A Few Essentials

Introduction

In the UK the greater bulk of income tax which flows into the Exchequer does so by deduction at source. The tax is taken from income before it is paid to the taxpayer and most of this happens by way of Pay-As-You-Earn (PAYE). This collection system will no doubt be familiar to almost everyone who is in employment and also to those who receive pensions.

Most of the rest of the income tax collected at source comes from deductions made by banks or building societies from interest paid to savers. Most of us, children, the retired or working people alike, will have savings accounts of one sort or another and many might also have shares from which income arises in the form of dividends. These too are treated as having suffered income tax at source.

As these circumstances cover the overwhelming majority of individuals, more than 80% of the population will have little or no regular contact with HM Revenue and Customs (HMRC), the organisation that administers and regulates all taxes in the UK.

Around 9 million taxpayers have something more than just a regular income taxed under PAYE and interest on savings. Instead they might have income from their own business or receive rent from a property. Alternatively, it may be that their income is significant enough to attract higher rate tax so that the tax deducted at source on their savings income is insufficient. These taxpayers may be asked to complete a self assessment return each year and then they will have direct contact with HMRC.

Income tax is not the only means by which the government relieves us of our hard earned cash. You may own assets such as a precious antique, a second home or shares. If such an asset is sold, the chances are that a profit will arise and this may give rise to a liability to capital gains tax.

Details of any capital gains may have to be included on the self assessment return.

Inheritance tax may be payable on the assets that you give to others in your lifetime or leave behind when you die. At one time very few individuals had to worry about this tax. Rises in house prices have changed this and many more estates have now become liable. The government has implemented some changes to try and address this issue but many people will still need careful planning to minimise this tax.

Many of those in business have to understand the principles of Value Added Tax because they will have to act as an unpaid collector of this duty. In addition, those who run their business through a limited company need to know about corporation tax which taxes a company’s profits.

This guide is designed to provide you with a simple guide to all of these taxes from five perspectives - that of the family; the working man or woman in employment; the person running their own business; the taxation of investments; and, finally, knowing that nothing is certain except death and taxes, the potential liability on your estate.

Please use the guide to help you identify planning opportunities, pitfalls to avoid and areas where you may need to take action and then contact us for further advice.

Self assessment (SA) timetable

• Income tax and capital gains tax are both assessed for a tax year which runs from 6 April to the following 5 April.
• Shortly after 5 April - SA returns are issued by HMRC.
• 31 October following - non-electronic returns are to be submitted to HMRC by this date.
• 31 January
  following - final date for submission of return and all outstanding tax to be paid.
• There is an automatic penalty for late filing of the return of up to £100 and more serious penalties for on-going default.

Family Matters

Married couples

Spouses, which includes registered civil partners, are taxed as independent persons, each of whom is responsible for their own tax affairs. All individuals are entitled to a basic personal allowance before any income tax whatsoever is paid. The personal allowance for 2009/10 is £6,475. The tax bands and rates shown below are applied to each spouse separately, so that each may have taxable income up to £43,875 before they start to pay higher rate tax. There is no aggregation of income, no sharing of the tax bands and the basic personal allowance may not be transferred from one spouse to the other.

Tax rates

There is no change to income tax rates for 2009/10. Basic rate tax continues to be 20% and higher rate tax 40%.

The 10% rate band will continue to be available for savings income in circumstances where an individual has taxable earned income of less than £2,440. There are no changes to the tax rates applicable to dividends.

The increase in the basic personal allowance and the basic rate band overall amount to an increase in excess of £3,000 before people start paying the higher rate of income tax. The effect of this change will be partly offset by the increase to the national insurance bands.

Higher allowances for those aged over 65

The basic personal allowance is increased to £9,490 where the taxpayer is aged 65 or over on the last day of the tax year in question and to £9,640 where the age on that day is 75 or over. This more generous allowance is reduced by £1 for every £2 that the taxpayer’s income exceeds £22,900. It cannot be reduced below the basic allowance of £6,475.

Married couple’s allowance

In 2009/10 a married couple’s allowance is only available to those couples where at least one spouse is 75 or over on the last day of the tax year. It is normally claimed by the husband, except for marriages on or after 5 December 2005, where it is claimed by the higher income spouse.

This allowance can be worth nearly £700 per year to a couple but its detailed application is complex. It is worth noting, however, that this allowance can be transferred to the wife or shared between the spouses if they so choose.

Minimising the tax bill

It follows from the basic rules set out above that tax is minimised if spouses equalise, as far as possible, their income so that all personal allowances are fully utilised and higher rate tax is minimised.

