CONTENTS THE SUMMER BUDGET A SUMMARY. Introduction. 1. Income tax THE SUMMER BUDGET A SUMMARY

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1 CONTENTS THE SUMMER BUDGET A SUMMARY PROPOSED CHANGES TO THE TAXATION OF DIVIDENDS HMRC REVIEW OF THE USE OF DEEDS OF VARIATION THE PERSONAL SAVINGS ALLOWANCE - CONSULTATION LAUNCHED THE TAPERED ANNUAL ALLOWANCE THE SUMMER BUDGET A SUMMARY Introduction Two months and a day after the general election, George Osborne presented his seventh Budget which was the first purely Conservative Budget since Ken Clarke s finale back in November Traditionally the first Budget after an election is the one in which Chancellors administer their most controversial fiscal medicine as, by definition, it is furthest away from the next visit to the polling station. In this regard, Mr Osborne did not disappoint this was a radical Budget, with hints of more to come. His main proposals, which are relevant to the financial services industry and financial advisers, were: 1. Income tax INCOME WITHDRAWAL RATE FOR AUGUST 2015 For 2016/17, the government will increase the personal allowance from 10,600 to 11,000 and it will further increase to 11,200 in 2017/18. This document is strictly for general consideration only. Consequently Technical Connection Ltd cannot accept responsibility for any loss occasioned as a result of any action taken or refrained from as a result of the information contained in it. Each case must be considered on its own facts after full discussion with the client's professional advisers. Published by Technical Connection Ltd, 7 Staple Inn, London, WC1V 7QH. Tel: Fax: enquiries@technicalconnection.co.uk The basic rate limit will increase to 32,000 for 2016/17 and 32,400 for 2017/18. As a result the higher rate threshold will increase to 43,000 and 43,600 respectively. Legislation will be introduced which will provide that the basic, higher and additional rates of income tax will not increase above 20%, 40% and 45% respectively for the duration of this Parliament. 1

2 The 10% dividend tax credit will be replaced by a new 5,000 tax-free dividend allowance for all individual taxpayers from April The dividend tax rates will be set at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers. Trustees are expected to pay 38.1% tax on dividends they receive but are unlikely to benefit from the 5,000 tax-free allowance see later for more detail on this. From April 2016, the government will increase the rent-a-room relief from 4,250 to 7,500 a year. Finance costs, such as mortgage interest, will gradually be restricted to 20% on buy-to-let residential properties from 6 April When the personal allowance reaches 12,500 it will be increased automatically in line with the equivalent of 30 hours at the national minimum wage that individuals over 21 are entitled to. 2. National insurance contributions The Class 1 NIC rates are to be frozen for the duration of this Parliament. The Employment Allowance is increased to 3,000 from 6 April However, it will no longer be available for one-person companies where the sole employee is the company director. The government will consult in the autumn on abolishing Class 2 NICs and reforming Class 4 NICs for the self-employed. The government is to actively monitor the growth of salary sacrifice arrangements. 3. Capital gains tax The government will stop investment fund managers from using tax loopholes to avoid paying the correct amount of capital gains tax on the profits of the fund payable to them (known as carried interest). 4. Inheritance tax A new dedicated "residence nil rate band" (RNRB), in addition to the existing 325,000 nil rate band, will be introduced from April 2017 specifically to protect the family home from inheritance tax. Salient features of the new nil rate band are as follows:- - it will be phased in gradually between 6 April 2017 and 6 April 2020 on the following basis: 100,000 for the tax year 2017/18 125,000 for the tax year 2018/19 150,000 for the tax year 2019/20 175,000 for the tax year 2020/21 and in subsequent tax years it will increase in line with the CPI. 2

