How to reduce your tax bill
The final days of the tax year ending on 5 April 2012 are fast approaching, so now is a good time to review your position and consider the available tax reliefs, exemptions and general planning points of interest, says Paul Gough, Managing Director of Intouch Accounting, the personal online accounting adviser for contractors and freelancers.
Advice relevant to your individual personal and financial circumstances has never been more important; this document is written in broad terms so specific account will therefore need to be taken of your own individual circumstances, before taking any action.
The 2012 Budget will be delivered on Wednesday 21 March and we can expect some interesting tricks to balance the need to raise money in these austere economic times with the equally important need to promote economic growth. We will let you know more about the Budget announcements when they are made. But, for the time being, we hope you find the planning points and comments on the following pages helpful.
A quick warning
This article is intended to provide general information and guidance only and is not intended to provide advice to any specific person. You are recommended to seek competent professional advice before taking or refraining from taking any action based on the contents of this publication. Tax law is subject to change. This publication represents our understanding of the law and HM Revenue & Customs’ (HMRC) practice as at February 2012.
If you require any further information or would like to implement any of the points described please contact your Personal Adviser at Intouch, or your existing accountant.
With regards to advice on investments, you are recommended to seek advice based on your particular circumstances and financial profile from an Independent Financial Adviser. Note that tax planning is not regulated by the Financial Services Authority.
A. Tax reliefs and tax efficient investments
Personal Pension Contributions
Almost anyone in the UK under 75 years of age can pay up to £3,600 into a pension scheme each year and qualify for tax relief, even if they do not pay tax. Most pension contributions are paid after deducting 20% tax, so to put £3,600 into your pension you would currently pay £2,880 and HMRC would contribute £720.
If you earn more than £3,600, you can pay up to the whole of your earnings into a pension scheme, but the tax relief is capped by the annual allowance. For 2011/12, the annual allowance is £50,000 but you can also carry forward any unused annual allowance from the last three tax years.
If your pension contributions in 2011/12 exceed the total annual allowance available, including any unused allowance carried forward, you will be liable to an annual allowance charge to remove the tax relief on the excess contributions.
The maximum you can hold in tax favoured pension schemes reduces from £1.8 million to £1.5 million from 6 April 2012.
Enterprise Investment Scheme (EIS)
Income tax relief is available at 30% on up to £500,000 when you subscribe for ordinary share capital in unquoted trading companies, providing that all the conditions of the EIS scheme are met.
Capital gains on the realisation of the EIS investment are tax free, providing the EIS shares are held for three years.
Individual Savings Accounts (ISAs)
Anyone over 18 can invest up to £10,680 in an ISA for 2011/12. There are separate limits in the ISA for components relating to shares and cash.
Children under 18 can only invest in a Junior ISA account if they live in the UK and don’t qualify for a Child Trust Fund. Parents, family and friends can pay up to £3,600 into the fund.
Venture Capital Trusts (VCTs)
You can obtain 30% income tax relief up to a maximum investment of £200,000 when you subscribe for shares in a VCT, which is basically a quoted investment vehicle looking to invest in small unquoted trading companies. To obtain tax relief in 2011/12 the VCT shares must be issued to the subscriber on or before 5th April 2012.
Dividends and capital gains from the VCT are tax free, provided the VCT is held for five years. Capital gains cannot be rolled over into VCT investments.
Other Tax Free Investments
Income from any investment in premium bonds is tax-free. There are currently no other tax free Index Linked Savings certificates or fixed interest savings certificates on general sale although children’s bonus bonds continue to be tax-free.
Higher rate tax relief can normally be obtained on Gift Aid (no minimum amount) and on charitable Deeds of Covenant.
If certain shares and securities (mainly quoted shares) are gifted to a UK charity then a deduction from income can be claimed for the market value of the shares at the date of the gift. Land can also, in certain circumstances, be gifted tax efficiently to a charity. No capital gains tax arises on the gift to charity.
Gifts made under Gift Aid may be particularly tax effective for individuals who will lose all or part of their personal allowance because their income exceeds £100,000.
Investing for capital gains
Capital gains are not counted as part of income. Consequently, investing in assets that pay a low or nil income, but provide capital growth, will have the benefit of a lower tax rate. There are many investment products that are geared towards producing capital growth rather than income, such as low-yield unit trusts and OEICs. Talk to your financial adviser.
Tax Efficient Borrowings
Tax relief is generally available on loans (not overdrafts) taken to invest in a business, partnership, a family company or to purchase commercial or buy to let property.
In certain circumstances, it may be possible to restructure your borrowings so as to obtain a higher rate of tax relief on more of your borrowings.