Jointly owned assets

Married couples will often own assets in some form of joint ownership. If they do not, then it is usually advantageous for tax purposes for transfers to be made to ensure joint ownership. This can have benefits for income tax, capital gains tax and even inheritance tax.

Where assets are owned in joint names any income is deemed to be shared equally between the spouses. If the actual ownership shares are unequal, income is still deemed to be split equally unless an election is made to split the income in the same proportion as the ownership of the asset. This does not apply to shares in close companies (almost all small, private, family owned companies will be close companies) where income is always split in the same proportion as the shares are owned.

Capital gains tax

Independent taxation also applies to capital gains tax. Each spouse is entitled to take advantage of the annual exemption of £10,100 before any capital gains tax has to be paid.

This is advantageous where assets are held jointly and then sold as each spouse can use their annual exemption to save tax.

The transfer of assets between spouses is neutral for capital gains tax. This is sometimes done shortly before assets are sold to minimise tax. Advice should be sought before undertaking such transactions to ensure that all tax aspects have been considered.

Capital gains tax is payable on the amount of capital gains over the annual exemption at 18%.

Separation

The breakdown of a marriage will often involve the transfer of assets between spouses. The marriage continues until the divorce is legally finalised, but, for transfers of assets to be entirely free of a charge to capital gains tax, the transfer must be made before the end of the tax year in which the separation takes place. Separation is deemed to happen when the couple cease to live together as man and wife - quite different to the date the divorce is final which is often much later.

Conversely, for inheritance tax, transfers which take place before the divorce is final will continue to be exempt.

There is usually neither tax relief on maintenance payments made by one former spouse to another nor on any payments required by the Child Support Agency.

Children

It is often assumed that children are not taxpayers until they achieve some particular age.

In fact HMRC will tax a child just as readily as anyone else if the child has sufficient income to make them liable.

Transferring income to children

Children have their own personal allowances and tax bands. Where their only income is, at best, a few pounds from a paper round or a Saturday job, there may be some scope for transferring income producing assets to the children to use up their personal allowance.

However such assets should not be provided by a parent, otherwise the income remains taxable on the parent, apart from the first £100 each tax year.

Children and capital gains

Children also have their own annual exemption for capital gains tax so that assets transferred to them which have a bias towards capital growth rather than income may prove to be more advantageous.

Repayment claims

Where children have significant sources of income from which tax has been deducted, such as bank interest or trust income, they will almost certainly be entitled to a repayment. In such cases a repayment claim should be made.

Child Trust Fund

For children born on or after 1 September 2002 a Child Trust Fund is available. The idea is to encourage tax efficient savings, with the government’s help, to build a savings fund which the child can access once they reach 18. The government’s initial contribution is £250 or £500 for low income families, with a further payment of £250 (and again £500 for lower income families) once the child reaches the age of seven.

Other contributions of up to £1,200 per annum can be added to the fund by family or friends and, although there is no tax relief on making the contributions, the fund is tax exempt. This is therefore a tax efficient medium to which regular transfers can be made.

Child Tax Credit

The Child Tax Credit is means tested and potentially available to families who have responsibility for one or more children. It is a tax free payment made direct to the main carer and it will be available where combined annual income is less than £58,175 or £66,350 if there is a child under one year old.

There are several elements to the credit and claims can be complicated. Please talk to us.

Civil partnerships

All the special rules for married couples, both those dealt with in this section and those covered in other sections of this guide apply equally to same-sex couples who have entered into a registered civil partnership.

What about unmarried partners?

It still pays to equalise income as much as possible, as income tax will be minimised. However transfers of assets may be liable to capital gains tax and, if substantial, could also lead to an inheritance tax liability. It is vital for unmarried couples to each make a Will if they wish to benefit from each other’s estate at death.

A word of warning

There is a limit to the extent to which a couple should allow tax savings to influence them! To do so has been known to have a high cost in terms of family relationships. There must be as much trust in matters of finance as in those other areas that go with the institution of marriage!

Moreover transferring assets or interests in a business between husband and wife can, and often does, attract the interest of HMRC. This is especially where it is obvious that it has been done primarily for tax saving purposes. Transfer of ownership of an asset must be real and complete, with no right of return and no right to the income on the asset given up.

If a non-working spouse is given shares in an otherwise one-person, private company, HMRC may regard this as a sham and seek to tax the working spouse on all of the dividends (see the income shifting notes in the ‘Working for Yourself’ section).

Working for Others

Few avoid working for others at some time in their life and most will have encountered the PAYE system operated by employers to collect the income tax and national insurance (NIC) due on wages and salaries.

