As the end of another tax year approaches, now is a good time to consider your financial position and check whether you have taken full advantage of the tax reliefs and exemptions that are available. This note is intended to provide a brief guide to the opportunities that we believe may be worth considering. There are many tax-saving measures available and we detail below a number of steps that can be taken to improve your tax position, without significant effort.
Of course, the impact of taxation is only one element in establishing your financial position – you should also be considering at this time such issues as:
- your savings and investments;
- the extent of your wealth and how it will be passed to the next generation.
Savings and Investments
- Individual Savings Accounts (ISAs)
Have you taken out an ISA in 2006/07? You can invest up to £7,000 in an ISA in each tax year. Capital gains and most income on investments within an ISA are tax-free. The limit for a cash ISA is £3,000.
The rules regarding pensions changed with effect from 6 April 2006, 'A' Day. The earnings cap and percentage limits are now abolished, replaced with an initial lifetime allowance of £1.5M and annual allowance of £215,000. Both limits will increase annually.
Most individuals can make pension contributions of up to £3,600 gross per annum and obtain tax relief on them, even if they are not taxpayers. This reduces the actual cost to only £2,808 for basic rate taxpayers and £2,160 for higher rate. As well as improving your own financial position, this could be used to establish savings for children, or grandchildren, or for a non-earning spouse.
Capital Gains Tax Planning
- Annual exemption
First and foremost, consider whether you have used your CGT annual exemption for 2006/07 in full. Each individual can realise net capital gains (gains less losses) of up to £8,800 in the year without incurring a CGT liability. If the exemption is not used this year, it cannot be carried forward.
- Capital losses
It may be that assets will be sold at a loss. If your gains are already above the annual exemption this year, then you might consider if there are investments on which a tax loss will arise which could be sold to minimise or avoid having to pay CGT. It may not be necessary to actually sell the investments – if their value has fallen to such an extent that they are considered to be of "negligible value", a capital loss can be claimed without an actual disposal being required. If you have made capital losses this year that are greater than your capital gains, the excess can be carried forward to future years.
- Taper relief
Taper relief is a discount from the taxable gain that increases the longer the asset has been held. The relief increases after every complete year of ownership. For assets held before April 1998, each complete year is calculated by reference to the tax year-end date i.e. 5 April.
Whilst business assets attract maximum taper relief of 75% after two year's of ownership, non-business assets only attract maximum relief of 60% after ten years.
Income Tax Planning
- Using allowances
Each individual can receive income of up to £5,035 in 2006/07 without incurring liability to income tax. Above that figure, tax will be payable but not at the higher rate of 40% until taxable income exceeds £33,300. For married couples, where only one spouse is a higher rate taxpayer, consider ways of transferring income to the lower earning spouse in order to reduce the overall tax bill (for example, by transferring investments held by one spouse into joint names). Income producing assets may be transferred, in a similar way, to children to obtain the benefit of their personal allowances (although this will not be effective where children are under 18, unmarried and the funds are provided by their parents).
- Trust distributions
If you have young children or grandchildren who are beneficiaries of a discretionary or an accumulation and maintenance trust, consider whether there is scope for making a distribution of income to them in this tax year. If the beneficiaries are non-taxpayers, or liable to lower rates of tax, they will be able to reclaim part or all of the tax paid by the trust. The rules relating to 'tax pools' are complicated and HMRC has expressed a desire to make changes in future legislation.
- Gift Aid
Apart from the normal cash donations to charities it is also possible to gift assets such as shareholdings and property. Relief is given by way of a deduction from total income in the year of gift.
It is also possible for higher rate tax relief purposes to elect for cash donations to be treated as made in the preceding tax year giving the potential for repayments of tax.
Inheritance tax (IHT) planning
- IHT annual exemption
Each individual can make IHT exempt gifts of up to £3,000 in a tax year. If the exemption is not used this year, it can be carried forward for one year only, so that gifts of £6,000 can be made in 2007/08 free of IHT. Likewise, if you did not use the annual exemption in 2005/06, you could make gifts of up to £6,000 before the end of this tax year.
- Gifts out of income
Transfers of wealth above the level of the annual exemption are potentially liable to IHT. Most gifts will become exempt, however, if you survive for seven years after making the gift. This "waiting period" of seven years does not apply to regular gifts that can be regarded as paid out of your income. These are immediately exempt. There is no absolute limit on these gifts, although clearly they must be of an amount that leaves you with sufficient income to maintain your standard of living. This can be a valuable exemption and is often overlooked, but requires detailed records to be kept. Further information can be supplied on request.
- IHT Nil Rate Band
A chargeable lifetime gift or an estate on death will result in an IHT liability only to the extent that it exceeds (currently) £285,000: the IHT "nil rate band". This increases to £300,000 on 6 April 2007. Each individual should attempt, as far as possible, to provide for the distribution of his or her estate on death in such a way that the nil rate band is fully utilised. We can advise on suitable drafting of Wills to achieve this as well as lifetime IHT planning.
The above comments are for general guidance only and are based on the tax legislation as at 6 March 2007. Changes in tax legislation may be announced in the 2007 Budget on 21 March 2007 that may become effective before the end of the 2006/07 tax year. Detailed advice should be obtained before taking action, or refraining from taking action, in connection with any of the tax planning opportunities described above.