SPECIAL ISSUE - Year End Tax Planning Tips
Tax is a subject that excites very few people. It is easy to ignore awkward issues involving tax, such as those mentioned in this newsletter. Don’t - it could cost you dear. The onset of spring should prompt a review of your tax affairs. The 2001/02 tax year ends on 5 April 2002. Here we summarise the more important year end tax tips to help you identify areas that should be considered. As always we would be delighted to discuss with you the issues involved and any appropriate action you may need to take.

CONTACT US Income tax saving ideas for the family Family Companies
Using tax efficient investments Capital taxes - could you benefit from planning ahead? Pensions - plan ahead - don't take a chance on your future
NI Issues Charity watch - please give generously Deadlines looming for employers

GENERAL NEWSLETTER

Income tax saving ideas for all the family
Married couples continue to be taxed separately. They may therefore have opportunities to reduce their income tax burden.

Consider the split of income between husband and wife. A transfer of assets (which must be outright and unconditional) may serve to redistribute income and reduce or eliminate higher rate tax liabilities.

Income arising from assets owned jointly is split equally between the spouses unless a declaration is made to the Inland Revenue stating that the asset is owned in unequal shares. This election can be made on a Form 17 but must be made before the income arises. Consider such a declaration when a new jointly owned asset is acquired or, alternatively, consider transferring existing assets between the spouses. Such transfers are usually tax neutral but may create substantial savings; for example, by using the personal allowance and the starting and basic rates of tax.

Income tax savings may be made if the husband or wife is self-employed. The spouse could be taken into partnership or employed by the business. Caution must be exercised - the Inland Revenue are likely to look at such situations to ensure they are commercially justified.

A spouse could be employed by the family company. However, the level of remuneration must be justifiable and payment of the wages must actually be made to the spouse. The National Minimum Wage rules may also impact.
Parents must remember that their children are also potentially within the tax system. It may be possible to utilise the children’s personal allowances and starting/basic rate tax bands. However, any income arising to a child but deriving from a parent will be taxed on the parent while the child is unmarried and under 18. This rule applies to income from outright gifts by parents as well as to income from trusts set up by parents. Where such income is not more than £100 (gross) per annum it remains taxable on the child. The ‘parental bare trust’ technique used to avoid this problem in the past is now only effective for trusts set up before 9 March 1999.

National Savings children’s bonus bonds (for children under 16) are a means by which parents can provide capital for their children which earns tax-free interest.

Income to use the child’s personal allowance could be provided by:
  • income deriving from capital provided by relatives other than parents (grandparents, uncles, aunts etc)
  • distributions from family trusts (set up by relatives other than parents)
  • employing teenage children in the family business - children under 18 are not affected by the National Minimum Wage rules.

Remember that dividend income is no longer an effective way to utilise the personal allowance - the tax credits are not repayable. Ensure other sources of income are available to use the allowance.

Taxpayers aged 65 and over are able to claim higher personal allowances. Remember that the benefit of these allowances is eroded where income exceeds £17,600. In such circumstances a move to capital growth or tax-free investments may preserve age allowances.
Family companies
Maximising the potential, minimising the extraction costs.
If the payment of bonuses to directors or dividends to shareholders is contemplated, careful thought must be given as to whether payment should be made before or after the end of the tax year. This will affect the payment date for any tax and may affect the rate at which it is payable. Remember that any bonuses must be paid within nine months of the company’s year end to ensure tax relief for the company in that period.

Recent changes to the tax regime make it important to reconsider the most tax efficient strategy for profit extraction:
  • the 10% starting rate for corporation tax
  • further reforms to the capital gains tax taper relief regime
  • the extension of employers’ NIC to most taxable benefits in kind.
Using tax efficient investments
Some investments benefit from a favourable tax status. We consider the main ones below. Any investment decision should involve consideration of all the relevant factors, the risk level, the need for income and capital in both the short and long term as well as the tax advantages.
ISAs

Individual savings accounts (ISAs) provide an income tax and capital gains tax-free form of investment. The maximum investment limits are set for tax years. Therefore to take advantage of the limits available for 2001/02 the investment(s) must be made by 5 April 2002. Stocks and shares, cash and life insurance can be held in an ISA (see table for maximum annual investment limits).