The tax code

Ensuring the right amount of tax is taken relies on a PAYE code, issued by HMRC and based on information given in a previous self assessment return or supplied by the employer. The employee, not the employer, is responsible for the accuracy of the code.

Code numbers try to reflect both your tax allowances and reliefs and also any tax you may owe on benefits. If you are in receipt of a state pension an adjustment will be made for this. HMRC may also try to collect tax on untaxed income or tax owing from an earlier year. The code may even try to allow for higher rate tax that has to be paid on investment income. You do not have to agree to tax owed on untaxed income and prior years’ underpayments being dealt with in this way. As can be imagined, with this many complications and some guess work involved, getting the code exactly right can be difficult and the right amount of tax will not always be deducted.

For many employees things are simple. They will have a set salary or wage and only a basic personal allowance. Their code number will be 647L and the right amount of tax will be paid under PAYE.

Others will be provided with benefits in their employment or they may be paid by the employer for expenses incurred. The more common examples of these benefits are considered below.

Benefits

Company cars

Company cars remain a popular benefit and for some a real status symbol, despite continued increases in the tax charge they give rise to.

The charge on cars is calculated by multiplying the list price of the car by a percentage which depends on the CO2 emissions of the car. You then pay tax at 20 or 40% on this charge depending on your overall tax position.

The table below shows the percentages for 2009/10. These are the same as the previous tax year 2008/09 which means there is no increase in the taxable benefit. However there will be an increase in 2010/11 by 1% if the car provided remains the same or a replacement car with the same CO2 emissions is provided. This is to encourage the provision of lower emission cars.

The CO2 emissions of most cars can be located on the internet and officially has to be recorded on the Vehicle Registration Document.

There are a number of other variations in computing the correct charge to apply. The main considerations are:

• If the car has a diesel engine the charge is increased by 3% (except that it cannot exceed 35%). However diesel cars registered before 1 January 2006 and which met the Euro IV emission standard do not suffer this supplement.
• Discounts apply to certain environmentally friendly cars.
• A 10% charge only applies to non-electric cars with emissions of no more than 120g/km. The environmentally friendly discounts do not apply to these cars but the diesel supplement does.

Fuel for private use

A separate charge applies where fuel is provided by the employer for a company car. The charge is calculated by applying the same percentage figure used to calculate the company car benefit to a fixed figure which for 2009/10 is set at £16,900.

Medical Insurance

The employee is taxed on the amount of the premium paid by the employer.

Home and mobile phones

There is no benefit on the provision of a company mobile phone even where it is used privately. However this is limited to one phone per employee. Where home telephone bills are paid by the employer, the amount paid will be taxable. The employee may make a tax claim for the cost of business calls only but not the line rental which is treated as private.

Cheap or interest free loans

If loans made by the employer to an employee exceed £5,000 at any point in a tax year, tax is chargeable on the difference between the interest paid and the interest due at an official rate - currently 4.75%.

Childcare costs

Childcare costs paid for by an employer are exempt from both income tax and NIC. This applies to a place in an employer operated nursery or where the employer pays for registered or approved childcare. In this latter case the exemption is limited to £55 per week and any excess over this is subject to tax and NIC.

The costs will normally be paid in the form of vouchers or alternatively paid direct to the childcare provider. Any scheme must be open to all employees or all employees at a particular location.

Approved childcare includes registered child minders, nurseries and play schemes, out of hours clubs run by a school on the school premises or by a local authority and childcare schemes run by approved providers.

Expense payments

Reimbursed expenses

Reimbursed expenses are taxable as a benefit but the employee can claim a deduction for those expenses incurred wholly for business purposes. The overall effect is usually neutral.

What happens is that at the end of each tax year, the employer sends a summary, to HMRC,  of all benefits provided on a form P11D for each employee. As well as the benefits covered earlier, this form will include all reimbursed expenses.

The employee can then make an expense claim to HMRC either on a self assessment return or by letter for any business expenses so that these are not taxed.

Because, often, nothing is taxable, employers can ask to be excluded from the expense reporting process if they write to HMRC. This is known as a dispensation.

Mileage claims

Many employers pay a standard rate of mileage to all employees who use their own cars for business journeys. HMRC set statutory rates for business mileage which are currently 40p for the first 10,000 miles in a tax year and 25p thereafter.

If the employee is paid for business miles at less than the statutory rates, tax relief is available on the difference. If, however, the employee is paid at more than these rates then the excess is taxable.

Mileage payments do not have to be shown on the form P11D unless the rates paid are more than the statutory rates.

