Pre-Budget Report 2007

In many ways we believe that this PBR gives more planning opportunities for our clients then any for several years. This may not have been the intention - in what was predicted to be a pre-election budget - but is certainly the effect. This note has been updated from 24 January to include the Press Releases issued in January.

Commentary

The abolition of taper relief will mean a significant increase in tax charges when a business is sold or liquidated. Many clients will want to liquidate their existing companies and start a new business before 5/4/08 to take advantage of the business assets taper. The New Entrepreneur's relief will keep the 10% tax rate on up to £1m of gain on business asset - including holdings of more than 5% in trading companies - but some clients who hope to have gains of over £1m over their lifetimes and so will want to take the advantage now.

The abolition of taper results in a significant tax saving for clients with capital gains without much taper. They may want to look at deferring tax charges in the last few years - e.g. by using EIS so that the gain is crystallised when the rate is only 18% - rather than 40%.

Clients with a large amount of indexation allowance - on assets acquired before March 1998 may also want to make a disposal.

New rules for non-domiciled clients means that many will need to rethink their tax planning strategy - but the detail of this will have to wait for the results of the consultation.

Clients with discretionary will trusts - set up to give two nil rate bands for IHT - will probably want to amend their wills to take these out - now that there is a statutory procedure to achieve the same ends.

Capital Gains Tax Reforms

For owners of businesses, Entrepreneur's relief will be available to reduce the tax rate to 10%. Eexamples will be included in these notes as details are announced. To qualify you will need to own at least 5% of the business.

For disposals made on or after 6 April 2008 a new set of CGT rules will apply.  Under the current regime the application of taper relief can reduce the tax rate to 10% for business assets.  The new rules will abolish taper relief, indexation allowance and a number of other detailed CGT calculation rules and replace it with a single 18% tax rate on all capital gains, regardless of the type of asset and the length of time it has been held.  This new 18% rate will apply for individuals, trustees and personal representatives.

Example
A is a small shareholder (1%) in a listed limited company, which was incorporated 2 years ago.  The company is to be sold and A will receive £100,000. A is a higher-rate taxpayer.

Before 6 April 2008
The gain of £100,000 will attract full business-asset taper relief so that only £25,000 is chargeable.  After deducting the Annual Exempt amount £15,800 will be taxable at 40% - amounting to £6,320 tax, an effective rate of 6.3%

After 5 April 2008
The distribution of £100,000 will be chargeable in full since there is no taper relief.  After deducting the Annual Exempt amount £90,800 will be taxable at 18% - amounting to £16,344 tax, an effective rate of 16.3%

In addition from 6 April 2008 the rules by which disposals of shares are matched to share purchases in order to determine the gain or loss made will be simplified.  Instead of the current “matching rules” – which follow a complex order to identify the shares being sold – there will be a more simplified system where shares of the same class in the same company will be treated as a single asset pool. 

The current rules will continue to apply for disposals up to and including 5 April 2008 and therefore for most clients it will be worthwhile considering how to use this remaining window to best effect.

Inheritance Tax - new married couples nil-rate band

Currently each individual taxpayer is entitled to an inheritance tax nil-rate band of £300,000 on their death.  Any excess in the value of their estate on death above this nil-rate band is taxed at 40%.  For most married couples and civil partners where the estate (or part of it) passes on death to the surviving spouse or civil partner that transfer is exempt from inheritance tax and therefore all or part of the nil rate tax band is wasted.  When the second spouse/partner dies they are then left with a significant tax bill since they have a larger estate and only their own nil-rate band to set against it. 

The new rules will apply for cases where the second spouse or civil partner dies on or after 9 October 2007 (regardless of the date of death of the first spouse or civil partner).

From this date any unused nil-rate band in relation to the deceased spouse or civil partner’s estate may be transferred to the estate of their surviving spouse of civil partner on their death.  To calculate the amount to be transferred the % of the nil-rate band unused at the date of the first spouse’s death will be multiplied by the value of the nil-rate band at the date of the second spouse’s death.

