Technical Connection’s John Woolley explores tax planning opportunities arising from this year’s Budget and Command Paper
It has been a long time since there has been so much anticipation around a Budget.
Given the massive debt that the UK government had built up during the pandemic to support people, business and the economy, there was speculation as to how it would seek to balance the books – would it introduce measures to stimulate the economy or measures to increase tax? And, in this respect, for the previous six months there had been intense speculation about tax increases in the area of capital gains tax (CGT), inheritance tax (IHT) and pensions.
What we actually got in the end was:
- A number of economic support measures.
- Continued support for individuals via an extension to the furlough system, a continuation and widening of the self-employed income support scheme and an extension to the period of Universal Credit payments and a number of important tax changes that do not have an immediate impact – but will during the next five years.
On the tax front, the Chancellor announced a future hike in corporation tax and a number of ‘stealth’ tax measures that freeze allowances, tax thresholds and exemptions at their 2021/2022 levels until 5 April 2026.
These changes will have an enormous impact over the years to come so we will examine the implications and planning opportunities.
Other than these, there were no substantive tax changes. However, that was not quite the end of the story. A couple of weeks after the Budget on what came to be known as ‘Tax Day’, the government laid a Command Paper before the House of Commons, which looked at tax policy for the next 10 years. The areas to be covered in this paper were kept out of the Budget because they did not impact on what was to be included in the Finance Bill 2021 but they could have a significant impact over time.
The Command Paper made little change to the substantive tax policy that will impact clients. Interestingly, there was no real mention of CGT or pensions. Some future rationalisation of IHT was mentioned which we will examine.
- Corporation tax
This is probably the change that is expected to give the Chancellor the biggest tax intake. Here, the government has proposed that the corporation tax rate for companies with profits in excess of £250,000 will be 25% from 1 April 2023. For companies that have profits of less than £50,000, the current tax rate of 19% will continue to apply, with a marginal rate (expected to be 26.5%) on profits of between £50,000 and £250,000 to bring the overall tax rate up to somewhere between 19% and 25%.
Companies that are close investment companies – typically family investment companies – will not benefit from the £50,000 small profits rate. It may well be that all of their profits will be taxed at 25%. However, on the basis that most of their income is dividend income, this change will have little impact because companies do not pay tax on UK dividend income. In general, property holding companies that let property to persons who are unconnected with the company will not be treated as close investment companies and so will be entitled to the £50,000 small profits corporation rate – if appropriate (see property-related taxation).
With effect from 1 April 2021, a company will, for two years, be able to offset 130% of its capital expenditure on plant and machinery for tax purposes. Based on a current 19% corporation tax rate, this will currently give a company tax relief of 24.7% on such expenditure. From 1 April 2023, a 100% allowance would give tax relief of 25% at a corporation tax rate of 25%.
So, it is probably the case that this allowance has been introduced to stop companies delaying expenditure until 2023 simply to gain greater tax relief.
Given that a number of businesses will have suffered business losses recently, the Chancellor has announced that business losses of up to £2m in each of tax years 2020/2021 and 2021/2022 can now be carried back for tax purposes for a period of up to three years (later years first) – rather than the one-year period that previously applied.
The Chancellor revealed that the previously-announced increases in the personal allowance and higher rate tax threshold would apply in 2021/2022.
The personal allowance has increased to £12,570 (from £12,500) and the higher rate tax threshold to £50,270 (from £50,000). However, after these increases both amounts will be frozen until 5 April 2026.
It should be noted that the threshold for the High Income Child Benefit (HICB) tax charge will remain at £50,000, which means that it is theoretically possible for a basic rate taxpayer to be subject to the HICB tax charge.
No changes were announced in the level of the starting savings rate tax band (£5,000); personal savings allowance (£1,000/£500); and dividend allowance (£2,000).
The freezing of the personal allowance and higher rate tax threshold will have an impact on individual tax liabilities.
