John Woolley analyses the changes announced in March’s Budget and examines the impact and planning opportunities for advisers
he Budget on 11 March 2020 was an unbelievable 500 days since the last Budget in October 2018. The chancellor, Rishi Sunak, had still only been in the job a matter of weeks and to say the Budget represented a challenge for him is a massive understatement. Even more so given the current world events which led to this Budget being dubbed by some as the “Corona Budget”.
The chancellor promised the government would help people during the difficult coronavirus days ahead by making sick pay available in a speedy and effective manner for all. In what amounted to a series of subsequent Budget announcements, the government also did its best to support small businesses and the self-employed by deferring VAT and self-assessment payment dates. The chancellor also announced a raft of further provisions to help small businesses and secure the jobs of millions of employees during the current crisis.
In many ways, the tax measures revealed on 11 March (total cost about £30bn) were dwarfed by the wider health and economic changes announced subsequently (cost at least £50bn plus up to £330bn of loan guarantees). No wonder the chancellor confirmed that the government would hold another Budget in the Autumn.
As far as changes to fiscal policy were concerned, the main highlights for financial planners were as follows:
- a reduction in the lifetime allowance for entrepreneurs’ relief from £10m to £1m;
- a £90,000 increase in the threshold income and adjusted income limits for pension annual allowance taper to £200,000 and £240,000 respectively, with the minimum annual allowance falling from £10,000 to £4,000;
- an increase in the junior individual savings account (JISA) contribution limit to £9,000 from £4,368;
- a clarification of the rules on top-slicing relief when chargeable event gains from a life policy cause adjusted net income to exceed £100,000;
- an increase in the employee’s primary threshold limit (and the Class 4 lower profits limit) to £9,500;
- an increase in the employer’s national insurance contributions (NIC) employment allowance to £4,000;
- an increase in the capital gains tax (CGT) annual exemption to £12,300;
- the announcement of a review of the taxation of UK funds;
- the announcement of an intention to review how non-taxpaying employees in net pay pension schemes can be treated in the same way as those who pay contributions direct and so give basic rate tax relief to both types of saver;
- a continued commitment to combat perceived aggressive tax avoidance.
Surprisingly, and despite considerable speculation, there was no announcement of any changes to inheritance tax or even a review of the current system.
We will now look at the proposals that most affect the clients of financial advisers and highlight any planning opportunities that arise.
The government confirmed that corporation tax will remain at 19% from 1 April 2020 and not reduce to 17% as previously scheduled and legislated for.
This is not a surprise as the current rate of corporation tax is still one of the lowest in G20 countries.
It also means that companies will still benefit from tax relief at 19% on pension contributions.
No changes were announced to:
- the personal allowance (£12,500);
- the higher rate tax threshold (total income £50,000; taxable income £37,500);
- the dividend tax allowance (£2,000), personal savings allowance (up to £1,000;) and zero rate savings band (£5,000).
In 2015, the government made a commitment that, by 2020, the higher rate tax threshold would be £50,000 and to keep everyone with income of less than £12,500 out of tax. They achieved both of these last year and legislated for a freeze in the Finance Act 2019.
Of course, in Scotland, a different system of rates and bands apply to earned income and rental income and changes were made here to the starter, basic and intermediate tax bands. The threshold for higher rate (41% in Scotland) taxable income stayed at £30,930 (total income £43,430) and the threshold for additional rate tax (46%) was unchanged at £150,000.
NATIONAL INSURANCE CONTRIBUTIONS
(i) Employment allowance The employment allowance gives a reduction in the NICs paid by an employer and is given as a credit against the other NIC liability. In 2020/21 this will increase from £3,000 to £4,000 and is available provided the business did not have a Class 1 employer NIC liability of £100,000 or more in the previous tax year. As before, the allowance is not available if a company’s sole employee is a director.
This is a welcome improvement on an employer’s liability to NICs which will help small businesses.
(ii) NIC rates and bands
As promised in the Conservative manifesto, the primary employee’s NIC threshold increases from £8,632 to £9,500 in 2020/21. Employees pay 12% on excess earnings up to £50,000 with 2% thereafter. The government’s intention is to eventually increase the primary threshold to £12,500.