This transfer must be claimed by the personal representatives usually within the later of 2 years from the end of the month in which the surviving spouse or civil partner dies or 3 months from the beginning of the date on which the personal representatives first act as PRs.

Clients who currently have a discretionary will trust in place may wish to consider changing their wills by codicil to take account of the new rules.

Examples

A dies on 14 April 2007 with an estate of £400,000, which he leaves entirely to his spouse, B.  B dies on 17 June 2009 leaving an estate of £600,000 equally between her two children.  When B dies the nil-rate band is £325,000.  As 100% of A’s nil-rate band was unused, the nil-rate band on B’s death is doubled to £650,000.  Accordingly since the value of B’s estate is less than the nil-rate band there is no IHT to pay on her death.

Income-splitting legislation – following the Arctic Systems Case

Following the Revenue’s recent loss in the Arctic Systems case in the House of Lords we expected some new anti-avoidance legislation addressing the way in which income from small businesses is split between husbands and wives. 

We have had a short reprieve – the Government has announced that it intends to open a consultation process on the draft legislation with the intention that it should come in force from 2008-09.  Until then the decision in Arctic Systems prevails leaving us a short window of opportunity to take advantage of the tax-planning opportunities offered by income-splitting.

Residence and Domicile Review

The Government has announced changes to the rules governing the determination of UK residence for tax purposes and affecting the way in which non-UK domiciled individuals will be taxed.  These changes will apply from 6 April 2008.

Currently UK residents who are not domiciled or not ordinarily resident in the UK will only suffer UK tax on overseas income and capital gains that are remitted to the UK.

From 6 April 2008 once an individual is resident in the UK they will have a choice.  Either:

1. They can continue using the remittance basis providing they do not claim personal allowances or the CGT annual gains exemption and if they have been in the UK for more than seven years they pay an additional tax charge of £30,000 per year or
2. They will be taxed in the UK on their worldwide income and gains regardless of whether they are remitted to the UK.

In addition the rules for establishing whether a taxpayer is resident in the UK will also change.  The current practice of ignoring days of arrival and departure when calculating whether an individual is present in the UK enough days to be resident will be changed so that on/after 6 April 2008 days of arrival and departure will be calculated as days of presence in the UK.  For some clients who work their annual average very closely this change will be very significant.

In addition where a person elects to continue to use the remittance basis after 6 April 2008 they will not be entitled to claim personal allowances against their income tax liability or, if they were previously entitled to them, married couples allowance or blind person’s allowance.

In addition the legislation relating to the operation of the remittance basis will be tightened-up to remove some of the current loopholes.  Perhaps the most significant of these changes will be the extension of the definition of remittance (which is already widely drawn) and the reduction in the scope for using offshore structures to reduce liability to UK taxes.

Changes to Income Tax Self-Assessment Payments on Account

Currently, where taxpayers have an annual income tax liability, after deducting tax paid at source (PAYE, tax on bank interest etc), of more than £500 they have to make payments on account of their tax liability on 31 January during the tax year and the 31 July after the end of the tax year, with any balancing payment due on 31 January after the end of the tax year.

From 6 April 2009, ie in respect of tax year 2009-10 onwards, this threshold will be doubled to £1,000.  The first payments on account affected will therefore be those due on 31 January 2010 and 31 July 2010, since these relate to the 2009-10 tax liability.  Therefore, where a taxpayer’s income tax liability for 2009-10 (after deducting tax collected at source) is less than £1,000 – no payments on account will be required on 31 January or 31 July 2010.

This should reduce the number of taxpayers having to make payments on account.

Changes to Stamp Duty

Currently taxpayers acquiring shares or securities in UK companies via a stock transfer form or other instrument suffer small amounts of fixed or ad valorem Stamp Duty, often not exceeding £5.

From Budget Day 2008, where the Stamp Duty on these transfers does not exceed £5 the transfer will be exempt from Stamp Duty and the instrument will not have to be presented for stamping.

This applies to:

• Transfers of shares and securities currently attracting a fixed stamp duty charge of £5
• Transfers of shares and securities which attract ad valorem duty and where the consideration is £1,000 or less