It is estimated that, by 2026, this will result in one million more taxpayers (whose income has drifted above the personal allowance) and one million more higher rate taxpayers whose taxable income exceeds £50,270. So it is evident that this change will have a dramatic effect. Of course, this will mean that there will be even more incentive for those higher rate taxpayers to make pension contributions (to obtain 40% tax relief) and use other tax-efficient investments such as ISAs.
Pension contributions may also be useful to reduce the adjusted net income for those whose current income level causes them to lose their personal allowance (£100,000) or be subject to the HICB tax charge (£50,000) – see the ‘Pensions’ section for more information.
Last year saw a dramatic increase in the employee’s primary National Insurance contributions (NIC) threshold to £9,500. This year, the Chancellor announced more restrained changes for 2021/2022.
The primary threshold for employees (PT) increases to £9,568 a year from £9,500 pa in 2021/2022, with the upper earnings limit (UEL) increasing to £50,270 in 2021/2022. Employee Class 1 NICs are charged at 12% between the PT and the UEL and 2% on earnings above the UEL.
The secondary threshold (employers) has increased to £8,840 a year from £8,788 a year in 2021/2022. Employer Class 1 NICs are charged at 13.8% on amounts above the secondary threshold – there is no upper limit.
The lower earnings limit remains at £6,240. This is the minimum level of earnings to qualify for state benefits.
The changes in the thresholds for NICs are always a relevant issue for those clients who trade through a private limited company and can therefore choose between salary and dividends as a means of drawing profits out of a company.
Key issues in making this decision are that:
- Dividend payments are not deductible for corporation tax purposes (whereas salary/remuneration/NIC payments are).
- The payment of a dividend is not subject to NICs.
It is always worthwhile paying salary up to a certain minimum level that will not give rise to an employee’s NIC liability but will provide a state old-age pension credit.
The bottom line is that despite the recent increase in the rates of income tax on dividend payments, currently it will still be more tax-efficient to make most of the payment as a dividend. However, this may not be true in 2023 when corporation tax rates increase.
The level of improvement that dividends offer depends on the level of profitability of the company. So, for example, where a company had either £60,000, £125,000 or £200,000 available and the sole shareholder/director had no other income and wished to receive at least £9,568 as salary with the balance as salary or dividends, the increased return from a dividend payment in 2021/2022 would be as follows:
Some important points that come out of this area of planning are as follows:
- If possible, dividend payments should be taken up to the higher rate tax threshold of £50,270 – as they are only taxed at 7.5%.
- A shareholder should only draw dividend income that causes him/her to exceed the higher rate tax threshold if this income is needed to live off.
- The position will change in 2023 for those companies with profits of more than £50,000, because corporation tax rates will increase and dividends are not deductible for corporation tax purposes.
While it might seem to be attractive to leave profits in a company with a view to withdrawing them as capital and paying CGT when the company is ultimately sold, restrictions can apply in relation to business asset disposal (entrepreneurs’) relief if a company has significant cash holdings. Indeed, this is an area where the government may well tighten the rules still further in the future.
Of course, the most attractive way of removing cash from a company, if sufficient pension allowances are available, will be by way of an employer company pension contribution. This will be tax deductible for the company, not be taxed on the director/shareholder and be invested in a tax-favoured fund.
The only change on pensions that was announced was that the current lifetime allowance (LTA) will be maintained at its current level of £1,073,100 until 5 April 2026. Previously, it was supposed to increase in line with the consumer prices index (CPI) each year. Had the LTA increased by the current level of CPI until 2025/26, it is estimated that it would then have been worth about £1.2m and so, effectively, the pension member will lose about £31,725 in tax-free cash (£126,900 @ 25%).
Where the value of a pension fund exceeds the LTA on a crystallisation event, excess funds will be taxed at 55% if drawn as a cash payment, and 25% if the fund is then designated to drawdown (with subsequent withdrawals suffering income tax as appropriate). At age 75, the scheme administrator will apply a 25% charge on funds that exceed the available LTA.
Clients who have a pension fund with a value approaching the LTA (or who might have in the future if they have reasonable investment growth) should give careful consideration to the question of whether they should continue to pay contributions. Clearly, one mitigating factor would be a situation where employer contributions are being made, especially if there is no option to take those contributions as remuneration or in another form.