Annual ISA investment limits - applicable until 5.4.06
£
Total investment 7,000
Which can include:
Cash investment (up to) 3,000
Life insurance (up to) 1,000

In practice most ISA providers are selling ISAs solely investing in stocks and shares. Banks and building societies are providing mini cash ISAs. Note however, that if, say, a cash mini-account is opened, no maxi-account can be opened in the same tax year so that only a mini stocks and shares ISA can be opened (which is limited to a £3,000 investment).

Tax credits on dividends received by ISAs are repayable until at least 5 April 2004. In addition from 6 April 2001 it has been possible for 16 and 17 year olds to open a cash ISA. The contribution limit is £3,000 a year until 5 April 2006.
TESSAs

Although no new TESSAs can be opened, existing accounts are allowed to run their full five year term. Remember that the annual investment limits for a TESSA apply by reference to the date the account was opened rather than by reference to tax years. On maturity, the capital may be transferred into a TESSA-only ISA without affecting the annual ISA investment limits.

PEPs

Like TESSAs, no new PEPs can now be opened. However, existing PEPs can be retained, the main tax advantage being that the 10% tax credits on dividends received by a PEP are repayable until at least 5 April 2004. Although new PEPs are unavailable it is now possible to consolidate single company PEPs with a general PEP or create a general company PEP out of single company PEPs. This will have the advantage of allowing more flexibility for sales and purchases of investments and may also reduce plan charges.

Other Investments

There is a wide range of National Savings products, eg NSB savings accounts, savings certificates, capital and income bonds. These are taxed in a variety of ways. Some, such as National Savings Certificates, are tax-free.

For those whose income may fall in the future, for example due to retirement, investments deferring income to a subsequent period may be attractive. For example single premium life assurance bonds and ‘roll-up’ funds can achieve this effect.

The Enterprise Investment Scheme (EIS) allows new equity investment of up to £150,000 in any tax year in qualifying unquoted trading companies. Income tax relief at 20% is available on the investment and capital gains tax exemption is given for shares held for at least three years (five years for shares issued before 6 April 2000).

Furthermore where capital gains are reinvested in EIS shares, those gains can be deferred.

A Venture Capital Trust (VCT) invests in the shares of unquoted trading companies. An investor in the shares of a VCT will be 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 (five years for shares issued before 6 April 2000).

Capital gains can be deferred into VCT investments in a similar way to EIS.

Two other investment schemes currently available are outlined below.

Film partnerships have become very popular due to the Government giving enhanced tax reliefs for investment in qualifying films. The scheme involves becoming a partner in a business which purchases a qualifying film. The loss created gives tax relief against income and/or capital gains. If you cannot fund the investment in cash, packaged loans are usually available. Borrowings are financed by a rental stream from the film producers, guaranteed for a fixed period of time. Of course, the rent is taxable, so the loss relief is effectively clawed back over a period of time.

A similar scheme involves Enterprise Zone Trusts (EZTs). Investing in commercial buildings via an EZT will give tax relief on the investment. Again, packaged loans, which work in a similar way to film partnerships, are often available.

There are no monetary limits to either of these schemes.

If you are interested in any of these investment opportunities, please talk to us.
Capital taxes
- could you benefit from planning ahead?
This is an area where expert advice is necessary. Otherwise it is all too easy to end up with a large capital gains tax (CGT) bill as a result of making a gift which is intended to save inheritance tax (IHT). IHT has received little attention from this Government so far. But things may change in this year’s Budget. Some of the opportunities currently available may cease to exist after the Budget.