3 - the RNRB can be offset against the value of property that at some point has been occupied as the family home. The RNRB will be available when an owner dies on or after 6 April 2017 and the family home is transferred on death to the direct descendants of the deceased - the transfer can be by will, under intestacy or by some other means eg. transfers into trust in limited circumstances - any unused RNRB can be transferred to a surviving spouse or civil partner - special rules will be introduced to protect those who downsize. How this will work in practice will be subject to consultation - where the value of the deceased s estate exceeds 2 million then, broadly, the RNRB will be reduced by 1 for every 2 excess value. This means, for example, that by 2020/21 there will be no RNRB available on first death if the net value of the estate exceeds 2.35 million (2.7 million on the death of a surviving spouse when a full RNRB is available to the surviving spouse). - where the first death occurred before 6 April 2017 an RNRB may be available on the second death irrespective of whether the first to die left an interest in a family home direct to descendants. There is some doubt as to how this rule will apply in practice and we will report further on this when we have more information. The nil-rate band is currently frozen at 325,000 until April It will now remain frozen at 325,000 until 5 April The government will legislate to ensure that, from April 2017, inheritance tax is payable on all UK residential property owned by non-domiciliaries, regardless of their residence status for tax purposes, including property held indirectly through an offshore structure. From April 2017 the point at which a non-domiciled individual is deemed to be UK domiciled will be reduced from 17 out of the last 20 tax years to 15 out of the last 20 tax years. The test will apply for inheritance tax, capital gains tax and income tax purposes. In the December 2014 Autumn Statement, the government announced that it was not going to proceed with the introduction of a single settlement nil rate band as part of its reforms to the IHT treatment of discretionary trusts. Instead, the government confirmed that it would introduce new same-day addition rules to target IHT avoidance based on multiple trusts. In this Budget it was confirmed that draft legislation on this will be included in the Summer Finance Bill It will apply to trusts created on or after 10 December 2014 (unless those trusts receive added property from a will executed before 10 December 2014 where the deceased dies before 6 April 2017) and will apply to chargeable events that arise after the Finance Bill receives Royal Assent. 5. Corporation tax and other business changes The corporation tax rate will fall to 19% for the Financial Year beginning 1 April 2017 and to 18% for the Financial Year beginning 1 April

4 The permanent level of the annual investment allowance (AIA) available to businesses is to be 200,000 with effect from 1 January The AIA was scheduled to be 25,000 from 1 January The change has effect for expenditure incurred on or after 1 January Tax avoidance The government announced the following measures in its action against tax avoidance: - Continued action to target evasion to be provided for in post-budget regulations. Legislation to implement the direct recovery of debts by HMRC. The GAAR to be strengthened. Serial avoiders to be named and shamed. Consultation on IR35 reform. Additional HMRC resources to target non-compliance by wealthy individuals. Measures to ensure the full (28%) CGT rate is applied to fund managers carried interest see also the capital gains tax section. Intermediaries and advisers to be required to notify their clients about their duty to fulfil their responsibilities to declare offshore income and gains. 7. Savings and investments Tax-free personal savings allowance of 5,000 for savings income confirmed to be introduced from 6 April A Help to Buy ISA will be made available from 1 December 2015 to boost savings for first-time home buyers. The government will pay 50 for every 200 saved subject to a maximum of 3,000 which will be paid at the time the property is bought. Further VCT/EIS limitations/conditions to be introduced. New dividend taxation rates to be introduced from April 2016 for basic, higher and additional rate taxpayers at 7.5%, 32.5% and 38.1% respectively see later for more detail on this. 8. Pensions Lifetime allowance reduction to 1m confirmed from 6 April Transitional protection will be available to protect existing rights up to 1.25m. Lifetime allowance to be indexed annually in line with the CPI from 6 April The annual allowance for those people with total income plus all pension contributions ( adjusted income ) that exceeds 150,000 will be restricted by being tapered down to a 4

5 minimum of 10,000 at 210,000 of adjusted income from April This restriction will be subject to an income floor where total income (without pension contributions) exceeds 110,000 this amount of income is called threshold income. See later for more detail on this. Immediate changes to Pension Input Periods (PIPs). Secondary annuity market implementation delayed until Consultation launched on reforming pensions tax relief. The tax rate on lump sum benefits payable on death at or after age 75 to be reduced from 45% to the marginal rate(s) of the recipient from April Where death benefits are paid to a trust after 5 April 2016 and suffer a 45% tax charge, on a later payment to a beneficiary that beneficiary will receive a credit for an appropriate amount of that tax payment. Pensions Wise guidance service to be extended to those aged 50 or over. Government to monitor salary sacrifice schemes. 9. Employee benefits On 8 July HMRC published draft regulations to implement a package of measures, included in Finance Act 2015, that give effect to recommendations made by the Office of Tax Simplification in The measures, which are due to take effect from the start of the 2016/17 tax year, are: the abolition of the 8,500 threshold for benefits in kind; allowing employers to voluntarily report and deduct tax on benefits in kind in real time (known as 'payrolling'); and the introduction of an exemption for qualifying business expenses. Consultation on the draft regulations will run until 2 September Tax simplification The government remains committed to a continual process of simplifying the tax system. The Office of Tax Simplification will be made permanent. Various consultations, eg. on the alignment of tax and NICs, the taxation of small companies, the tax and the NICs treatment of termination payments, the tax treatment of travel and subsistence and the abolition Class 2 NICs and reforming of Class 4 NICs, will all take place shortly. 5