Another issue is whether the freezing of the LTA means that the client should review their plans on crystallising benefits. For example, the member may previously have decided to defer drawing benefits on the basis that the LTA, as increased by CPI, would always exceed the value of the pension fund. That may not now be the case.
Other planning action may involve the client revisiting the question of an election for Fixed Protection 2016 or Individual Protection 2016 to benefit from an increased LTA. Of course, a number of conditions would need to be satisfied for these elections to be made.
As is well known, there are many tax advantages of pension schemes. In particular, tax relief on pension contributions costs the Treasury some £40bn each year. Future changes cannot be ruled out – particularly in the current fiscal climate. This means that clients, especially those who are higher rate taxpayers, who have scope to pay further contributions within their annual allowance (including carried forward of unused relief) and their LTA should take action while they can.
Indeed, tax relief can be enhanced if the payment of the pension contribution can be used in situations where:
- A client’s adjusted net income is reduced below £100,000 to recover the personal allowance; or £50,000 (and not £50,270) to avoid the HICB tax charge; and
- The basic rate tax band can be extended to reduce tax on capital gains or chargeable event gains on the encashment of single premium bonds.
There were two announcements in the property sector.
To begin with, the Chancellor announced the introduction of a government-backed mortgage guarantee scheme. Under this, the government will guarantee mortgage repayment where people take up to a 95% mortgage on a loan-to-value basis to buy a property worth less than £600,000.
Secondly, the Chancellor announced an extension to the earlier Stamp Duty Land Tax (SDLT) concession. Under this concession, there was no SDLT on the first £500,000 of the purchase price of a residential property purchased before 31 March 2021. This deadline has now been extended to 30 June 2021, and for house purchases completed between 1 July 2021 and 30 September 2021, the concession will give an exemption on the first £250,000 of the purchase price before returning to the previous figure of £125,000 on 1 October 2021.
While this concession applies to the purchase of all private residences – including buy-to-lets – it should be noted that this gives no exemption from the 3% SDLT surcharge that applies when an individual purchases an additional residential property such as a buy-to-let or holiday home.
This SDLT concession also applies in cases where SDLT would otherwise apply on the transfer of a residential property to a company. It is therefore currently possible for an individual to transfer a buy-to-let property worth less than £500,000 to a company and pay only the 3% SDLT surcharge.
Separately on Tax Day, the government announced that it would be clamping down on property investors who claim their property is furnished holiday lettings when no such intention exists, with this being done purely to obtain business rates and avoid the full residential council tax charge.
The extension of the SDLT concession will be of great interest to those buy-to-let owners who are considering transferring their buy-to-let property to a company in order to be able to offset mortgage interest for tax purposes and pay the lower rates of corporation tax that apply to the company – currently 19% as compared to, say, 40%/45% if the individual owns the property.
However, the CGT issues of such a transfer would also need to be considered. Incorporation relief may be available to defer the payment of CGT if all of the conditions of s162 Taxation of Chargeable Gains Act 1992 are satisfied – including the need for the individual to be operating as a business. The position on any outstanding mortgages would also need to be checked prior to transfer.
Of course, one point to watch here is the possible further increase in the corporation tax rate to 25% with effect from 1 April 2023. For companies other than close investment companies, the small profits tax rate of 19% will apply on profits of up to £50,000. The good news here is that a buy-to-let company will not be treated as a close investment company, so it will still be entitled to the £50,000 small profits rate.
The increase in corporate tax will also have an impact for CGT purposes – particularly in cases where the capital gain that arises on the sale of a property is substantial and takes the company into the 25% rate tax, which is only 3% below the 28% top rate currently payable by individuals. There would also be further tax for the individual when extracting cash from the company.
All of these factors need to be considered before deciding whether to hold a buy-to-let portfolio in a company or in individual ownership.