Other transport issues

Vans

Where employees are provided with a van and the only private use of this is to go to and from work (including any incidental private use), then no taxable benefit should arise. If there is private use beyond this, there is a benefit of £3,000 per annum and an additional £500 if fuel is provided for private as well as business journeys. In order to avoid this charge, it is advisable to have a formal, written policy and detailed mileage logs. These will support the limited private use of the van and may avoid problems with HMRC in the future.

Working for Yourself

Starting up a business of your own is a big step and not one to take lightly. The taxation of your business is only one of many commercial and legal aspects of starting a business that you will need to consider.

Preparation is the key and a proper business plan should be one of the first things you should do. However tax matters are our main concern here.

Choosing a business structure

The alternative business structures are:

Sole Trader

This is the simplest form of business since it can be established without legal formality. The business of a sole trader is not distinguished from the proprietor’s personal affairs. If the business incurs debts which are unpaid, the creditors can seek repayment from the sole trader personally.

Partnership

A partnership is similar in nature to a sole trader but involves two or more people working together.

A written agreement is essential so that all partners are aware of the terms of the partnership. Again the business and personal affairs of the partners are not legally separate.

Sole traders and partnerships are often referred to as unincorporated businesses and the individual owners as self employed.

Limited Company

A company is a legal entity in its own right, separate from the personal affairs of the owners and the directors. A company provides protection from liability, which means that the creditors of the company cannot make a claim against the owners or the directors except in limited circumstances. Often this advantage is somewhat eroded because a bank, for example, may seek personal guarantees from the directors.

These potential advantages carry the downside of greater legal requirements and regulations that must be complied with.

Limited Liability Partnerships (LLPs)

LLPs are a halfway house between partnerships and companies. They are taxed in the same way as a partnership but are legally a corporate body. This again gives some protection to the owners from the partnership’s creditors.

In this section we consider the differing tax treatments of the alternatives but you should choose which structure is right for you based on more than just the tax issues alone.

Many will start off as a sole trader, taking advantage of the lack of any formal procedures to establish the business. Some, however, will need the protection of limited liability because they are in a high risk business or they may need the additional stature that is seen as attaching to a limited company. Alternatively, they may need to establish and protect a particular name which only the formation of a limited company will allow them to do.

The tax regime

Unincorporated businesses

A new business must register with HMRC within three months of commencing to trade. Income tax is paid on the profits of the business. The amount that the proprietor, or a partner in a partnership, draws out of the business (referred to as ‘drawings’) is irrelevant.

Profits are taxed on a current year basis as shown by the example, although a new business will be subject to special rules, which we can outline for you.

Working out profits

Profits are calculated using accepted accounting practices and crucially this means that profit is not necessarily simply receipts less payments. Instead it is income earned less expenses incurred.

Not all of the expenses that a business incurs are allowed to be deducted from income for tax purposes but most are. It is important that you keep proper and comprehensive business records so that relief may be claimed.

Capital allowances

When assets are purchased for the business, such as machinery, office equipment or motor vehicles, capital allowances are available. As with expenses, these are deducted from income to calculate taxable profit. There have been recent major changes to the regime.

Plant and machinery - Annual Investment Allowance (AIA)

The AIA was introduced for expenditure incurred on or after 6 April 2008 (1 April 2008 for companies) by all businesses.

It gives a 100% write-off on most types of plant and machinery costs, but not cars, of up to £50,000 per annum. Any costs over the AIA will attract an annual ongoing allowance of 10% or 20% depending upon the type of asset.

The £50,000 limit may need to be shared between certain businesses under common ownership.

In addition to the AIA all businesses are eligible to a 100% allowance, often referred to as an enhanced capital allowance, on certain energy efficient plant and low emission cars.

Other plant and machinery allowances

General first year allowances (FYA) were abolished in 2008 but a temporary FYA of 40% is available for expenditure incurred by a qualifying activity in the12 month period commencing 1 April 2009 for companies and 6 April 2009 for individuals and partnerships. This will be useful if a business plans to spend more than its AIA entitlement but it is not available for certain expenditure including plant which is classed as integral features and cars.

Motor cars

The tax relief rules on cars purchased from 1 April 2009 for companies and 6 April 2009 for individuals have significantly changed. The tax relief position is now determined by the CO2 emissions of the car not by the price of the car. Cars already purchased will continue to get a 20% annual allowance with a maximum annual allowance of £3,000 if exclusively used for business.

The tax allowance on new purchases will depend on CO2 emissions. Essentially those with emissions up to 160 will continue to get the 20% allowance and those in excess of 160 will only be eligible for a 10% allowance. There is no £3,000 restriction.