In 2020/21, the employer’s secondary NIC threshold increases to £8,788 from the current £8,632. Earnings over and above this are generally subject to NICs at 13.8%. Because there is a mismatch between the employee’s primary and the employer’s secondary NIC limit, this means that where an employee takes salary of £9,500 there will be no employee liability but an employer NIC liability of £98.
The lower earnings limit is the minimum level of earnings that need to be paid to qualify for state benefits. This increased in 2020/21 by £2 a week to £120 a week (£6,240 a year).
Because NIC thresholds have changed, people who trade as a director/shareholder through a profitable private limited company will need to consider how remuneration should be drawn out of the company in the most tax efficient way.
Usually the options will be between taking drawings from a company as either:
- remuneration/salary; or
- salary up to the employee’s primary threshold (£9,500) with the balance as dividends.
When making this decision it will now be necessary for the director/shareholder to take account of the following key financial data.
Primary threshold (employees) £9,500
Secondary threshold (employers) £8,788
Employer Class 1 NIC rate 13.8%
Employee Class 1 NIC rate 12%
Corporation tax rate 19%
Personal allowance £12,500
Basic rate income tax threshold £37,500 (outside Scotland)
Income tax rate on earnings – basic rate 20%, higher rate 40% (outside Scotland), additional rate 45%.
Income tax rate on dividend income – basic rate 7.5%, higher rate 32.5%, additional rate 38.1%.
If a salary of £9,500 is taken (no employee’s NICs but employer’s NICs of £98) with a dividend top-up, the company will pay corporation tax on the net profit in the company (after deduction of salary and employer’s NICs of £98).
Assuming that the dividend allowance is fully available, but the employment allowance is already used, if cash of £60,000, £125,000 and £200,000 is available in the company and all of this is to be drawn by the director/shareholder either totally as salary/bonus or partially as salary with the balance as dividends, the results are as follows:
The tax efficiency of the extraction of the excess funds over £9,500 as dividends is due to the fact that they are not subject to NICs. However, the freedom from NICs totalling up to 25.8% comes with costs:
- As the Government has made clear in guidance on its Self-Employed Income Support Scheme (SEISS), individuals who operate via a company are employees, not self-employed. Their employer/company can only claim under the Job Retention Scheme (JRS) on the basis of 80% of the salary paid to the employee/director (capped at £2,500 a month). Dividends may look like remuneration and be spent as such, but they are not covered by the JRS. In presenting the SEISS, the Chancellor hinted that there could be changes to NICs in the future to bring all employment options into line in terms of contributions paid. This needs to carefully be borne in mind.
- In an effort to recoup some of the lost NIC income, changes made from 2016/17 mean that dividends are subject to a higher rates of income tax than they were previously.
There is a case to be made for director/shareholders with unused basic rate tax band to draw dividends and pay 7.5% basic rate tax on them rather than leave money in the company where the undistributed profits will potentially be liable to capital gains tax of 20% and (perhaps even 10%) when the company is sold. Indeed, if retained amounts are not needed by the shareholder/director such sums should be extracted by way of a pension contribution with all of the tax reliefs and advantages this generates. Any surplus sums can be kept in the company.
CAPITAL GAINS TAX
We need to consider CGT in terms of Budget changes that affect investments and business assets.
The government have announced that the CGT annual exemption will increase to £12,300 in 2020/21. The trustee exemption will similarly increase to £6,150 (subject to dilution when the same settlor has created more than one trust).
A number of planning opportunities arise out of the CGT annual exemption, as follows: - investors should use the exemption in a tax year. If they do not use it, they will lose it – carry forward is not available;
- the exemption is available to all investors. Married couples/civil partners should, if possible, distribute wealth between them so both can use it; and
-minor children are also entitled to the annual exemption. Parents and grandparents can effectively arrange to utilise a child’s CGT annual exemption by establishing a bare trust or designated account for them. Where the settlor is the parent, the £100 per annum income tax anti-avoidance rule will apply so, in such cases, any investment in the trust should be made with a view to generating capital growth rather than income.
