It’s human nature to leave things until the last minute. Whether it’s Christmas shopping or booking the summer holiday, something else always seems to get in the way of doing it, until the last minute. The same applies to tax planning, with action often not taken until the last few weeks of the tax year, but a lot of planning should be considered at the start of the tax year.
So this year, to ensure best use of all the exemptions, allowances and reliefs available, perhaps consideration should be given to the following sooner rather than later:
Capital gains tax
Individuals have an annual exempt amount of £11,300 which is available on a “use it or lose it” basis. If gains are not realised up to this amount by a suitable disposal, some or all of the benefit of this exemption will go down the drain. Note that a disposal could be triggered by switching from one fund into another. Care needs to be exercised by the active investor, therefore, to ensure that following a particular investment strategy does not lead to total gains being inadvertently triggered over the annual exempt amount.
Maximum use of the annual exempt amount is available simply by encashing fund investments each tax year to realise gains within the exemption, and reinvesting the cash. If the reinvestment is made into the same fund within 30 days, however, the investor could fall foul of the 30 day bed and breakfasting rule. This can be avoided by reinvesting into a different fund, even if it has a similar focus.
Trustees also have an annual exempt amount, but this will be lower. Generally, it will be £5,650 but, if the same person has created two or more settlements that are still in existence, those settlements will have to share the lower annual exempt amount. Three settlements, for example, would each have an annual exempt amount of £1,883.33. Note, however, that if there are more than five settlements with the same settlor, the annual exempt amount for each will not be reduced below £1,130.
Although the annual exemption from inheritance tax has remained at £3,000 since 1981, it should be remembered that each individual has an entitlement to this exemption. Thus, a couple (whether married, in a civil partnership or otherwise) will have £6,000 between them. Once the current tax year’s annual exemption has been exhausted, any unused annual exemption from 2016/17 can then be mopped up. So, if no advantage has been taken of the annual exemption at all, a married couple will be able to make gifts of up to £12,000 completely free of inheritance tax and without having to worry about surviving for the next seven years before the gifts become exempt.
Perhaps the most useful exemption from inheritance tax is the one that’s least used. Gifts made regularly out of income that do not reduce the donor’s standard of living are immediately exempt from inheritance tax. Why is this potentially the most useful exemption? Because if a client is able to afford regular gifts from income, there is no limit to the amount that can be given away fully exempt. This is ideally suited to the payment of regular premiums under a protection policy that is subject to a discretionary trust for the client’s children, for example.
The wisdom of reviewing the contents of clients’ wills was reinforced by the introduction of the new residence nil rate band, which came into effect from 6 April 2017. This new nil rate band is not available where the residence – or part of the residence if held as tenants in common – is made subject to a discretionary will trust, even if the beneficiaries are restricted to lineal descendants. Additionally, the entitlement to the residence nil rate band will be reduced where the total estate (including the value of the residence) exceeds £2m – another reason why lifetime gifts might be beneficial.
This year’s ISA contribution limit is £20,000. This is a significant amount to be placed into an investment giving tax-free returns. However, it must be borne in mind that, unless investment is in AIM shares that have been owned for at least two years, an ISA will not be entirely tax-free – it will potentially be subject to inheritance tax on the death of the investor.
In addition, if a child or grandchild has a Child Trust Fund, up to £4,128 can be paid into it. Note, however, that this has to be done before the child’s birthday, rather than the end of the tax year.
The Child Trust Fund is no longer available, having been replaced by the Junior ISA. The amount that can be paid into this is the same, £4,128, but the deadline is the end of the tax year, not the child’s birthday.
Since the introduction of pension freedoms, it does make sense to maximise pension contributions as much as possible. Not only will tax relief be enjoyed on the contributions at the taxpayer’s highest rate but also the pension fund will grow free of UK tax as well as being inheritance tax efficient.
Currently, there is an annual allowance of £40,000, although unused annual allowances from the previous four tax years (including the two ‘mini’ tax years in 2015/16) can be carried forward to be used in this tax year. Note that the £40,000 limit will be restricted where income exceeds £150,000. There is also a lifetime allowance which is currently £1m.
Consideration should also be given to paying a pension contribution on behalf of a child or grandchild, for example. Even if they have no net relevant earnings, a pension contribution of up to £2,880 can be paid net of basic rate each tax year. The pension scheme administrator will be able to claim up to £720 from HMRC, resulting in up to £3,600 being invested for the child’s pension fund.
Investment bond gains
Care needs to be taken with partial withdrawals in excess of the cumulative 5% tax-deferred allowance. Even if an amount over the allowance is withdrawn before the end of the tax year, the actual gain may not be triggered until the following tax year.
This is because the chargeable event created by the excess withdrawal does not take place until the end of the policy year. If 5 April 2018 occurs after the excess withdrawal but before the end of the policy year, the chargeable gain will be assessed in the 2018/19 tax year. Whilst this will delay the date on which tax is due, it could have a negative impact if the client’s marginal rate of tax is lower in the 2017/18 tax year compared to the following tax year. Of course, the converse could also apply; if the client is a higher rate taxpayer this tax year but is retiring after 5 April 2018 and expects to be a basic rate taxpayer in 2018/19, the fact that today’s excess withdrawal will not be assessed until the following tax year could be beneficial.
Charitable donations can be eligible for gift aid to gross up the amount by 25%, provided that the donor has paid at least that amount of tax. Thus, a charitable donation of £80 using gift aid will allow the charity to claim £20 from HMRC, resulting in a gross amount of £100 going to the charity.
Note that, for a higher or additional rate taxpayer, the benefit of higher or additional rate relief goes to the donor, not the charity. Thus, an £80 charitable donation using gift aid from a higher rate taxpayer, for example, will still allow the charity to claim only £20 from HMRC. The donor would be able to claim a further £20 relief, making the net gift £60.
Venture Capital Trusts (VCTs), Enterprise Investment Schemes (EISs) and Seed EISs
Whilst these investment vehicles are not for everyone, as they generally appeal to those with a higher risk appetite, they do offer very generous tax reliefs. Initial income tax relief of 30% (50% for Seed EISs), capital gains tax relief and tax-free dividends are available. There are maximum limits to the amounts that can be invested – £200,000 for VCTs, £1m for EISs and £100,000 for Seed EISs – and there are minimum holding periods for some of the reliefs to apply. Nevertheless, they may be attractive to some clients.
Wherever possible, clients should be encouraged to do their tax year planning early rather than leaving it to the last minute – ensuring they avoid the end of tax year rush.