Capital gains tax
There was huge speculation before the Budget that, given the big disparity between the rates of CGT and income tax, the Chancellor would announce an increase in the rates of CGT. In fact, all that was announced was a freeze in the annual exemption at £12,300 until 5 April 2026. Similarly, the maximum annual CGT exemption for trusts will remain at £6,150. So, during the next five years, more taxpayers will naturally fall into charge to CGT purely because the exemption is frozen.
So, what should taxpayers do to improve their position? The following action should be considered:
- Use the annual exemption before the end of each tax year; if it is not used, it cannot be carried forward so is wasted.
- Use the annual exemption of spouses/civil partners if possible – taxpayers should remember that any transfers of assets between them should be unconditional with no understanding that proceeds will be returned to the original owner.
- Establish bare trusts for the benefit of children to use their CGT annual exemptions.
- Use ISAs to accumulate capital gains, free of tax.
- Use loss relief – remember when using carried-forward losses it is possible to restrict the useable loss to the available annual exempt amount and carry forward any excess gains; this is not so easy to achieve with same-year losses without careful planning.
- Remember that the ‘bed and breakfast’ rules will prevent an effective taxable crystallisation event if the same asset is reacquired within 30 days of a disposal; to overcome this, strategies to use should include ‘bed and spouse’, ‘bed and ISA and ‘bed and SIPP’, or the sale of an investment with the reacquisition of a similar but not identical investment.
Given all the speculation and the recent Office of Tax Simplification (OTS) report on reforming CGT, changes cannot be ruled out in the future. For some, where there is a genuine choice, it may therefore be appropriate to take gains earlier rather than later.
The Chancellor announced the IHT nil rate band of £325,000 and residence nil rate band (RNRB) of £175,000 would be frozen until 6 April 2026. Previously, the RNRB was due to increase in line with CPI each year.
The £325,000 IHT nil rate band has been frozen since 2009. Had it increased by inflation, it would now be about £415,000. In that period, house prices have increased by 54% and UK shares by 80%. Of course, in the meantime, we have had the introduction of the RNRB.
The moral is obvious – during the next five or so years, the estates of more and more people will fall within IHT because of the frozen nil rate band(s).
It will be remembered that the OTS published two reports on IHT – the first, covering administrative issues, in 2018; and the second, covering the tax itself, in 2019.
On Tax Day, which followed the Budget, the government announced some reforms to IHT based on these previous OTS reports. In one, the government announced that from 1 January 2022, tax return procedures will be simplified so that “over 90% of non-taxpaying estates” will no longer have to complete IHT forms when probate or confirmation is required. This should result in about 225,000 fewer IHT forms being completed each year.
The government also confirmed that it will respond to the many simplification recommendations made in the second OTS IHT report (such as replacing the multiplicity of lifetime gift exemptions with a single personal gift allowance) “in due course”.
So, what should clients do?
There must be at least a reasonable chance that the IHT rules will change in the future as a result
of the OTS report and All Party Parliamentary Group discussions late in 2019. Wide-ranging changes were recommended and so far nothing has happened. Future change cannot therefore be ruled out.
Clients should consider taking advantage of the current favourable IHT rules while they can to, for example:
- Set up a programme of regular gifting out of surplus income to make use of the current advantageous normal expenditure out of income exemption.
- Make outright gifts, which are potentially exempt transfers, which do not need to be reported and fall out of account on survival by the donor for seven years.
- If control is required over the ultimate beneficiary of such gifts, use an appropriate trust; and
- If the donor also requires access to income from the gifts as well as control, use a Discounted Gift Trust and/or Loan Trust arrangement.
In November 2018, a consultation paper on the taxation of trusts was issued. The Command Paper issued on Tax Day simply said: “The responses did not indicate a desire for comprehensive reform of trusts at this stage. The government will keep the issues raised under review.”
Overall, the most important Budget change this year was a non-change – namely no increase in the personal allowance and the higher rate tax threshold for at least five years. More and more people will be higher rate taxpayers and need advice on pensions and other tax-efficient investments. This is very good news for independent financial advisers.
John Woolley is director of Technical Connection/St. James’s Place