CGT and Non-Business Assets
Much has been made of the Capital Gains Tax (CGT) changes, announced in the pre-budget report in October, regarding the taxation of business assets, due to the abolition from 6 April 2008 of ‘taper relief’. However, the CGT position regarding non-business assets will also change significantly from that date.
At the moment, CGT is payable on gains exceeding the annual ‘CGT-free allowance’ (currently £9,200) in any year. The effective rate is the marginal Income Tax rate of the taxpayer, which means the CGT payable can be as much as 40 per cent of the chargeable gain. From 6 April 2008 CGT will be payable at a flat rate of 18 per cent.
However, one big change is that CGT ‘indexation relief’ will be abolished completely. This will greatly increase chargeable gains on assets which were acquired many years ago. At the moment, indexation relief acts to remove the effect of inflation from the date of acquisition (or 31 March 1982 if the asset was acquired prior to that date) to the date of disposal of the asset by applying an uplift to the notional cost. Although indexation relief stopped when taper relief was introduced, the indexation relief up to April 1998 (when the Retail Price Index was 162.6) was preserved, which significantly reduced the chargeable gains.
If you have assets the disposal of which would trigger CGT, you should give consideration to your tax position. Assets in this category would include stocks and shares, second homes and so on. Your principal private residence continues to be exempt from CGT.
Partner Note
Source – Cornish Accounting Solutions Newsletter, November 2007.
Dividend Waivers – Making Them Work
When a company is set up, it is common to divide the shares in it in approximately equal proportions amongst the subscribers. Whether or not this proves to be the most effective way to split them in the long run depends on a variety of factors, of which the effect on the governance of the company is often the most significant. However, one problem which sometimes results is that where dividends are paid in proportion to the shareholding, this can lead to dividends being payable to a shareholder who does not need them or who would have to pay higher-rate tax on them.
When a shareholder does not wish to receive a dividend, this can be effected by the execution of a dividend waiver. The use of such waivers can be an effective tool in tax planning, so it is unsurprising that HM Revenue and Customs (HMRC) are generally not keen on them. Unless a dividend waiver is executed in the right way, HMRC are likely to use anti-avoidance legislation to attack the scheme.
The essential steps are:
- The dividend waiver must be a formal election by the person entitled to receive the dividend. It must be done on paper in appropriate form and dated and witnessed;
- The waiver must be executed before the dividend is declared; and
- It is always better if there is a commercial reason for the dividend to be waived – this will normally be to allow the company to retain funds for some specific purpose.
It is unwise to use dividend waivers too frequently. HMRC will look more closely at arrangements which are repeated and the practical effect of which reduces the overall tax payable – for example, where the shareholder executing the waiver is a higher-rate taxpayer and the shareholder who receives the dividend is not.
Partner Note
Source – Tips and Advice – Tax, September 2007.
Drawdown Lifetime Mortgages
For people who have money tied up in their homes who wish to release capital for expenditure, or possibly to give to family members, the drawdown lifetime mortgage (DLM) is a possible vehicle.
A DLM is simply a mortgage, but one which is drawn down over time. For example, a person whose home is valued at £500,000 may get agreement that a drawdown of £125,000 will be supplied. There is no need to take the sum at once and interest is only payable on the amount actually drawn down. In practice, sums are taken piecemeal. The advantage of such a scheme is that the savings in interest payable can be considerable compared with taking the whole sum ‘up front’. Also, it is not uncommon for people who release a large sum all at once to spend it more quickly than they had anticipated.
One other advantage of DLMs is that the property remains yours so any future growth in value belongs entirely to you. This can be very useful, particularly if you intend to ‘downsize’ at a later date. In such circumstances the loan can usually be readily transferred to the new property. Also, most drawdown plans carry a guarantee that should the value of your property fall to the extent that the loan plus interest and charges exceeds the value of your house, your right to remain in your home is preserved.
If you wish to take out a DLM and someone else lives with you in your property, it will be necessary to get them to sign a waiver confirming that they have no right to remain in the property if you die or move into a long-term care home. Should it become necessary for you to have care provided in your own home, the way contributions to the cost of the care are calculated means that the value of your home and mortgage are ignored. Where care at home is necessary, if you have a large lump sum, then that money will be taken into account when assessing your contribution to the care costs. This may in effect mean that the capital is lost over time. However, with a DLM the authorities cannot require you to draw down the rest of the available drawdown facility, which can assist in the preservation of family capital.