Investment in offshore bonds has the benefit of avoiding UK income tax until funds are taken from that bond. In the meanwhile, the funds can roll up within the bond free of UK tax.
Such investments might therefore be appropriate for individuals who may be paying 50% income tax, as the funds can then be withdrawn at later date when income falls below the 50% tax rate.
Setting up your own family investment company
As companies currently pay corporation tax on their profits of between 20% and 26% (20% and 25% for 2012/13), a significant tax saving can be made if investments are made through a family owned company rather than personally.
By this means, the company’s investment income is taxed at the company’s corporation tax rate instead of income tax rates of up to 50%. In addition, dividends received by companies from other UK companies are free of corporation tax altogether.
A company is unlikely to be a suitable vehicle if investments are to be made for capital growth. This is because companies pay tax at their normal corporate tax rate of between 20% and 26%, whereas individuals may pay tax at a lower rate and be able to access certain reliefs.
Children are entitled to a personal allowance. However, if the income of unmarried children under 18 derives from assets passed from the parents (other than interest on National Savings Children’s Bonus Bonds), this will be taxed on the parents if it exceeds £100.
Children’s personal allowances can be used against income on gifts from persons other than parents.
A parent, grandparent or other relative can make contributions into a personal pension plan for children. Contributions are paid net of basic rate tax.
As the maximum gross contribution that can be paid into a personal pension plan is £3,600 per annum (where the child has no earnings), in effect the actual contribution by the parent or grandparent is £2,880. The Government adds the balance of £720 to the fund.
The child tax credit (CTC) is income related support for children, and does not depend upon parents working. The working tax credit (WTC) assists the lower paid with a wage top-up.
The calculation of the amount of CTC and WTC due to a family is complex and as we do not advise on tax credits you should use the HMRC web site tools to assess your position – www.hmrc.gov.uk.
B. Wills and Inheritance Tax
Inheritance Tax (IHT) has changed over the last five years and, accordingly, many wills will need to be reviewed or re-written. Effective planning should enable the potential exposure to be substantially mitigated.
The currently favourable “potentially exempt transfer” regime for lifetime gifts between individuals may be susceptible to a change of policy, so it may be sensible to hasten any tax planning of this kind. However, the capital gains tax implications of such gifts must be borne in mind.
With the decline in asset values, there is a window of opportunity to gift assets to the next generation with reduced exposure to capital gains tax. A review of assets values should be considered.
The transfer of assets between spouses can be beneficial as such transfers are generally exempt and may ensure that both spouses’ nil rate bands for Inheritance Tax are fully utilised.
An individual can give away up to £3,000 per annum IHT free, even if they do not survive seven years. This exemption can only be carried forward for one year at a time. Therefore, if you did not use the 2010/11 exemption, you could gift £6,000 by the end of the tax year.
Any number of small gifts up to £250 can be given, but not to the same person.
Unlimited regular gifts by an individual out of income can be made free of IHT, provided that the income is surplus to meeting normal living expenses.
If you have gifted an asset for IHT purposes, but you continue to benefit from its use, then you may be exposed to Income Tax liabilities under the Pre-owned Assets rules. Liabilities can be avoided by paying something for the benefit you receive; this is a complicated area that requires specialist advice.
C. Capital Gains Tax
Capital gains tax (CGT) is charged at either 18% (basic rate taxpayers) or 28% (higher rate taxpayers) for 2011/12.
Everyone (other than non domiciled individuals claiming the remittance basis) has a CGT annual exemption of £10,600. Review any disposals you have made since 6 April 2011 in order to ensure that you are fully using the exemption wherever possible.
If you have not utilised your annual exemption, please note that the previous method of crystallising gains by selling shares and repurchasing the next day (“bed and breakfasting”) no longer works. Any shares sold and repurchased within a 30-day period will be matched, so the gain or loss that would otherwise have arisen on the shares will not be realised.
With careful planning, crystallisation of gains to use the annual exemption can be achieved by selling shares and reacquiring them in an ISA. Alternatively, your spouse may wish to repurchase the shares in their own name.
A 10% tax rate applies to the whole or part of a gain up to a lifetime limit of £10m per individual, if the disposal qualifies for Entrepreneurs Relief. This relief will generally apply to gains arising on disposals of trading businesses and to gains arising on certain disposals of shares in trading companies.
Where assets are standing at a loss, it may be advisable to realise the loss either to set off against current year gains or to carry the loss forward. Negligible value claims can be made even if the asset has not actually been sold or disposed of (e.g. in the case of a company going into administration) although such a claim should be made prior to the company being struck off.
