TAX PLANNING AFTER THE MINI BUDGET Most readers will have realised straight away that, owing to the exigencies of printers’ deadlines etc., last month’s edition of Schmidt Tax Report had to go to press before the new Chancellor’s first Budget announcement on 9th October. So this is our first opportunity to comment on the proposals. Following our normal policy after Budget announcements, we have no intention of treating the subject in an encyclopaedic way: no lists of rates or allowances etc., because these are all available in any event, for those that want them, on the Revenue’s website. Our aim here is to give you an angle on the proposed changes that you certainly won’t find on the Revenue’s website! And rest assured, this article isn’t going to indulge in any ‘clever’ references to the new Chancellor’s surname. What a relief For the sort of people who, on average, form our readership, we think there are three big changes that really dominate the whole picture, the:
These are big changes, and in many ways at least the first two can be unfavourable in their effect, but perhaps we ought to whisper the next bit. It could have been an awful lot worse. Flat-rate CGT Although Alistair Darling is now Chancellor of the Exchequer, would we be being too fanciful to detect the dominating influence of Mr Gordon Brown behind this new change? What better way to announce your new premiership than cutting through reams of legislation with a simple and revolutionary new regime? Carpers and cavillers might point out that the reams of legislation that this new rule is cutting through have been introduced by Mr Brown himself, and this certainly does give commentators some pause for thought. What would you call a tax regime where a major new relief is introduced in 1998, is substantially modified in 2000, again in 2002, and again in 2004, and then has its abolition announced in 2007? Our answer would be: a tax regime in which it becomes almost impossible to plan one’s business or financial affairs. Far from being a world-class environment for outsiders to set up their business, it could look to many more like a world-class mess. But enough of this ranting. The detail of the change, put briefly, is that taper relief for individuals has been abolished and in its place a flat rate of 18% applied. This also takes the place of indexation allowance for individuals. None of these changes applies to limited companies, which continue to pay at corporation-tax rates on gains and have the benefit of indexation allowance. So how does this radical change affect tax planning? (We say little or nothing here about the proposed ‘retirement relief’ re-introduction, which at the time of going to press looks as though it will be fairly trivial in amount.) One very significant effect is that the distinction between business assets and non-business assets flies out of the window. When we think of all the oceans of ink we have expended in these pages explaining how important it is that your assets should qualify as a business asset (giving an effective 10% rate of CGT) rather than a non-business asset (where you could be paying anything between 24% and 40%), we could cry. However, let’s not look on the negative side but on the positive side. One clear winner is the investor in the non-trading assets, like rental properties and quoted shares. These will now suffer, in most cases, a significantly lower rate of tax in the hands of individuals and trustees. One very perceptive trade unionist wrote to the Financial Times recently saying that the effect of this new rule would be that everyone will try to turn income into capital. No, surely not? Just consider this straightforward scenario, which is reminiscent of the days before CGT, or at least the days when CGT was a flat rate of 30% as against 60% or more income tax. A property developer is considering buying up a site and covering it with houses and flats, to help house the over one million extra population that is migrating to this country every year. He has, basically, a choice. Should he build out the site and sell the resultant freeholds and leaseholds to the army of investors and would-be owner/occupiers, who always seem to be on the scene when such a development takes place, or should he build them in order to form a permanent investment portfolio, to give income from rents in the future? We’ll give you a clue: if he sells out, he is ultimately (to get the money in his own hands, at least) looking at tax/National Insurance of 40% or more of the profits he makes from the development. If, on the other hand, the development is in the nature of the improvement of a capital asset, then capital gains, when they are made from the sale of flats and houses over the years, can now be brought within the 18% rate by an appropriate structuring of the business. It is quite likely that 18% would apply even if some of the flats and houses were sold straight away, as soon as they were complete, if the overall intention were one of making an investment in property. Note carefully here, too, that we’re not talking about dressing up income as capital. That’s something the taxman could counteract. What we’re talking about is making a real commercial decision that has the effect of reducing your tax to less than half of what it would have been. In other words, it’s not income dressed up as capital: you have decided that it really will be capital. As we’ve commented elsewhere in this magazine (see ‘The Business Column’), one thing this new rate hasn’t done is make it more advantageous, in most circumstances, to hold assets through limited companies. The