“If you are considering obtaining a DLM, as with all such financial products there are pros and cons which should be taken into account,” says <<CONTACT DETAILS>>. “There may be ramifications for your Income Tax and Inheritance Tax positions and there may also be an effect on the division of your estate. For all these reasons, professional advice should always be taken at an early stage when considering such action.”
Enterprising Investment Made Simple
Successive governments have recognised that the spirit of entrepreneurialism, though deeply ingrained in the UK’s culture, is not really very well supported by the financial institutions. In an attempt to provide more ready access to investment capital for entrepreneurs, a variety of schemes have been created – such as the Loan Guarantee Scheme, which provides financial guarantees for loans made by lenders to smaller businesses.
One of the less well-known schemes is the Enterprise Investment Scheme (EIS), which allows an investor to subscribe for new shares in a qualifying company and to obtain Income Tax relief on the investment at 20 per cent. If the shares are held for three years after the investment is made, any subsequent gain on them is not subject to Capital Gains Tax (CGT). EIS shares can also be used to ‘roll over’ a prior gain – deferring the resulting CGT liability until the EIS shares are disposed of.
For a company to issue EIS shares, certain conditions must be met:
- the shares cannot be quoted on a recognised stock exchange and arrangements for a flotation cannot be in progress. Note that a flotation on the Alternative Investment Market does not count for this purpose;
- there are limitations on the trades that are allowed for EIS relief. In particular, land-based businesses, professional services and financial activities are excluded;
- the company must have fewer than 50 full-time employees;
- the gross asset value in the company’s balance sheet must be less than £7m before the issue of the EIS shares (£8m afterwards); and
- there is also a limitation of £2m in any twelve-month period on the total amount which can be raised using the EIS or similar schemes, such as Venture Capital Trust investments.
A number of limitations apply regarding who can invest in the EIS shares of a company – investments by ‘connected persons’ and some others do not qualify for EIS treatment.
The EIS can be both a useful investment vehicle for investors not afraid of the risk involved and a source of capital for the smaller company which may find more conventional finance difficult to obtain.
Contact <<CONTACT DETAILS>> for advice on all corporate finance matters.
Partner Note
Source – ‘Business Matters’, autumn 2007.
Farmer Who Worked For Free Gains Share of Will
A farmer who helped a relative run his farm for more than 20 years has been awarded the property he helped to run. David Thorner was the son of Peter Thorner’s cousin. He helped Peter to run his 400 acre farm in Somerset when Peter began to suffer from ill health. What started as a temporary measure became a lifetime of commitment, as David spent the next 25 years working on the farm without taking a holiday and sometimes working up to 18 hours a day. He was never paid for his work, only receiving a modest allowance from his parents.
The two men had an understanding that on Peter’s death, David would inherit the farm. However, Peter destroyed the will he had made in 1997, which left the farm and most of his estate to David, and never made another. This appears to have occurred because Peter had a falling-out with one of the other beneficiaries under the will. On Peter’s death in 2005, no will could be found, so the laws of intestacy applied. In such cases, the estate passes to the nearest relatives, who in this case were Peter’s nieces.
David relied on the principle of estoppel – in essence that it would be unfair to divide the estate according to the intestacy laws. He argued that the result of Peter’s not having made a new will led to the unfair result that David would not inherit the farm as per their agreement. The claim was defended on the basis that there was no promise as such that David should inherit the farm and thus if he had any claim to having provision made for him out of the estate, it would be a much lesser amount. The court heard a great deal of evidence that Peter had an ‘indirect’ way of saying things – for example, saying, “What are you doing tomorrow?”, when what he meant was “Can you help me tomorrow?” This was claimed to account for the lack of direct evidence for Peter’s promise.
David applied to the court for provision out of the estate and was successful in his claim. The Court awarded the ‘non-agricultural’ assets of approximately £1m to the nieces and the farm to David.
Says <<CONTACT DETAILS>>, “Peter’s failure to leave a valid will meant that the family faced two years of legal wrangling to divide up his estate. All of that expenditure was avoidable. If you have a relative who has assets and is intestate, they may not realise the benefits of making or the consequences of not making a will. The laws of intestacy are often not fair and in this case, had David not made a challenge, the whole of the estate would have passed to family members who had very little to do with the deceased.”
Partner Note
Thorner v Curtis & Ors [2007] EWHC 2422 (Ch) (26 October 2007).