Industrial and agricultural buildings and hotels

These are currently being phased out with 2 tax years still to run. For example, the annual rate of allowance for 2009/10 (1 April 2009 for companies) is 50% of the allowance claimed in 2007/08. In 2010/11 it will be 25% and then the allowances will cease. Special rules apply for accounting periods straddling these dates.

Paying the tax

The self employed may have to pay tax three times a year, namely:

• 31 January in the tax year
• 31 July following the tax year
• 31 January following the tax year.

In certain circumstances, the first two payments can be waived.

Companies

Unlike sole traders and partnerships who pay tax on profits only (and drawings are ignored), companies have two layers of tax. The first is tax payable by directors and shareholders on money they take out of the company and the second is corporation tax which is due on the company’s profits.

Tax on ‘drawings’

The directors of the company will normally be paid a salary and this is taxed under PAYE as for all employees. The cost of this, including the employer’s NIC, is generally an allowable expense of the company.

The government initially planned to increase the small company rate to 22% in the year to 31 March 2010 but this has been deferred.

The shareholders of the company may be rewarded by the payment of dividends on their shares. In most small companies the directors and shareholders are one and the same and so they can choose the most tax efficient way to pay themselves. Using dividends can result in savings in NIC. This requires planning. Please talk to us to decide the best options for you.

Tax on profits

The profits of a limited company are calculated in a similar way as for unincorporated businesses and the same rules about expenses and capital allowances generally apply. Remember though that the salaries paid to directors, but not the dividends paid to shareholders, are deductible from the profits before they are taxed.

Payment of tax

PAYE and NIC on salaries is payable monthly (or quarterly where the amount due is less than £1,500 per month).

Corporation tax is usually payable nine months and one day after the year end, so the choice of year end has no tax consequence.

Income shifting

Over recent years, many families have been attracted by the savings that can be made by combining small salaries and large dividends. The savings could be increased by introducing a non-working family member into the business as a shareholder or co-owner, to use up their personal allowance and lower rates of tax.

Proposed new rules aimed at counteracting this were due to be introduced from 6 April 2009 but have been shelved for the present. Care still needs to be taken as aspects of the existing ‘settlements legislation’ could still be used to challenge certain arrangements. If you have any questions or concerns, please do not hesitate to contact us.

Value added tax (VAT) and your business

VAT is a tax ultimately paid by the final consumer and businesses act as the collectors of the tax. There are heavy fines for failing to operate the system properly.

What does VAT apply to?

VAT is chargeable on the supply of goods and services in the UK when made by a business that is required to register for VAT.

A registered business must charge VAT on its sales which is known as output VAT. There are currently three rates of VAT which can be payable on what are known as taxable supplies. These are the standard rate of 15%, the reduced rate of 5% and zero rate. The standard rate of VAT of 15% only applies until 31 December 2009 when it will revert back to 17.5%.

Zero rate is where the supply is deemed to be subject to VAT but the output VAT is charged at 0%, meaning that no VAT would be payable.

However a business also pays VAT on the goods and services it buys. This is known as input tax.

If the output tax exceeds the input tax, then a payment of the difference has to be made to HMRC. This calculation is normally done quarterly. If input tax exceeds output tax a repayment of VAT will be made. This calculation is also done quarterly except that if repayments occur regularly this can be done monthly. Regular repayments would perhaps apply where a business generally makes zero rated supplies.

Supplies

Certain supplies of goods and services are not subject to VAT at all and are known as exempt supplies. A business that makes only exempt supplies cannot register for VAT and will be unable to reclaim any input tax.

As there are three rates which can be applicable to taxable supplies, standard, reduced or zero rated, it is important to identify the type of supplies correctly and apply the correct percentage of VAT.

Some input VAT is not reclaimable by a VAT registered business. Two common examples are VAT incurred on entertaining business customers and VAT on the purchase of a car.

Do I need to register?

A business must register if its taxable supplies exceed an annual figure, currently £68,000. If taxable supplies are less than this a business may still register voluntarily. So, for example, if the business makes only zero rated sales, it can still register and reclaim the input tax suffered.

VAT can affect competition. A plumber, for example, who sells only to the general public, will be at a disadvantage if he has to register for VAT. He may have to charge up to 15% more than a plumber who is not registered to earn the same profit. On the other hand, if the same plumber only works for other VAT registered businesses, such as building companies, then it will not matter if they are registered because the customer will be able to recover the VAT that is charged.

Indeed, in general, a business that always sells to other VAT registered businesses will normally register, even if below the annual limit, because then it can reclaim VAT on purchases and expenses. This will improve profit. This can be especially relevant for new businesses because there are often high start up costs that carry VAT.

