Tax rates
Yet again there has been no change to income tax rates. Therefore for 2004/05 the starting rate remains at 10%, the basic rate at 22% and the higher rate at 40%. The system continues to be further complicated by the rules for savings and dividend income.
Tax rates - trustees
From 6 April 2004 the rate of tax on the income and capital gains of trusts will increase from 34% to 40% (and the corresponding dividend trust rate from 25% to 32.5%).
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Comment
This will bring the rate of tax suffered by UK trusts into line with the rates applied to higher rate taxpaying individuals.
People who receive income from trusts will still be able to reclaim any excess tax paid by the trustees on their behalf and those liable at higher tax rates will still get credit for tax paid by the trustees. |
Allowances
For 2004/05 the personal allowance for the under 65s is increased in line with inflation to £4,745. Personal allowances for those aged 65 and over are increased in line with earnings.
Jointly owned property
Currently income from property jointly owned by a married couple is treated for tax purposes as belonging to them in equal shares unless an election is made for the income to be split according to the actual proportions of ownership and entitlement to income.
From 6 April 2004 married couples will be taxed on dividends from jointly owned shares in ‘close’ companies according to their actual ownership of the shares. Close companies are broadly those owned by the directors or five or fewer people. For example if a spouse is entitled to 95% of the income from jointly owned shares they will pay tax on 95% of the dividends from those shares.
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Comment
This measure is designed to close a perceived loophole in the rules and will not apply to income from any other jointly owned assets. |
Pre-owned assets
The December 2003 Pre-Budget Report included a reference to the scenario where the owner of an asset makes a gift of it to remove it from their estate for inheritance tax (IHT) purposes. However if the former owner continues to enjoy the benefits of ownership then the gift is generally ineffective for IHT purposes since the ‘gift with reservation’ rules apply. The government is concerned that the rules can be avoided and many have set up ‘home loan’ or ‘double trust’ schemes for the family home precisely to achieve this.
However rather than amend the IHT rules they have decided on an alternative approach. They propose that with effect from April 2005, income tax will be charged each year on the value of the benefit of using an asset formerly owned by the user. Logically there will be a deduction for any rent actually paid and a de minimis threshold of £2,500. Other exclusions cover situations where:
- the asset still counts as part of the taxpayer’s estate for IHT purposes or
- the asset was sold at an arm’s length price, paid in cash.
Taxpayers who have already entered into a scheme now caught by the new rules will be able to elect for transitional relief.
Pensions
The maximum earnings for which tax allowable pension contributions can be made is increased from £99,000 to £102,000 from 6 April 2004.
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Action points
Under the current pensions regime, individuals can contribute £3,600 (gross) per year with no link to earnings. This makes it possible for non-earning spouses and children to make substantial contributions to pension schemes.
Higher levels of contribution require a link to earnings. However earnings in one year can be used as the basis of contributions for that year and the next five. This rule allows a company to pay remuneration in one year and dividends in the following five. This in turn enables a director/shareholder to make personal pension contributions every year and the company and individual to save national insurance. Make the most of this over the next two years because the new pensions rules to be introduced in April 2006 will not allow this. |
Proposals for radical simplification of the taxation of pensions were originally announced in December 2002 and initially intended to take effect from April 2004. Following representations from the pensions industry, the start date has now been delayed until April 2006. The plan is to scrap the existing eight tax regimes for pensions and replace them with a single set of rules that would include:
- a single, lifetime limit on the amount of pension saving that can benefit from tax relief initially to be set at £1.5 million (not £1.4 million as previously proposed) and rising to £1.8 million by 2010
- any excess over the lifetime limit to be subject to a 25% ‘recovery’ charge
- allowing funds in excess of the lifetime limit to be withdrawn entirely as a lump sum subject to a higher recovery charge of 55%
- an annual allowance of £215,000 (not £200,000 as previously proposed) rising to £255,000 by 2010
- tax relief being given on the higher of 100% of relevant earnings or £3,600
- an increase in the age at which pensions can be drawn to 55 by 2010.
