Stability or All Change?

Tucked away in the small print was an announcement that planned changes designed to cancel the tax advantages of income shifting have been postponed until the Finance Bill 2009. Income shifting, whereby individuals arrange their business interests so that income which might otherwise be attributable to one individual  is taxed on another, is now perceived as an abuse and was due to have been taxed from 6 April 2008. Typically, the income shift takes place between husband and wife but the tax charge could have applied to a much wider range of income shifts. including transfers to children, couples living together and other non-commercial transfers. Legislation was due to be introduced following H M Revenue & Customs losing in the House of Lords in the well publicised Arctic Sytems case, Jones v Garnett.

The proposals have been criticised, not just in relation to the width of their scope but also in respect of how they would have breached confidentiality between independent taxpayers, the way in which they would have introduced subjectivity into quantifying tax bills and the difficulties of being able to apply the rules under self assessment.  While many are relieved  that we will not see the rules in their proposed form, entrepreneurs need to be aware that they have not been totally shelved. Careful thought needs to be given to business structures and how ownership is spread around families to optimise the overall tax position. The bad news is that the postponement means a year of uncertainty but there is an opportunity to use the time to improve structuring and ensure the correct amount of tax is paid.

All entrepreneurs will one day sell up, retire, or pass the business onto the next generation. The capital gains tax changes which take effect on 6 April 2008 create a need to reappraise the business structure. Even if the business rises in value due to  inflation, any gain will be taxed. And while 18% is not the highest rate of capital gains ever faced, there will be a real desire for entrepreneurs to maximise the benefits of the new entrepreneurs’ relief which allows for up to £1million of gains to be taxed at 10% as a lifetime allowance for any one person. Qualification for the new relief requires a minimum 12 month ownership and in the case of shares in a company requires it to be trading and for there to be a minimum 5% interest held.

While some people will be confident that a 10% capital gains tax rate awaits them, others still face losing out on 6 April 2008 and may have to weigh up the pros and cons of acting before 6 April against the problem of having to pay tax at 10% on 31 January 2009.

It is not just entrepreneurs that face this dilemma – ordinary investors in shares need to consider whether to defer selling their shares or not (although not be the case for those who hold shares in their employer). In relation to other assets, despite the fall in the tax rate, this may be offset by the fact that any gain going back as far as 1982 is now exposed to tax, even if wholly attributable to inflation. For many it will be hard to understand why companies have retained an exemption for inflationary gains but individuals will be taxed on them.

General investment strategy is also going to need an overhaul. For example, an investment could produce a return in the form of either a dividend or as capital growth when sold.  A basic rate taxpayer would have no additional tax to pay on the dividend  but  a higher rate taxpayer will pay an additional 25% of the dividends received. On the other hand, capital growth may be exempt if within the annual capital gains tax exemption, set at £9600 for 2008/09 and taxed at 18% if above that. Some collective investments such as investment bonds or offshore funds attract income tax rather than capital gains tax on profits. Taxpayers could be better off switching into alternative investment. However in the case of an investment bond the tax is deferred and an annual ‘income’ of 5% can be withdrawn without any tax being paid each tax year – for the elderly entitlement to higher tax allowances may still make this type of investment attractive.

Each individual should act to review their own personal position and to recognise that by ‘stability’,  Mr Darling may mean ‘all change’.

Contact details
Email: Valerie Smart
Tel: +44 (0)131 260 4497