Flexible Pensions – A Wealth Planning Tool
There is a popular misconception that pensions are something you get ‘at pensionable age’ and that therefore saving by way of pension policies offers little in the way of flexibility. This is certainly true of the state pension, which is payable as of right at the statutory retirement age. The state pension can be deferred, but that is seldom advisable.
However, the reality relating to personal pensions is somewhat different. For example, if the pension scheme rules permit it and you were born before 6 April 1960, your pension fund can be used to provide a pension at any time (up to age 75, when it must be taken) after the age of 50. If you were born after 6 April 1960, you must wait until your 55th birthday. There are some circumstances in which retirement pensions may be taken at a younger age, but they are limited.
A personal pension can be taken without retiring, so if you wish to continue working past retirement, you can supplement your income by taking your pension. In some circumstances, it may even be possible to contribute to a pension plan whilst drawing benefits from it at the same time.
Most modern pension funds are split into sub-funds, which can be taken independently of one another, offering still more flexibility. For example, a pension fund split into ten sub-funds may be able to be taken as ten separate annuities, with a tax-free lump sum taken from each.
There is also a variety of options available regarding the draw-down of the pension funds, which permits a great deal of planning of income to be done.
The opportunities for using pension funds to maximise your after-tax income are limited after the age of 75. However, at ages below 75, pension fund planning and the planning relating to the taking of pension benefits can be a significant part of an income and wealth-planning strategy.
Says <<CONTACT DETAILS>>, “It is often worth considering a rapid draw-down of the pension fund if there are significant other assets that are available to use for funding retirement in later years. Such decisions should always be made with the benefit of professional advice. We can assist you to ensure your financial and wealth-management strategies are successful.”
Getting it Right Next Time
If trustees act in a way that gives rise to an unintended liability to tax, the situation can be put right by going to court to have the trust deed rectified. Traditionally, all the trustee had to do was to persuade the court that the unexpected tax liability was something which was important and which he had not considered. The court would then order the transaction to be set aside.
There is some evidence that the courts are taking a somewhat tougher stance nowadays when faced with claims for rectification of trust deeds, as a recent case shows. In it, the settlor of a trust created a discretionary trust for the benefit of his children. He did not realise that such a transfer is an immediately chargeable transfer for Inheritance Tax (IHT) purposes, thinking that it was a potentially exempt transfer. An application was made to have the trust deed rectified.
The judge refused, stating that there was no misapprehension about the effect of the trust deed, only its fiscal consequences. The deed as created reflected the settlor’s true intentions. The claim made by the trustees was to create a completely different settlement, not to rectify a mistake in the original settlement.
The Court of Appeal agreed – the settlor had wished to save IHT without giving gifts directly to his children. The trustees could not show the mistake in the deed that required rectification. They could only offer an alternative.
More recently, rectification has been refused in another case in which the only effect of the rectification requested would be that a fiscal advantage would be obtained. In that case the rights of the grantor of the trust and the intended beneficiary would have been completely unaffected by the proposed rectification.
Says <<CONTACT DETAILS>>, “It is far better to take good professional advice and get it right the first time than to go to court to rectify a defective trust document. With proper planning, such action should not be necessary. Otherwise, not only will there be an avoidable cost, but also the courts appear to be becoming increasingly unwilling to cooperate in such circumstances.”
Partner Note
Allnutt v Wilding [2007] EWCA Civ 412.
Wills v Gibbs [2007] All ER (D) 509 (Jul).
HMRC Publishes Nil Rate Bands
The recent Inheritance Tax (IHT) change which allows the transfer of ‘unused’ nil rate bands from spouse to spouse or from civil partner to civil partner has been generally welcomed, but it has caused some consternation as determining the ‘old’ nil rate band that applied on the first death can be tricky.
It is widely thought that the balance of the allowance available is based on the current allowance but, in reality, it is based on the proportion of the allowance that was unused in the tax year during which the first death occurred. Therefore, to work out the available amount of nil rate band which can be offset on the second death, it is necessary to know both the value of the estate transferred on the first death and the amount of the nil rate band for that year. The available allowance on the second death is the deceased’s own allowance plus the unused percentage of that of the first spouse times the allowance in the year of the second death.
In an attempt to make the calculations easier, HM Revenue and Customs (HMRC) have published nil rate band tables for IHT and for its predecessor taxes (Estate Duty and Capital Transfer Tax), for all years from August 1914 to date.