Entrepreneurs’ relief is a very attractive relief for business owners who sell their business. It applies where a business consists of a trade and an individual has owned the business interest for at least two years. Also, in the case of a company, the shareholder must have basically owned and had the right to dividends/distributions on at least 5% of the share capital.
In such cases, the lifetime allowance for entrepreneurs’ relief was £10m. This meant that capital gains arising on the disposal of a business interest of up to this threshold throughout the individual’s lifetime would only be taxed at a CGT rate of 10%. As was expected from their Election manifesto, the Government reduced the lifetime allowance for entrepreneurs’ relief (now known as Business Asset Disposal Relief) to £1m with effect from 11 March. The Finance Bill 2020 includes anti-forestalling measures aimed at, for example, conditional contracts put in place before the Budget.
The owners of businesses could clearly suffer higher CGT in the future. Some of the tax planning they should consider to offset this change will include: - a consideration of bringing spouses/partners into the business ownership as they will qualify for their own entrepreneur’s relief lifetime allowance; and - using pension contributions as a means of reducing the value of a company for CGT purposes in a very tax-efficient way whilst building up a tax-efficient fund outside of the company which cannot be accessed by the company’s creditors. This planning also uses company profits now whilst profitability is hopefully good as circumstances can rapidly change before the date of an intended business sale (something those who say “my business is my pension” should bear in mind).
The plight of NHS doctors and clinicians has been well publicised. Simply put, many have had to pay additional income tax bills because the calculated contributions have infringed the annual allowance rules, particularly those
that apply to taper reduction where adjusted income exceeds £150,000.
The government has taken a bold decision in solving this problem by introducing the following provisions.
(a) an increase in threshold income (income less individual pension contributions) from £110,000 to £200,000.
(b) an increase in adjusted income (income including employer contributions) from £150,000 to £240,000.
(c) a reduction in the maximum contribution for persons with adjusted income of more than £300,000 as a result of allowing the taper to be extended to produce a new minimum annual allowance of £4,000 (reached at £312,000 of adjusted income). Previously this was £10,000 reached at adjusted income of £210,000.
Whilst there are mainly winners, there are some losers as the table below (which ignores carry-forward relief) demonstrates.
It is estimated that these changes will lift 250,000 people out of the pensions taper tax threshold with around 98% of consultants and 96% of GPs out of the taper altogether.
Advisers should therefore approach clients who were caught by these taper restrictions to ascertain whether there is scope for further contributions to be paid – given that in tax year 2020/21 many will now have a full £40,000 annual allowance. However, remember that when calculating the carry forward relief from previous years, the rules that then existed will apply and so clients may well be subject to the restrictions that applied in those years.
There were no announced changes to the annual ISA contribution limit of £20,000 per annum per person (unchanged since 2017/18). Remember, unused allowances cannot be carried forward.
Surprisingly, from 6 April 2020, the annual allowance for a JISA has increased from £4,368 to £9,000. Funding a JISA for the full £9,000 each year from the birth of a child with underlying investment growth of 5% pa, could produce more than £265,000 at age 18. Such a fund could then be used to assist with the costs of university education or help with house purchase. The average size of an annual JISA contribution in 2017/18 was about £1,000 so £9,000 will be beyond the means of most. Also, of course, the child will have full access to the ISA at the age of 18 and the parent/grandparent would need to be comfortable with this.
Also, as announced from 1 September 2020, maturing child trust funds can be moved into adult ISAs. If no action is taken, the CTF will continue to enjoy ISA-type tax benefits in a ‘protected account’, pending further instructions. Previously only cash could be taken at maturity.
This gives advisers the perfect opportunity to discuss with children (and their parents) any maturing CTFs and the scope to continue tax-efficient investment inside an ISA from age 18 years. Indeed, some children may like to consider encashing their CTF and starting an investment in a Lifetime ISA (LISA – maximum investment £4,000 per tax year) in order to benefit from the 25% Government bonus that is on offer.