On the other hand registration comes at the cost of having to meet onerous record-keeping requirements, a need to submit VAT returns on time and a fundamental need to get it right! Failure on any of these points exposes the business to penalties which, in some cases, can be substantial.

Schemes for a small business

The Flat Rate Scheme

This scheme, designed to make the VAT system simpler, is open to a business whose annual taxable supplies are less than £150,000. It allows a business to pay VAT at a fixed percentage of their total turnover and no specific claims to recover input tax need to be made. The fixed percentage depends on the type of business.

The Cash Accounting Scheme

If annual taxable supplies are less than £1,350,000, a business may calculate its VAT payable by considering only the output tax and input tax on invoices which have been received/paid, rather than by reference to the invoice date alone. This is advantageous where a business has to wait a long time before it is paid by its customers.

The Annual Accounting Scheme

If taxable supplies are below £1,350,000 a business may choose to make only one annual return instead of quarterly returns. Interim payments of VAT must be made monthly or quarterly by direct debit based on an estimate of the amount due.

VAT is a tax full of pitfalls for the unwary but most problems arise from poor record keeping or a lack of understanding of the rules. We can help with both of these issues and make your life a lot simpler.

Tax and Your Investments

Setting aside income in the form of savings is important for us all, to provide for the unexpected or to build up a nest egg that we can enjoy in retirement. Given that the earnings from which our savings come have already been taxed, people often object to the fact that any return they enjoy on their investments will usually be taxed again.

In this section we consider what are the most tax efficient investments to make.

Pensions

Pensions are one of the most tax efficient forms of saving. A higher rate taxpayer can contribute £100 to a registered pension fund at a cost of only £60 and investment income and capital gains will accrue within the scheme largely tax free.

An individual is entitled to tax relief on personal contributions in any given tax year up to the higher of 100% of earned income or £3,600 (gross).

The contributions are paid net of basic rate tax and the pension provider will then recover that basic rate tax from HMRC. Higher rate relief, if appropriate, can be claimed from HMRC. Contributions in excess of the individual’s limit can be made into a scheme but the excess will not attract tax relief.

An employer may make contributions to a scheme and a deduction from profits may be available to the employer.

Despite these generous reliefs there are controls which serve to limit very high levels of contribution. These are complex but, put simply, they will give rise to a tax charge if annual contributions result in an increase in pension rights for a year of more than £245,000 (for 2009/10) or if the value of the fund when benefits are taken is greater than a lifetime allowance which, for 2009/10, is £1.75 million.

When the pension is taken, the fund is normally used to buy a life annuity. Part of the fund, normally 25%, may be used to take a tax free lump sum

Tax free savings

Individual Savings Accounts (ISAs)

ISAs are free of income tax and capital gains tax. There are maximum investment limits which apply for each tax year but, over several years, large investments can be built up. The ISA can be in stocks and shares, or cash but most ISA providers invest solely in stocks and shares. Banks and building societies provide cash ISAs.

Other tax efficient investments

The following investments work in varying ways. You should consider your needs in detail before entering into any commitments.

National Savings and Investment (NS&I)

There are a number of products, taxed in different ways, but some, such as savings certificates, are tax free.

Premium bonds

Another NS&I product, premium bonds, is tax free and you could win £1 million!

However the annual rate of return is a lottery. The more you invest (maximum £30,000) the more frequently you are likely to win, the smaller prizes at least. However, there is no guarantee of a steady rate of return and other savings vehicles may be more suitable.

Single premium insurance bonds

These provide a means of deferring income into a subsequent period when it may be taxed at a lower rate.

The Enterprise Investment Scheme (EIS)

Income tax relief at 20% is available on new equity investment (in qualifying unquoted trading companies) of up to £500,000 in 2009/10. Capital gains tax exemption may be given on sales of EIS shares held for at least three years. If the proceeds realised on the sale of any chargeable asset (eg quoted shares, second homes, etc) are reinvested in EIS shares, the gain on the disposal can be deferred.

Venture Capital Trusts (VCT)

These bodies invest in the shares of unquoted trading companies. An investor in the shares of a VCT will be exempt from tax on dividends and on any capital gain arising from disposal of the shares in the VCT. Income tax relief currently at 30% is available on subscriptions for VCT shares, up to £200,000 per tax year, so long as the shares are held for at least five years.

Buy to let properties

In recent years, the stock market has had its ups and downs. Add to this the serious loss of public confidence in pension funds as a means of saving for the future and it is not surprising that investors have looked elsewhere.

The UK property market, whilst cyclical, has proved over the long-term to be a very successful investment. This has resulted in a massive expansion in the buy to let sector.