HMRC have also published on their website further guidance, in the form of frequently asked questions, about the transfer of the nil rate band: see the ‘What’s New’ pages of HMRC’s website at http://www.hmrc.gov.uk/cto/iht/whatsnew.htm.
HMRC Win Residence Decision
The rules concerning whether or not income is taxable in the UK are affected by several factors. Recently, the Government has announced measures to curb what are seen as abuses of the system whereby non-domiciliaries who are resident in the UK avoid paying tax on income they leave outside the UK.
However, for most taxpayers the key concept in determining their tax status is not their domicile (which is a complex concept, based on ‘where they belong’) but their country of residence. Typically, this is decided by ‘physical presence’ tests, based on the number of days in a tax year that a person is in the country.
HM Revenue and Customs recently won a significant case which allowed them to adopt a stricter definition of the time someone is in the UK than they had previously applied (and than the definition used in their own guidance on residence).
More recently still, the stricter interpretation has been confirmed by the courts in a case involving a music agent, who has, as a result, been assessed to tax on nearly £3m which he received when out of the country. He argued that he was not resident in the UK for tax purposes when the payment was made, but the courts concluded otherwise as he had not shown he had made a ‘distinct break’ from the UK. In this case, his continued involvement with his UK company was also significant.
With the growing internationalisation of life and business, the authorities are increasingly taking a tough stance on any ‘grey areas’ involving residence and domicile where significant tax is at stake.
Partner Note
Reported in Accountancy Age, 1 November 2007.
If the Taxman Gets it Wrong – Sue
A surprising decision by the Court of Appeal has opened the door to claims against HM Revenue and Customs (HMRC) from taxpayers who suffer financial loss as a result of the negligence of an HMRC employee.
Builder Neil Martin appealed against a 2006 High Court decision that HMRC did not owe him a duty of care and thus were not liable for the nearly £1/2m he lost owing to their negligence. The case involved a very lengthy failure to issue a construction industry contractor’s certificate, the practical effect of which was to cripple the cash flow of Mr Martin’s company since, under changes introduced in 1999, it could not receive payment for construction work done until in possession of the relevant certificate.
Mr Martin’s case turned on the fact that an HMRC employee incorrectly prepared the documentation on an ‘individual’ basis in Mr Martin’s own name, instead of in the name of Mr Martin’s company. This led to the considerable delay and hence the loss. Had the delay occurred as a result of the same error but committed by Mr Martin, it is clear that his appeal would not have been successful.
The Court of Appeal’s decision turned on the fact that HMRC were involved in the completion of the declaration for Mr Martin’s CIS sub-contractors registration and this was done contrary to his instructions. Where assistance has been given by an HMRC employee in the completion of a form, and this then results in loss (normally, as in this case, because of a delay), the taxpayer may have a valid claim for compensation.
Partner Note
Neil Martin Ltd v HMRC [2007] EWCA Civ 1041. See
An appeal on the basis of a violation of Mr Martin’s human rights was rejected.
IHT and the Pre-Budget Report – Traps Still Remain
It is likely that the changes in Inheritance Tax (IHT) announced in the October pre-budget report were motivated more by Chancellor Alistair Darling’s desire to steal the Tories’ thunder than a recognition of the true problem, namely that rising house prices have plunged many people of modest means into a tax regime originally designed to affect only the rich.
Be that as it may, the changes – hailed widely as a ‘doubling of the IHT nil rate band’ – were seized upon with great enthusiasm. On closer inspection, however, there seems less to cheer about than was first thought.
Firstly, the IHT nil rate band will not be doubled, except in cases in which two spouses or civil partners die in the same tax year. In other cases, the amount available on the second death will be the amount of the IHT nil rate band in the tax year in which the second death occurs plus an amount calculated on the proportion of the IHT nil rate band which was not used up on the first death. An example will illustrate how this works. Suppose a man died in September 1991, leaving an estate of £100,000. The IHT nil rate band for that tax year (1991/1992) was £150,000. Two-thirds of the 1991/1992 nil rate band was therefore used up on the first death. If the man’s widow were to die in the current (2007/2008) tax year, IHT would be payable on her estate above £400,000…the current nil rate band of £300,000 plus an additional one-third based on the ‘unused proportion’ remaining from the first death. The first problem arising here is that unless past records have been retained, it might be difficult to know what the value of the earlier estate was and hence the value of the unused nil rate band. This would be especially so if the value of the estate was low enough to make the filing of a return unnecessary. Also, where the IHT nil rate band was largely used up on the first death (and the nil rate band amounts were much lower in the middling past) the ‘extra’ relief could be rather small. In any circumstances, the maximum nil band available on the second death is twice the single nil rate band.