LIFE POLICY TAXATION
Two important changes were announced in the way the chargeable event rules apply in calculating tax on chargeable event gains that arise under life policies.
(1) Order of offset of tax allowances and reliefs In general, in calculating an income tax liability, the taxpayer has the right to choose the income against which he will offset tax allowances and reliefs, in order to produce the lowest tax liability.
In future, for the purposes of calculating top-slicing relief:
- the rules that require reliefs and allowances to be set off in the most beneficial way for the taxpayer will no longer apply; and
- an individual’s reliefs and allowances must be deducted from other income before being deducted from a chargeable event gain. This means that the personal savings allowance (PSA) must be set against other savings income in priority to a chargeable event gain.
(2)Top-sliced gains and the personal allowance
As is well known, when a person’s adjusted net income (ANI) exceeds £100,000, the personal allowance is gradually eroded by £1 for every £2 of excess income. So, on the basis of a personal allowance of £12,500, this is totally lost when adjusted net income (ANI) is £125,000 or more.
In the past, in calculating top-slicing relief under a life policy (say an investment bond) HM Revenue and Customs (HMRC) has always taken the view that it is the full chargeable event gain that is included in adjusted net income – and not the top-sliced gain. This view was challenged in the Silver case where Mrs Silver maintained that only the top-sliced gain should be taken into account and the First-tier Tribunal upheld her claim. HMRC has now dropped its appeal to this decision to the Upper Tax Tribunal.
Proposals in the Budget, in effect, now bring in provisions that mean that in future, when calculating top-slicing relief, it will be only the top-sliced gain that is taken into account as ANI for the purposes of entitlement to a personal allowance. However, in general terms, this only applies on chargeable event gains that arise on or after 11 March 2020. Following HMRC’s decision to drop their appeal in the Silver case, and because FTT decisions are not binding on others, this will mean that where chargeable event gains were realised before March 11 2020, tax liabilities will be dealt with on a case by case basis.
Going forward this will be very important for the taxpayer as a good number have, in the past, been caught in this trap.
Example – Rachel
Rachel, who has gross earnings of £50,000 pa, owns a UK investment bond.
She purchased the investment bond for £100,000, 8½ years ago. Its current value is £180,000 and she is considering encashing the bond. She has made no previous surrenders or withdrawals.
The chargeable event gain is £80,000 and the profit slice for top-slicing relief purposes is £10,000. The tax position on the encashment of the bond under the old and new rules is shown in the table in the previous column.
So, Rachel is £5,000 better off by encashing the bond on or after 11 March 2020. And because her other income is equal to (or just above) the higher rate tax threshold if she was able to further reduce her adjusted net income, she could save income tax on the chargeable event gain. For example, a pension contribution of £4,000 net (£5,000 gross) would save income tax of £8,000 on the chargeable event gain and a contribution of £8,000 net (£10,000 gross) would mean that no tax was payable on the chargeable event gain.
So clearly, for those higher rate taxpayers who are contemplating encashing a single premium investment bond, the new rules may considerably ease the position. Of course, all the individual circumstances of the investor and the investment will need to be considered before encashment takes place.
AREAS WHERE NO CHANGES WERE ANNOUNCED
There were three areas where changes were expected to be announced but none were:
(i) The reform of inheritance tax where the Office of Tax Simplification (OTS) made a number of suggestions for reform in 2018 and 2019.
(ii) The operation of the high income child benefit tax charge. Many commentators (including the OTS) feel reform is overdue.
(iii) An amendment to the rules for non-taxpayers so that such persons who are in net pay pension arrangements (including thousands of auto-enrollers) can benefit from some form of a basic rate tax pension credit. The Government have acknowledged the unfairness of this issue and promised to address it.
We may see more announcement in these areas in the 2020 Autumn Budget.
We live in difficult times. But clients need financial advice – perhaps now more than ever. The Budget announcements give rise to a number of areas advisers should discuss with clients.
This article is based on the provisions in the Finance Bill 2020 which can change during its passage
John Woolley of Technical Connection / St. James’s Place