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Comment
Some doubt was cast over the numbers potentially affected by the lifetime limit cap with the government suggesting a figure of 5,000 and independent experts putting the figure closer to half a million. National Audit Office research commissioned by the government suggested that 5,000 may be a little on the low side but is not wildly out and consequently the new regime has been given the green light but the start delayed until April 2006.
Where an individual has pension rights valued in excess of £1.5 million when the new rules are introduced, this value can be protected together with any growth up to the RPI. Alternatively individuals who plan to cease contributions to all pension schemes by April 2006 can register for ‘enhanced’ protection thereby avoiding the recovery charge altogether.
Consider boosting contributions over the next two years if you are a high earner or already have a valuable pension fund. |
Self assessment tax returns
A new four page short tax return (STR) for people with relatively simple tax affairs has been piloted with 50,000 taxpayers in four areas. In April 2004, the Inland Revenue plans to introduce the form to more taxpayers over a wider area and to roll it out nationwide in April 2005. Only certain people will be eligible to use the STR. For example, some employees (other than company directors) with P11D benefits, the self employed where turnover is less than £15,000 and pensioners in receipt of a pension. In addition they may have modest amounts of investment income.
Venture Capital Trusts (VCTs)
VCTs invest in the shares of unquoted trading companies. An investor in the shares of a VCT is currently exempt from tax on dividends (although the tax credits are not repayable) and on any capital gains arising from disposal of the shares. Income tax relief at 20% is available on subscriptions for VCT shares, up to £100,000 per tax year, if the shares are held for at least three years. Capital gains (up to £100,000 per tax year) can be deferred into VCT investments. There has been a sharp reduction in funds invested in VCTs as a result of the global downturn in equity markets. Consequently changes are being made to the VCT rules as follows:
- there will be an additional temporary improvement to income tax relief for a period of two years from 6 April 2004 (from 20% to 40%)
- from 6 April 2004, the upper limit for eligibility for income tax relief will be increased from £100,000 to £200,000 in any single tax year
- from 6 April 2004, the ability to defer capital gains by investing in VCT shares will be withdrawn.
Other minor changes have been made to introduce greater flexibility.
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Comment
The doubling of the annual investment limit is unlikely to affect the majority of investors since the average VCT investor subscribes for only £25,000 of shares. However a minority are constrained by the current limit and will therefore benefit from the increase. |
Enterprise Investment Scheme (EIS)
The EIS allows new equity investment in qualifying unquoted trading companies (including AIM). Income tax relief at 20% is available on investments up to £150,000 per tax year and CGT exemption is given for shares held for at least three years. Furthermore unlimited capital gains may be deferred by reinvestment in EIS shares.
From 6 April 2004 the annual investment limit for eligibility for 20% income tax relief is increased to £200,000.
Child Trust Fund (CTF)
The government announced the introduction of a new CTF in the 2003 Budget. Children born since September 2002 are eligible for a CTF account if Child Benefit has been awarded for them and they are living in the UK.
The government will provide an initial endowment of £250 (£500 for low income families) and a further payment when the child reaches the age of seven. Other features of the fund will include:
- allowing additional contributions to be made by others (family and friends) of up to £1,200 a year
- being accessible at age 18
- different sorts of accounts available, including cash deposit accounts, unit trusts, and life products
- children not being taxable on the income and gains they make on the investments in their CTF account, but there will be no tax relief for contributions made to a CTF account.
Charitable giving
A loophole in the Gift Aid scheme has allowed certain charities to obtain relief for day admissions. That loophole will be blocked but not immediately.
In an effort to stimulate interest in payroll giving, the government is to pay grants to SMEs which establish schemes for their employees.
Life assurance policies
Gains from some life assurance policies are taxed as income under special rules. If when a policy comes to an end there is a deficit rather than a gain, ‘deficiency relief’ may be available. Avoidance schemes that create deficiency relief, typically for high net worth individuals, have been stopped by limiting the deficiency relief to the total of any earlier gains which formed part of the same individual’s income. The measure affects all new contracts entered into on or after 3 March 2004 and certain earlier contracts.
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