Here are some ideas to help you with IHT planning:
  • Has there been a recent change in circumstances - a birth or death in the family which may provide opportunities for IHT planning?
  • Consider making transfers of capital. The donor should be prepared to sever all beneficial connections with the property.
  • When considering transfers of capital the donor’s future needs must be taken into account, particularly the possibility of long term care costs.
  • Term life assurance may be obtained to cover the tax payable if death occurs within seven years of a lifetime gift of capital.
  • Use should be made of the annual exemption (£3,000) and other specific exemptions, particularly ‘normal expenditure out of income’.
  • Check that you have a valid Will, which carries out your intentions in a flexible and tax efficient manner.
  • Trusts can be a useful device for removing assets from one’s estate while still retaining an element of control.

If you have assets which could give rise to CGT when sold then here are some points to consider:

  • Each individual has an annual exemption of £7,500 for CGT purposes. Review your chargeable assets and consider selling before 6 April 2002 to utilise the exemption. Note that husband and wife both have their own annual exemption. A transfer of assets between them may enable them both fully to use this. Bed and breakfasting (sale and purchase) of shares is no longer a possibility. However sale by one spouse and repurchase by the other, or sale outside an ISA and repurchase inside, can achieve the same effect. This can be done either to utilise the annual exemption or to establish a capital loss which can be set against gains.
  • Children also have their own annual exemption and this may be utilised by investing for capital growth, such as in zero coupon preference shares.
  • Another alternative is second hand endowment policies (SHEPs). An unwanted policy is acquired and paid to maturity. Although this gives a capital gain, the acquisition cost and premiums can be deducted. Careful planning can lead to £7,500 of gain per family member being realised every year tax-free.
  • On the other hand, deferring disposals until after 5 April 2002 may be beneficial as this will delay the payment of CGT. The due date will be deferred from 31 January 2003 (for 2001/02) to 31 January 2004 (for 2002/03).
  • Deferral of a gain to a later tax year may also give higher rates of taper relief on the gain. This can make a very significant difference to the ultimate chargeable gain.

  • However, as taper relief goes up, retirement relief goes down, 2002/03 being the last possible year of claim. Deciding in which year to ‘retire’ or sell a business can have a significant impact on capital gains. Please talk to us before taking any action.
  • Remember that capital losses can be established by making a claim where assets no longer have any value - a ‘negligible value’ claim.
Pensions - plan ahead - don’t take a chance on your future!
Pension planning forms an important part of a year end tax planning review not least because tax relief on pension contributions is still available at 40% for higher rate taxpayers.
Employees who are members of a company pension scheme attract tax relief on additional voluntary contributions to the extent that, together with the employee’s other contributions, they do not exceed 15% of remuneration.

The self-employed or those in non-pensionable employment obtain tax relief for payments under personal pension contracts (PPCs). The rules for PPCs were changed from 6 April 2001. It is now possible for individuals to 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. Further contributions can be made depending on age and earnings levels, generally referred to as net relevant earnings or NRE.

The position has been further enhanced by a special new rule, whereby the NRE of a particularly good year can be used as the basis of contributions for that year and the next five. If NRE increases in future years, a new base year can be notified to the pension provider.
Furthermore, if an individual stops work, goes abroad or retires, they have no NRE. This has previously meant that no further PPCs could be made. However, for 2001/02 onwards, where an individual ceases to have NRE, they can look at the year of cessation or any of the previous five years and select the best NRE figure. This can then be used as the NRE figure for the five years after cessation.

The new rules give great opportunities for pension planning but they can be complicated. Please talk to us if you wish to discuss pension planning further.

Family company directors should consider making additional employer’s contributions to existing company pension schemes. If a spouse is employed by the company, consider including them in the company pension scheme or setting up such a scheme for the purpose. Even where salary levels are modest, such a scheme can provide significant benefits.

Remember that pension funds can no longer reclaim dividend tax credits. There may be a case for making extra contributions to compensate for the potential loss of income.