Buy to let involves investing in property with the expectation of capital growth with the rental income from tenants covering the mortgage costs and any outgoings.

However the gross return from buy to let properties - ie the rent received less costs such as letting fees, maintenance, service charges and insurance - is no longer as attractive as it once was. Investors also need to take a view on the likelihood of capital appreciation exceeding inflation. Investors should take a long-term view and choose properties with care.

Which property?

Investing in a buy to let property is not the same as buying your own home. You may wish to get an agent to advise you of the local market for rented property. An agent will also be able to advise you of the standard of decoration and furnishings which are expected to get a quick let.

Letting property can be very time consuming and inconvenient. Tenants will expect a quick solution if the central heating breaks down over the bank holiday weekend! Don’t cut corners - a correctly drawn up tenancy agreement will ensure the legal position is clear.

Tax on rental income

Income tax will be payable on the rents received after deducting allowable expenses. Allowable expenses include mortgage interest, repairs, agent’s letting fees and an allowance for any furnishings provided.

Captial Disposals

Capital gains tax (CGT)

Introduction

Making the most of your investments requires some understanding of CGT. CGT arises on the sale of most assets and, subject to various reliefs and exemptions, is payable on the difference between the sale proceeds and the original cost. The first £10,100 of gains, for 2009/10, are tax free. A flat rate of CGT then applies to any chargeable gain (after losses, reliefs etc) of 18%.

Some assets are exempt from CGT such as motor cars (including classic cars), personal goods such as jewellery or antiques sold for less than £6,000, UK government bonds and, crucially, your only or main home.

Where a gain is chargeable, there are a number of reliefs which could be considered mainly in relation to business assets. Such reliefs are mainly used to defer tax until a later date rather than reduce the gain permanently. Entrepreneurs’ Relief is the exception.

Entrepreneurs’ Relief

The effect of the relief is to reduce the gains liable to CGT at 18% by 4/9ths resulting in an effective rate of 10% (18% x 5/9ths). The relief is available for gains of up to £1 million on qualifying business disposals by an individual over their lifetime.
Qualifying business disposals include:

• qualifying shareholdings
• the whole or part of an unincorporated business
• disposal of assets on cessation of a business

There also needs to be a qualifying period of ownership of one year up to the disposal.
Where an individual makes a qualifying business disposal, relief may also be available on an ‘associated disposal’.

An ‘associated disposal’ is a disposal of an asset:

• used in a qualifying company or group of companies of the individual or
• used in a partnership, where the individual is a partner.

The ‘associated disposal’ must be part of the withdrawal of the individual from participation in the business and the available relief may be diluted due to various restrictions.

Trustees may benefit from the relief but only in very limited circumstances.

Main residence

An individual’s or married couple’s only or main residence is exempt from CGT. The exemption extends to grounds of up to half a hectare.

Larger grounds may also be exempt.

The sale of a part of the garden or grounds for development may also be covered by the exemption.

Subject to exceptions, periods of absence are chargeable but, if the main residence was let during absences, as a result of which a charge arises, a ‘letting relief’ may apply to reduce the chargeable gain.

Where an individual (or married couple) have two or more residences, only one residence at any one time can be treated as the main home for exemption. This is done by an election. Provided a particular residence has been the main home at some time, then the last three years of ownership will always be exempt. This applies even if another residence has now become the main home during this time.

The main residence exemption can be complex and often causes a good deal of misunderstanding. Please contact us for further advice before making transactions in property.

Preserving the Inheritance

Inheritance tax (IHT) has some unique features. It is easy to collect because the authorities meet with least resistance but, conversely, it is relatively easy for wealthy taxpayers to at least minimise it, if not avoid it altogether, and consequently IHT is sometimes referred to as a voluntary tax.

Nonetheless planning to minimise IHT is something that many put off until it is too late and early attention to this tax is almost always worthwhile.

Currently the threshold for IHT is £325,000 (this is sometimes called the nil rate band) and even if your assets are worth less than this you should consider making a Will so that you choose who gets your assets after your death.

The current regime

The key points of the current regime are as follows:

• IHT is charged on a person’s estate when they die and on certain gifts made during their lifetime
• the rate of tax on death is 40% and 20% on lifetime chargeable transfers. The first £325,000 is not chargeable
• some lifetime gifts are treated as ‘potentially exempt transfers’ or PETs. So long as the donor lives for at least seven years after making the PET there will be no possibility of an IHT charge whatever the size of the gift
• there are numerous exemptions and reliefs.

So what’s the problem?