Secondly, the new limits will apply only to spouses and civil partners. Cohabiting couples (presumably because a review of the law relating to them is ongoing) obtain no benefit from these proposals and no nil rate band is transferred between them. Indeed, they will not even inherit each other’s estates unless they have wills.
Thirdly, the emphasis on IHT deludes many people into thinking that if they know they will not have an IHT liability, they will be able to pass their entire estate into the hands of their family, untrammelled by the state. Regrettably, for hundreds of thousands of families, this is merely false optimism. The spectre that faces many families is the rising cost of care for the elderly, which can destroy the wealth of a family of modest means. The reason for this is that currently (2007/2008) a person with assets exceeding £21,500 normally pays the whole of the cost of any long-term residential care they receive, which can amount to over £1,000 a week.
Says <<CONTACT DETAILS>>, “Our concern is that people will seize on the IHT changes as a reason for neither making a will nor undertaking planning to preserve family wealth and will unnecessarily end up transferring assets to the state, rather than their family.”
IHT and the Pre-Budget Report – Traps Still Remain
It is likely that the changes in Inheritance Tax (IHT) announced in the October pre-budget report were motivated more by Chancellor Alistair Darling’s desire to steal the Tories’ thunder than a recognition of the true problem, namely that rising house prices have plunged many people of modest means into a tax regime originally designed to affect only the rich.
Be that as it may, the changes – hailed widely as a ‘doubling of the IHT nil rate band’ – were seized upon with great enthusiasm. On closer inspection, however, there seems less to cheer about than was first thought.
Firstly, the IHT nil rate band will not be doubled, except in cases in which two spouses or civil partners die in the same tax year. In other cases, the amount available on the second death will be the amount of the IHT nil rate band in the tax year in which the second death occurs plus an amount calculated on the proportion of the IHT nil rate band which was not used up on the first death. An example will illustrate how this works. Suppose a man died in September 1991, leaving an estate of £100,000. The IHT nil rate band for that tax year (1991/1992) was £150,000. Two-thirds of the 1991/1992 nil rate band was therefore used up on the first death. If the man’s widow were to die in the current (2007/2008) tax year, IHT would be payable on her estate above £400,000…the current nil rate band of £300,000 plus an additional one-third based on the ‘unused proportion’ remaining from the first death. The first problem arising here is that unless past records have been retained, it might be difficult to know what the value of the earlier estate was and hence the value of the unused nil rate band. This would be especially so if the value of the estate was low enough to make the filing of a return unnecessary. Also, where the IHT nil rate band was largely used up on the first death (and the nil rate band amounts were much lower in the middling past) the ‘extra’ relief could be rather small. In any circumstances, the maximum nil band available on the second death is twice the single nil rate band.
Secondly, the new limits will apply only to spouses and civil partners. Cohabiting couples (presumably because a review of the law relating to them is ongoing) obtain no benefit from these proposals and no nil rate band is transferred between them. Indeed, they will not even inherit each other’s estates unless they have wills.
Thirdly, the emphasis on IHT deludes many people into thinking that if they know they will not have an IHT liability, they will be able to pass their entire estate into the hands of their family, untrammelled by the state. Regrettably, for hundreds of thousands of families, this is merely false optimism. The spectre that faces many families is the rising cost of care for the elderly, which can destroy the wealth of a family of modest means. The reason for this is that currently (2007/2008) a person with assets exceeding £21,500 normally pays the whole of the cost of any long-term residential care they receive, which can amount to over £1,000 a week.
Says <<CONTACT DETAILS>>, “Our concern is that people will seize on the IHT changes as a reason for neither making a will nor undertaking planning to preserve family wealth and will unnecessarily end up transferring assets to the state, rather than their family.”
‘Non-Dom’ Tax – Fair or Not?
The recent proposal to introduce a flat-rate £30,000 tax on long-term UK residents who claim to be not domiciled here has been presented as a way of ensuring that foreign ‘fat cats’ living in the UK make a contribution to the Exchequer.