Also consider FURBS (Funded Unapproved Retirement Benefit Schemes), particularly if you wish to provide top-up pension benefits in excess of the maximum limits allowed for approved schemes.
NI Issues
Entitlement to a state pension

Where a spouse is employed by the family business, the earnings are often kept below the national insurance (NI) threshold to avoid payment of contributions.

For 2001/02 it is worth paying earnings of between £72 (the lower earnings limit) and £87 (the earnings threshold) per week. There will be no employees’ contributions due on the earnings but entitlement to a state retirement pension and certain other benefits is preserved. No employer contributions are payable unless earnings exceed £87 per week in 2001/02.

Small earnings exemption

For the self-employed there is a requirement to pay a flat rate contribution (Class 2). If your profits are low you can apply for exemption. The limit for 2001/02 is £3,955. If contributions have been paid for 2001/02 and it subsequently turns out that earnings are below £3,955 a claim for repayment of contributions can be made. The deadline for this claim is 31 December 2002.
Charity watch - please give generously!
There are several ways of donating to charity. A transfer of assets to a charity is capital gains free and inheritance tax exempt. In addition income tax relief may be available on the donation. Individuals wishing to make tax efficient gifts to charity may consider the following:

Example 1 - Alex makes a one-off donation under Gift Aid. The scheme potentially applies to any charitable donation large or small, whether regular or one-off. This allows the charity to claim basic rate tax (at 22%) from the Inland Revenue. As a higher rate taxpayer Alex will also qualify for higher rate tax relief.

Example 2 - Ben agrees to a regular deduction from his salary under the GAYE (Give As You Earn) scheme (no longer any upper monetary limit). His tax bill is reduced as the liability under PAYE (Pay As You Earn) is calculated after deducting the GAYE donation. Furthermore, the Government will pay a 10% supplement to the charity on all donations made under the GAYE scheme for three years from 6 April 2000.

Example 3 - Camilla decided to leave a substantial bequest to charity in her Will. This saves inheritance tax.

Example 4 - David gives some quoted shares to a charity, on which there is a substantial unrealised capital gain. However, no CGT arises on a gift to a charity. The charity can then sell the asset free of CGT providing it applies the proceeds for charitable purposes. Furthermore, income tax relief is available on the value of the shares gifted.

Ignore them at your peril! Remember that in most instances interest will be charged on tax paid late and penalties can be levied if forms are late or incorrect.
19 April 2002 - Interest will run on any 2001/02 PAYE and NIC deductions not paid over by this date.

19 May 2002 - Employers’ year end returns (P35/P14/P38) due for submission.

31 May 2002 - Employees must be provided with their P60 (certificate of pay and tax deducted).

6 July 2002 - Submission of P11Ds and P9Ds returning details of expenses paid and benefits provided to employees and directors. A copy of the P9D/P11D must also be given to each employee. A dispensation, allowing certain items to be omitted from the forms, can be granted by the Inland Revenue.

19 July 2002 - Class 1A NIC for 2001/02 on most benefits in kind provided to employees must be paid by 19 July 2002. The normal methods of making payment will apply and a special Class 1A NIC payslip is sent out in April.

19 October 2002 - PAYE settlement agreement liabilities for 2001/02 due, together with Class 1B NIC.

Employers’ action points
Contact us if:
  • You have any concerns over the accuracy or completeness of your PAYE records.
  • You need assistance with the completion of P11Ds or application for a dispensation.

Have you thought about
  • A PAYE settlement agreement as a useful way to account for tax on minor benefits provided to employees.
  • Obtaining a dispensation.
Benefits for employees
  • Much of the planning for employment income (including directors’ remuneration) focuses on the provision of tax efficient benefits.
  • However, since 6 April 2000 most taxable benefits in kind have given rise to an employer’s (but not employee’s) national insurance liability. To discuss remuneration packages and the provision of benefits further, don’t hesitate to contact us.

Disclaimer - for information of users
This newsletter is published for the information of clients. It provides only an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material contained in this newsletter can be accepted by the authors or the firm.