and start the new one prepared.

Louis Baker is head of the professional practices group at Crowe Clark Whitehill

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