IHT is still a problem because:

• many are simply not in a position to make substantial lifetime gifts because it will leave them with insufficient capital to live on. As a consequence there is likely to be significant value retained in estates on death.
• the current threshold for IHT at the time of writing is £325,000, the average price of a detached house in the UK is around £265,000. In many cases the house alone will use up the bulk of the nil rate band and any excess remaining assets, such as investments and cash reserves, may be charged to IHT at 40%.

It is important therefore to consider ways of reducing any potential IHT liability.

Mitigating the liability

Don’t waste your exemptions

Regularly using IHT exemptions will build up funds outside of the estate without incurring an IHT liability. A husband and wife can each take advantage of the exemptions, the main ones being:

• an annual allowance of £3,000 per donor per year. It can be carried forward for one year only if unused
• small gifts not exceeding £250 in total per donee per tax year
• gifts made out of income that are typical and habitual
• gifts made in consideration of marriage up to £5,000 if made by a parent, £2,500 by grandparents and £1,000 by others
• gifts to charities whether made during lifetime or on death
• gifts between spouses and registered civil partners, whether made during lifetime or on death.

Planning in lifetime

If possible you should make absolute gifts in lifetime. A gift to an individual will be a PET so there will be no liability if the donor survives seven years. Even if the donor fails to survive for all of that period there will be a tax saving because the charge which will arise on the PET will be based on the value of the asset when it was originally gifted and not on the value at the date of death. If the value of the gift is below the threshold there will be no charge. If any tax is due it may be reduced to reflect the actual period between the dates of the gift and death.

Remember that you cannot continue to benefit in any way from the asset gifted because this will render the gift ineffective for IHT purposes. You cannot, for example, give away your home to your children but continue to live in it rent free.

Consider using trusts

Trusts can provide a way of reducing IHT liabilities not just for the donor but also for the donee. The rules are complex but significant tax savings can be achieved with careful planning. In particular, trusts can be an effective way of using important reliefs on businesses and agricultural properties.

Use the nil rate band on death

On death, assuming the nil rate band has not already been utilised in the last seven years, it pays to ensure that it is not wasted. In recent times the rules have been altered to allow any unused nil rate band on the death of the first spouse to be transferred to the estate of the surviving spouse.

Whilst the rules help many married couples, better planning could completely eliminate the IHT bill.

Discretionary Will trust

Couples with modest estates find it hard to leave the nil rate band to children in their Will since that may leave the surviving partner short of funds. This can be overcome by the use of Discretionary Will trusts.

Put very simply, the Will leaves an amount equal to the nil rate band into a discretionary trust and the remainder can pass to the surviving spouse. There will be no IHT payable on the death of the first spouse. The trustees will be given powers to pay income or capital to the surviving partner from the trust in the event that funds are needed.

On the death of the surviving partner this discretionary trust is outside of their estate and any assets owned in the surviving parties own right will attract the nil rate band.

The family home

As already mentioned, the growth in house prices has caused real IHT worries. The family home is often the largest asset in an estate and is the hardest one to deal with efficiently for IHT purposes because individuals need a place to live. There have been many schemes devised to solve the problem and HMRC have successfully tackled many of these.

It is still possible to plan to mitigate some of the effect of the value of the family home particularly by careful planning using Wills.

An important prerequisite of such arrangements is that the property, if occupied by spouses or civil partners, should be owned jointly in such a way that there is no automatic transfer to the survivor on the first death. This means that each spouse, or civil partner, has a clearly defined legal interest in the property which can be left according to their Will and does not automatically fall into the ownership of the survivor.

The legal systems in the different legal jurisdictions in the UK achieve this in technically different ways but each allows for this approach.

Please contact us if you need further information.

Use the reliefs

Important reliefs of up to 100% are available on business assets such as shares in a family trading company or on agricultural property. It is important that these reliefs are utilised because once the asset concerned is sold the relief will be lost. They can only be used in connection with transfers which are chargeable to IHT. In lifetime it may be worth considering transfers of such assets into trusts for members of the family. On death such assets should not automatically be left to the surviving spouse because that transfer will be exempt and, if the survivor subsequently sells the asset, the relief will have been wasted.

Make a Will

If you die without a Will, the intestacy provisions will apply and may result in your estate being distributed in a way you would not have chosen. Keep your Will up-to-date to reflect changes in the family situation. In particular Wills need to be reviewed and amended as necessary on marriage or on divorce. The precise position depends on whether English or Scots law applies.

Use life assurance

Life assurance arrangements can be used as a means of removing value from an estate and also as a method of funding IHT liabilities. A policy can be arranged to cover IHT due on death. It is particularly useful in providing funds to meet an IHT liability where the assets are not easily realised, eg family company shares.