6 The government also remains committed to the transformation of the tax system over the lifetime of this Parliament by introducing digital accounts to remove the need for individuals and small businesses to complete annual tax returns. PROPOSED CHANGES TO THE TAXATION OF DIVIDENDS General From 6 April 2016 the non-reclaimable 10% dividend tax credit is to be scrapped. At the same time the Chancellor announced: A new dividend allowance from 2016/17 of 5,000 for all individual taxpayers; and New tax rates above the new allowance of 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers as the Chancellor said, a rise in all effective rates (based on the dividend paid with no grossing up) of 7.5%. Full details of the proposed changes will be included in the Finance Bill The net result is that 85% of taxpayers will be better off, or at least not worse off, according to the Chancellor. For those with dividend income above the new allowance of 5,000 a comparison of this tax year and the next tax year is shown below: Basic Rate Higher Rate Additional Rate 2015/ / / / / /17 Dividend Tax credit Taxable Tax liability Tax credit Tax to pay - _ Individual investors In connection with these changes, the Chancellor said 85% of those who receive dividends will see no change or be better off. Over a million people will see their tax cut. Are the changes really that good? From the viewpoint of an investor whose marginal rate of tax exceeds the basic rate, the 5,000 dividend allowance is very generous: For a higher rate taxpayer, the allowance represents a saving of up to 1,250 [22.5%/0.9]). To end up with a bigger overall tax bill on their dividends, the 40% taxpayer 6

7 would need to receive total net dividends (ie not grossed up) of over 21,667. Volume 28 Issue 10 July 2015 For an additional rate taxpayer, the corresponding figures are 1,528 and 25,250. The investors worst affected although there will be few are basic rate taxpayers with dividend income above 5,000. At present they pay no tax until they hit the higher rate threshold whereas from 2016/17 they will pay 7.5% tax. In other words, the dividend tax change is regressive, at least as far as most investors are concerned. In his speech Mr Osborne also said Those who have large shareholdings worth typically over 140,000 will pay more tax. That figure was a crude stab based on the fact that the FTSE All- Share Index yields about 3.5% 3.5% = 4,900). In practice, for most investors the value threshold will be higher because most collective investments will have charges deducted from income before dividends are paid, so the actual yield will be lower than the market figure; and the UK is a relatively high yielding market. Trustees With no solid information available on trusts we have worked on assumptions that there will be no dividend allowance for trusts, the 10% dividend tax credit disappears for trusts, too, and the dividend rate for trusts will, as now, match the additional rate, ie it will be 38.1% from 2016/17. As far as interest in possession trusts are concerned, income is taxable on the income beneficiary and retains its source character as dividend/savings income etc. Therefore the comments for individual investors basically apply. For other trusts (excluding those for vulnerable beneficiaries) that can be liable to the additional rate of tax, trustees net of tax income from dividends (assuming that the 1,000 standard rate band has been exhausted by other trust income) will be reduced: 2015/ /17 Dividend Tax credit Taxable Tax liability Net income to trust That is much as might be expected, given the effective tax rate on the net dividend paid is higher (38.1% against 30.56%). More interesting is the situation when trustees distribute their dividend income rather than accumulate it. This has generally been bad news because the tax calculation does not allow the trustees to benefit from the 10% dividend tax credit when making a distribution to beneficiaries. The trustees have to withhold 45% tax on their grossed-up distribution, but can only offset that with the extra tax they have paid on the dividend, producing an effective double taxation. Does the scrapping of tax credits make any difference? We thought it might and then we crunched the numbers 7