new regime leaves the ‘double-tax charge’, which is such a significant penalty of owning appreciating assets through a limited company, untouched, even though the two charges to tax will be at different rates in the future from what they have been in the past. The non-domiciliaries’ levy We think it’s wrong to deride the Chancellor for such an obvious piece of policy theft, as the new £30,000-a-year levy on non-UK domiciliaries certainly seems to be. To our way of thinking, it shows a welcome openness and receptiveness towards new ideas, which may make this regime more effective and intelligent than previous regimes have been. But make no mistake about it, this idea was lifted bodily from George Osborne’s suggested £25,000 a year levy, with the amount slightly changed and a ‘seven out of 10 years’ qualifying period bolted on. So what is this new levy all about? Until this new proposal, a lot of political pressure had been building up, aimed at the amazingly favourable regime from those who, though possibly resident and/or ‘ordinarily resident’ in this country, were not domiciled here. Without wishing to go on at length about what domicile actually is, we could sum it up by saying, first, that it is about where you belong or come from rather than where you physically are, and also that it is comparatively easy to establish non-UK domicile if your family originally came from abroad, unless this was many generations ago. What attracted the adverse criticism of the opponents of the non-domicile regime was that such individuals could live in the UK effectively permanently and yet pay no tax on income or capital gains arising outside the UK that were not remitted here. Also, it was actually very easy to make remittance through the back door by various means. Indeed, until the changes actually take effect, it still is. The politicians, however, were in something of a quandary, and we’re sure that George Osborne appreciated this just as much as Alistair Darling did. A lot of this country’s wealth and prosperity comes about as a result of its popularity with non-domiciliaries as a place where tax can effectively be completely avoided on large proportions of their worldwide income. Annoy these people, and not only do you not attract new investment into the UK but literally billions of pounds already invested in the UK go elsewhere. By definition, these very wealthy non-domiciliaries are also very mobile. So really it was a very clever idea suggesting that individuals could continue to enjoy the benefit of the non-domicile tax breaks, providing they paid an ‘entrance fee’, which would weed out all the less wealthy but mean nothing to the people who the politicians wanted to retain. At the time of writing, it isn’t clear whether all of the benefits of being non-UK-domiciled are going to depend equally on payment of the £30,000. For example, a non-UK domiciliary can effectively invest entirely CGT-free, even in UK assets, by using an offshore trust arrangement. Will this also be made dependent on the £30,000 a year? What it does look as though will be case, though, pending the detail of the rules coming out, is that you will be able to pick and choose years so that you can pay in one year to have the remittance basis applied, but perhaps next year not pay, and consequently pay tax on the arising basis. How the rules are going to be framed to avoid the obvious planning opportunities, with regard to the timing of offshore income arising, is difficult to see. An interesting challenge for the parliamentary draftsman! IHT-transferable allowances This appears to be an act of pure benevolence, as far as we can see. An anomaly with the old rules for IHT was that, if one of a married couple died and left the entire estate to the other (which the majority of wills do), effectively the couple were only getting one IHT nil-rate band (currently £300,000) between them. This was because there was no tax on first death in any event, because a bequest to a surviving spouse is entirely IHT-exempt. However, the amount left then increased the value of the survivor’s estate and was taxed instead on their subsequent death. Under the new proposals, all widows and widowers (and whatever the equivalent term is for civil partners) will benefit from any unused nil-rate band on the death of their former spouse, in addition to their own nil-rate band. So what is the implication of this for planning? Should everyone tear up their wills that have been carefully prepared with a nil-rate band discretionary trust in order to sidestep the anomaly under the current rules? Should new wills being drawn up from now on simply revert to the classic pattern of everything to surviving spouse and on second death to children equally? In our view, the answer to both of these questions is ‘no’. There is nothing to lose by having a nil-rate-band trust in your will, and having it can still give rise to a lot greater flexibility. Just to take one example (there are examples in other areas): if the estate of the first of the couple to die includes assets that are likely to increase in value, they could form part of a nil-rate-band legacy, and thereby not just the value on first death but also the increase in value between then and the survivor’s death is outside the survivor’s estate. It really comes down to a question of whether the assets concerned are going to increase in value at a greater rate than the nil-rate band or whether the increases in the IHT nil-rate band will outstrip asset values. There’s no doubt which way round it has been in the past! |
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