Regrettably, the new proposals would seem to create as many problems as they seek to solve. The reason why follows from the way tax law operates in the UK compared with other countries. In most countries, income is taxed on a ‘world income’ basis. The taxpayer files a tax return in their home country and any income earned abroad is included on it. The whole of their worldwide income is subject to tax in their home country, with relief given by way of ‘double taxation relief’ on their foreign-source income.
The UK also taxes world income, but the concept of ‘domicile’ complicates matters. Your domicile is ‘where you belong’ as opposed to where you live (‘residence’). Domicile can be changed, but it is much more difficult to change domicile than residence. A person not domiciled in the UK currently pays UK tax only on income brought into the UK (‘remitted’), so by leaving income outside the UK, UK tax is not paid on it. For Inheritance Tax purposes, a UK domicile can be established by residence for the requisite period. For Income Tax purposes, it is at least in principle possible to spend one’s entire life in the UK and never become domiciled here.
The UK is a relatively attractive base for foreign high-earners because of this rule. Income can be left abroad, in a low-tax or zero-tax country, and not be subject to UK tax.
The problem with the proposed change is that for high-earners the £30,000 payment will merely reduce their tax liabilities elsewhere if they claim double taxation relief. It will produce income for the Exchequer, in effect, by reducing the tax revenue of other countries. The possibility that those countries might retaliate does not seem to have been considered – for example, by making any non-income related flat tax unavailable for double tax relief. The second issue, which is a much more significant one, is that there are very large numbers of non-domiciliaries in the UK – certainly millions (1 in 6 marriages in the UK is to a foreign citizen). The Government’s announcements on the subject repeatedly refer to a figure of 111,000 non-domiciliaries, which must be an underestimate.Many of these people will have small amounts of foreign-source income. Presumably, in order to avoid paying £30,000 in tax on what might be a few thousand pounds of income, they will need to request extra pages for their tax returns, make sure they get bank statements, calculate the income at the prevailing rate of exchange and compute any double taxation relief for tax paid in the foreign country and so on. The paperwork involved could be phenomenal and as UK tax rates on savings are comparatively low, there is likely to be little additional tax revenue resulting from the change.
The Government has also announced its intention to introduce further measures to curtail the ability of non-domiciliaries resident in the UK to limit their exposure to UK Income Tax. It also intends to obtain information regarding the foreign bank accounts of UK citizens from a further 150 foreign financial institutions.
Whilst the UK is undoubtedly a tax haven for the very wealthy, what is really needed is a complete re-think of the tax rules to ensure that a system is developed which is fair and not overly complex.
Contact <<CONTACT DETAILS>> for advice on any tax matter.
Partner Note
Additional measures reported in the Times, 7 December 2007. Other items reported variously.
Northern Rock – Good News for ISA Holders
The panic that overnight turned Northern Rock from a respected High Street fixture to a lame duck saw thousands of holders of ISAs in ‘the Rock’ queuing to withdraw their savings.
Faced with the loss of the Income Tax and Capital Gains Tax benefits which attach to their ISA or the potential loss of the underlying capital, savers bit the bullet and opted for safety.
The Government has now stepped in and announced that, subject to the completion of the appropriate paperwork, a Northern Rock ISA cashed in by an investor after the ‘crash’ can be reinvested in a new ISA with Northern Rock or another ISA provider without penalty, provided that the reinvestment takes place before 5 April 2008.
Further details can be found on the HM Treasury website at www.hm-treasury.gov.uk.
Partner Note
Source – Accountancy Age, 25 October 2007.
Putting Cash into a Family Business
When younger members of a family start a business, they often ask other family members to provide part of the necessary capital. If you are approached to do this and are willing to provide funding, it is often difficult to know how best to provide the cash. The situation is complicated by the fact that what is and what is not agreed is often determined by family dynamics, rather than commercial considerations. There are significantly different effects depending on how the funds are provided. Here are the pros and cons of the most common methods.
Gifts
A gift of money is (if above the annual allowance) a potentially exempt transfer for Inheritance Tax purposes. It may therefore create a tax liability if you die within seven years of making the gift. Secondly, a gift creates no requirement for the recipient to do anything at all in return and certainly not a requirement to refund the gift at any time. If the business goes bust, there will be no tax relief available for the lost investment. If it succeeds, there will be no income stream arising.