8 2015/ /17 Dividend Tax credit Taxable income 1, Trustee liability Net income to trust Tax due on 45% Tax paid Balance of tax to pay Distribution to beneficiary So the result is exactly the same all taxpaying beneficiaries lose out because the net dividend paid to the trust effectively becomes transformed into gross non-dividend income (ie trust income) in the beneficiary s hands so this income cannot be covered by the 5,000 tax free allowance. Business owners The example below, for a higher rate taxpayer, illustrates that where a shareholder/director in a private limited company is considering remuneration strategies, dividends are still more attractive than bonuses but less so from 2016/ / /17 Bonus Dividend Bonus Dividend Marginal gross profit 25,000 25,000 25,000 25,000 Corporation 20% N/A (5,000) N/A (5,000) Dividend N/A 20,000 N/A 20,000 Employer s NICs 13.8% (3,032) N/A (3,032) N/A Gross bonus 21,968 N/A 21,968 N/A Director s NICs 21,968@ 2% (439) N/A (439) N/A Income tax (8,787) (5,000) (8,787) (6,500) Net benefit to director 12,742 15,000 12,742 13,500 Whereas under the 2015/16 regime the taxpayer receives 60% of the gross profit of 25,000 as a benefit, in 2016/17 there is a reduction of 1,500 as the effective rate of tax on gross profits is 46%. 8

9 HMRC REVIEW OF THE USE OF DEEDS OF VARIATION In his last pre-election Budget on 18 March 2015 the Chancellor announced a Government review of what he described as "attempts to avoid inheritance tax through the use of deeds of variation". To this end HMRC launched consultation on 16 July on the use of a Deed of Variation (DoV) for tax purposes to ensure that they are not being abused. HMRC is asking eight fairly straightforward questions and has said that anybody can respond and all responses will be considered. HMRC admits that it has little information about the uses of DoV, as the executors only need to notify HMRC where a DoV results in an adjustment of inheritance tax due. Although the consultation is referred to as a call for "evidence", no evidence as such is being asked for, merely a survey is being carried out. HMRC states that the questionnaire has been designed with the aim of understanding what role tax advantages play when a decision is made to vary a will by a DoV. One of the questions asks: What is the main reason (or reasons) for using a DoV? The choice of answers include the following: To update a will to reflect changes in family circumstances To reduce/increase a tax liability (IHT or CGT) To increase the amount of a charitable legacy To clarify a poorly drafted will These answers certainly do not cover all the possible answers to the question HMRC poses. And what if more people taking part tick the answer about tax liabilities, will this provide actual evidence that DoVs are used primarily for tax planning reasons? And if only a minority ticks the answer to that question, will this "evidence" be accepted by HMRC and DoVs be left alone? Or has the government already decided what it is going to do anyway? It also asks whether DoVs are ever used to support any contrived or artificial arrangements designed purely to reduce a tax liability. One wonders who might answer this in the affirmative. The deadline for responses is 7 October after which the evidence will be analysed and the government will consider the findings. COMMENT Most advisers will be familiar with the concept of a DoV, i.e. a device which, it is often said, allows you to rewrite a will (or intestacy) after someone has died, perhaps to improve the inheritance tax position after death or to skip a generation. DoVs are not used anywhere near to the same extent that they were before the introduction of the transferable nil rate band but they can still be useful. As mentioned above, deeds of variation have been picked for review as part of the government s drive to counter tax avoidance. It is certainly questionable whether changing a will provision by itself can be considered to be tax avoidance. After all, if the deceased had included equivalent provisions in the will (except, of course, those relating to the severance of a joint tenancy which cannot be via a will) - or had left a valid will, in the case of intestacy - such provisions would never be considered to amount to tax avoidance. Let us hope the review will come to sensible conclusions. Nevertheless, those contemplating using this device should bear the possible changes in mind and 9

10 may want to consider taking action sooner rather than relying on the two-year limit currently available. And the ongoing review should act as a trigger to review, and update if necessary, your own will - and to recommend the same to your clients. THE PERSONAL SAVINGS ALLOWANCE - CONSULTATION LAUNCHED In the March 2015 Budget it was announced that the government would introduce a personal savings allowance (PSA) of 1,000 for basic rate taxpayers (and 500 for higher rate taxpayers) on the interest earned on savings from 6 April The PSA will not be available to additional rate taxpayers. In addition, from April 2016, banks and building societies will stop automatically deducting 20% income tax on interest earned on non-isa savings and pay interest gross. The government said that by introducing a PSA it believed that 95% of people would not have to pay tax on the first 1,000 (500 for higher rate taxpayers) of interest they earn on their savings. Savings income for these purposes includes interest income, income from certain purchased life annuities, profits from deeply discounted securities, profits under the accrued income scheme and chargeable event gains under life assurance policies. In view of these proposed changes, HMRC has now launched an open consultation inviting comments on options for changes to current legislation. The aim of the consultation is to establish which options will best balance the following issues: making it as easy as possible for recipients to pay the right amount of tax; reduce risks to the Exchequer of the right amount of tax not being paid; easing administrative burdens and costs for payers of interest and other amounts; and the costs to HMRC of operating and policing the tax system. The consultation closes on 18 September 2015 and will be of particular interest to financial institutions and other businesses that pay interest or other savings income. However, HMRC also welcomes comments on how recipients of savings income may be affected. COMMENT Undoubtedly, the introduction of a PSA is a welcome change and it will be interesting to see the outcome of this consultation in due course. THE TAPERED ANNUAL ALLOWANCE Readers will be aware of the government s proposals to cut back tax relief on pension provision for those people who are additional rate taxpayers or other people with high levels of income. In brief, these provisions mean that individuals who have adjusted income of more than 150,000 and threshold income of more than 110,000 may have their annual allowance gradually reduced to a minimum of 10,000 (for those with adjusted income of 210,000 or more). Here we examine the definition of threshold income and adjusted income for these purposes. 10