If you have used your annual exemption, but your spouse has not, consider transferring shares or other assets to him or her prior to their disposal.
If you own more than one property available for occupation as your private residence, you may need to make a principle private residence election, which must be submitted to HMRC within two years of a second property being available. This enables the election to be varied at a future date and may save CGT when one is sold.
Couples may also wish to consider owning property, in respect of which there is no principle private residence election, jointly; as this may give them the benefit of two annual exemptions when the property is sold.
Capital gains can be deferred by investing in EIS shares. An investment in EIS shares in the current year may enable capital gains tax paid on gains in the previous three years to be reclaimed.
D. Business related matters
Some capital expenditure qualifies for tax relief. Businesses currently get immediate tax relief (100% deduction from taxable profits) on the first £100,000 a year spent on most types of fixtures and equipment. This limit reduces to £25,000 from 6 April 2012.
You should consider your capital expenditure plans to make sure you obtain the maximum benefit before the limit drops.
Company Cars and Car Fuel
If you are considering changing your company car, it is worthwhile checking the carbon dioxide emission rating of the chosen model and the resultant taxable car benefit.
Choosing a low emission or “hybrid” car can lead to significant tax savings.
Tax savings may arise by choosing to pay personally for all fuel and to charge the company with an agreed fuel rate for business mileage.
Sharing income around your family
Many of you will have arranged their affairs to ensure that spouses or civil partners are fully utilising their own tax allowances and reliefs.
The transfer of income producing assets from one member of a family to another can result in family income being spread between those members, so that as few as possible family members suffer higher rates of tax.
E. Other “Contractor related” Planning
Set the right wage levels
Now is the time to set your wages for the forthcoming tax year 2012 / 2013. Typically, contractors (and their other employees) adopt wages between the maximum level that still avoids incurring any PAYE or National Insurance (NI) deductions and the National Minimum Wage.
For 2012/ 2013 wages between £442 and £589 per month suffer no employee or employer NI liabilities but you still qualify for state benefits such as a state pension.
Normally at this level no Income Tax is deducted as PAYE, because the salary falls within the normal personal allowance; but watch out where any self assessment underpayment is being collected through your tax code, as this can easily eat into the level of your allowances.
IR35 always raises its ugly head at this time of the year.
You should consider every contract that existed during the tax year and consider whether or not you have any exposure to the deemed salary provisions.
IR35 tax liabilities for 2011 / 2012 are payable in April 2012, so you don’t have much time to decide and calculate the additional deemed salary to be reported at the end of the tax year.
If you have no IR35 issues then you will most likely be taking a low salary and dividends.
Now is the time to look at your total income, from all sources, and consider whether you can take additional dividends before 6 April 2012 that will fall within your basic rate tax band. Remember that when working out the maximum dividend, whilst avoiding higher rate taxes, you must gross up the net dividend received; gross up net dividends by dividing them by 0.9.
Even if you don’t need the money, you will have extracted maximum funds and long term minimised the tax you have to pay. Bonuses can also be considered, but you must remember the additional NI cost associated with salary versus dividends.
Apply the same test to all shareholders in the company and then consider if you need separate classes of share so you can easily vary individual shareholders dividends.
Overdrawn directors loans can be useful for planning short term variations in cash needs and protecting against higher rates of tax. But be careful… if your director’s loan is outstanding more than 9 months after the end of the accounting period, your company will incur a high tax charge.
If you owe your company money, then you may want to take this opportunity to declare a dividend just after the year end, to clear the balance and reset the clock on future amounts you need to take from your company.
Benefits in Kind
Think benefits in kind, meaning company owned assets made available for your private use or company expenditure that has a personal element, and take steps to avoid those benefits that are not intentional.
This article can only cover the main areas of pre year end planning in outline and is not an exhaustive list of matters that could apply in your circumstances.
Although saving tax is important, there are other factors you should always consider before taking action:
- Always try to look at tax planning in the overall context of your general financial planning. Make sure you have enough money to meet your personal and business needs.
- The value of investments can go down as well as up and past performance is not a reliable indicator of future performance. Some options involve commercial and investment risks.
- Flexibility is always desirable, even if it involves higher costs or tax.
- The cost and inconvenience of implementing some strategies might not always be worthwhile.
This blog has been prepared by Intouch Accounting. While we have made every attempt to ensure that the information contained in this blog has been obtained from reliable sources, Intouch is not responsible for any errors or omissions, or for the results obtained from the use of this information. This blog should not be used as a substitute for consultation with professional accounting advisers. If you have any specific queries, please contact Intouch Accounting.