Loans
A loan can be provided which carries interest at an agreed rate. If interest is payable, you will normally have to pay tax on the interest received. If the loan is repayable and the repayment terms are not met, you can sue for the money. You may also be able to get security for the loan, by way of guarantee from the borrower or by securing it on some asset or assets. What is important is to make sure that the paperwork recording the terms of the loan is done correctly. Relying on a verbal agreement is very unwise. If the loan is lost, relief for Capital Gains Tax (CGT) purposes is normally available as regards the capital sum. There is no real scope for a capital gain with a loan – your return will normally be limited to your investment plus interest. However, some loans may be convertible into shares, which may prove an attractive option if the business is successful. If the business fails, however, taking action to obtain repayment may prove to be especially unpopular if the debtor is a family member or friend.
Shares
If the business is a company, you may be offered shares in the company. This can be attractive if you expect the value of the shares to rise. If the business fails, a loss for CGT purposes normally arises and this can be carried forward to set against future chargeable gains. Also, in some circumstances a loss for Income Tax purposes may be available. For this to be the case, the shares must have been ‘new’ shares issued by the company, not shares bought from an existing shareholder. Other restrictions also apply for Income Tax relief to be granted in such cases.
However, shareholdings, especially minority shareholdings, have significant disadvantages. Firstly, a minority shareholder often has no control over the company nor, in particular, over the dividend stream arising. Secondly, there is no right of repayment and in many cases a minority shareholding may be difficult or impossible to sell. It is always sensible to try to protect a significant investment in the shares of a private company by having a shareholders’ agreement drawn up.
If you are thinking of investing in the business of a friend or family member, we can guide you through the issues involved and assist in creating any necessary legal agreements.
Revenue Change Trust Rules
HM Revenue and Customs (HMRC) have, without a formal announcement as such, apparently changed their views on the Inheritance Tax (IHT) implications of some transfers of property.
HMRC have written to some firms stating that in their view a transfer of an interest in possession dating from before 22 March 2006 (when the rules relating to IHT and trusts were radically overhauled) into a transitional serial interest (TSI) for the same person is a chargeable transfer for IHT purposes. This occurs where a beneficiary of an interest in possession created before 22 March 2006, under which they have a life interest, has that interest replaced by a TSI in their favour before 6 April 2008.
This is important. It was previously accepted by HMRC and practitioners alike that an immediate charge to IHT did not arise in such circumstances. It may, for example, affect people where a family member occupies a property owned by a trust created under a will. Discussions between tax professionals and HMRC are ongoing to try to resolve the matter.
Partner Note
ICAEW ‘Taxline’ – 8 October 2007. There is also a short note on this on the STEP website at http://www.step.org/index.pl?section=31.
The New CGT Regime – Who Wins and Who Loses?
The changes announced in the Capital Gains Tax (CGT) regime in the Chancellor of the Exchequer’s pre-budget report are more far-reaching than has generally been understood. In this article, we look at the impact of the changes and work out who are the winners and losers.
Losers
Business asset owners
Where a person disposes of a business asset held for more than two years, the effective rate of CGT for a higher-rate taxpayer will increase from 10 per cent to 18 per cent due to the abolition of CGT ‘taper relief’ from 6 April 2008.
According to the Tax Faculty of the Institute of Chartered Accountants in England and Wales, the abolition of indexation relief will significantly increase the CGT charge for those who hold assets acquired before 6 April 1998.
Particularly badly hit by the changes will be those who hold business assets for the longer term, for example farming businesses and furnished holiday lettings businesses.
Winners
Non-business asset owners
The current taper period for non-business assets is ten years, which complicates the situation somewhat. The application of non-business taper relief means that the minimum effective CGT rate on such assets is 24 per cent for a higher-rate taxpayer, so many higher-rate taxpayers with non-business assets are likely to be better off disposing of assets after 6 April 2008 and paying CGT at 18 per cent. However, the benefit or otherwise depends on the amount (if any) of the available ‘nil-band’ below which CGT is not payable (currently £9,200 per annum).
For basic-rate taxpayers, the effects are limited but mean that the effective tax charge on non-business assets held for five years or more rises.
What to do now
We strongly recommend that clients holding assets, especially business assets, consider their CGT position as soon as possible. Draft legislation is expected to be available at the beginning of 2008, so precise planning should be possible then. At the time of writing, a number of anomalies had been uncovered in the proposals, which are under discussion between the relevant professional bodies and HM Revenue and Customs.
We can advise you on tax-efficient strategies for holding and disposing of capital assets.
Partner Note
Source – ICAEW Tax Guide 4/07.