11 Threshold income (110,000) To provide certainty for individuals with lower salaries who may have one-off spikes in their employer pension contributions, a threshold income of 110,000 will apply. If the individual s threshold income is no more than 110,000 they will not normally be subject to the tapered annual allowance. However, anti-avoidance rules will apply so that any salary sacrifice set up on or after 9 July 2015 will be included in the threshold definition. Threshold income is: the individual s net income for the tax year as calculated under steps 1 and 2 of section 23 of the Income Tax Act 2007, less the amount of any lump sum death benefits accruing to the individual in the tax year mentioned in section 636A(4ZA) ITEPA 2003, plus the amount of any employment income given up for pension provision as a result of any salary sacrifice made on or after 9 July 2015 Steps 1 and 2 of section 23 of the Income Tax Act 2007 read as follows: Step 1 Identify the amounts of income on which the taxpayer is charged to income tax for the tax year. The sum of those amounts is total income. Each of those amounts is a component of total income. Step 2 Deduct from the components the amount of any relief under a provision listed in relation to the taxpayer in section 24 (eg early trade losses) to which the taxpayer is entitled for the tax year. See sections 24A and 25 for further provision about the deduction of those reliefs. The sum of the amounts of the components left after this step is net income. Adjusted income (150,000) The restriction will apply for an individual for any tax year where their adjusted income is greater than 150,000. Adjusted income is broadly an individual's net income plus any pensions contributions they make or made on their behalf. In more detail it is: the individual s net income for the tax year as calculated under steps 1 and 2 of section 23 of the Income Tax Act 2007 (see above), plus the amount of any relief under section 193(4) of Finance Act 2004 (a claim for excess relief under net pay) and section 194(1) of Finance Act 2004 (relief on making a claim) deducted at step 2, plus 11

12 the amount of any pension contributions made from any employment income of the individual for the tax year under net pay, under section 193(2) of Finance Act 2004, (to ensure fairness between those who have contributions deducted via net pay and those through relief at source), plus where non-domiciled individuals make contributions to overseas pension schemes, any relief claimed under Chapter 2 of Part 5 of the Income Tax (Earnings and Pensions) Act 2003 for the tax year, plus the value of any employer contributions for the tax year. From this amount it is necessary to deduct the amount of any lump sum death benefits accruing to the individual in the tax year mentioned in section 636A(4ZA) ITEPA The value of the employer contributions in respect of an arrangement for a tax year will be the pension input amount for the arrangement for the tax year less the total of any member contributions. For other money purchase (defined contribution) arrangements this will therefore be the actual value of any employer contributions paid in the tax year for that arrangement. For defined benefits and cash balance arrangements it will be necessary to work out the actual pension input amount for the arrangement for the tax year, using the normal annual allowance rules, and then subtracting from this figure the total of any member contributions to that arrangement paid in the tax year. The rate of reduction in the annual allowance is 1 for every 2 that the adjusted income exceeds 150,000, up to a maximum reduction of 30,000 at 210,000 of adjusted income. This means that those with adjusted income of 210,000 will only have an annual allowance of 10,000. COMMENT The number affected by this change is expected to be around 300,000 pension savers. It s important to note that the rules could be subject to change as they are included within the draft Finance Bill It may be worthwhile for those affected by this change, which is effective from 6 April 2016, to make the most of the annual allowance for this tax year to optimise use of the available tax relief. INCOME WITHDRAWAL RATE FOR AUGUST 2015 The appropriate gilt yield, used to determine the relevant annuity rate from HMRC s tables for an adult member commencing income withdrawals (or reaching an income withdrawal review date), in August 2015 is 2.50%. 12