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The Budget 2010 commentaries - personal tax & trusts

"The commentaries below are written in general terms. Details can also be found in our downloadable Budget Report brochure. You are strongly recommended to seek specific advice before taking any action based on the information given, both in the commentaries and in the publication."

Income tax and National Insurance rates, thresholds and limits

The proposed changes to personal tax rates, allowances and limits, and National Insurance Contributions (NIC) rates and thresholds are set out in the Appendix.

Personal tax allowances and rate limits will not be increased in 2010/11 and are set at the 2009/10 amounts as announced in the 2009 PBR.  This is with the exception of the introduction of the additional rate of tax from 6 April 2010 set at 50% which will apply to taxable income above £150,000. 

Taxpayers with an ‘adjusted net income’ exceeding £100,000 per annum will suffer a reduction to their personal allowance by £1 for every £2 in excess of £100,000.  The reduction will continue until the personal allowance is exhausted.

‘Adjusted net income’ takes into account specific deductions including payments made to pension schemes, gift aid donations and trading losses.

Comment

There were no surprises to personal tax rates and allowances as the above had all been announced in the 2009 PBR.  To illustrate the effect of these changes, an individual earning £200,000 will suffer additional tax of approximately £7,600 per annum as a result of the combination of the new 50% rate of income tax and the reduction in the personal allowance.

Capital gains tax: Increase in lifetime limit on entrepreneurs' relief (ER)

ER was introduced in Budget 2008 at the same time as the other major changes to the capital gains tax (CGT) regime, including the introduction of the flat rate of CGT of 18%.

ER gives individuals the ability to make a claim on capital gains arising on certain qualifying disposals of business interests. The mechanism for providing this relief occurs by reducing the gain by 4/9ths; hence, on current CGT rates, this reduces the CGT rate from 18% to an effective rate of 10%. However, each individual only had a lifetime limit of £1 million of gains that could be covered by this relief.

In order to qualify for the relief, the disposal must be of:

  • all or part of a trading business carried on by the individual, whether alone or in partnership;
  • assets used in the individual's business, whether alone or in partnership;
  • shares in the individual's personal trading company; or
  • assets owned by the individual and used by his personal trading company

For the purposes of the relief, a personal trading company is one where the individual was an officer or employee of the company holding at least 5% of the share capital (which must carry at least 5% of the voting rights), with both conditions having been complied with throughout the 12 month period ending on the date of the disposal. If a trade ceases, the disposal must be made within three years of cessation of the trade. The relief can also be claimed by trustees but only if a beneficiary personally qualifies by satisfying the rules including the requirement for a minimum 5% personal shareholding.

The change announced in Budget 2010 increases the amount of lifetime limit for individuals from £1 million to £2 million with effect from 6 April 2010. If the previous £1 million limit has been used, or partly used, between 6 April 2008 and 5 April 2010, additional relief up to the new limit of £2 million will still be available, however the increased limit will only be available for gains realised after 6 April 2010. No other changes are made to the rules for the relief.

Comment

Some commentators were anticipating an increase in the rate of CGT itself, but this was the only announced change to CGT. The increase in the lifetime limit to £2 million is a welcome increase for entrepreneurs.

However, the initial lifetime limit of £1 million seemed rather low in comparison to the business asset taper relief regime that it superseded, which allowed for up to 75% relief on an unlimited amount of gains. A lifetime limit of £1 million provided a maximum tax relief of £80,000 (on current CGT rates of 18%), doubling this still seems ungenerous compared to the business asset taper relief regime.

Also if the rate of CGT rises, as seems likely given the disparity between the top rate of income tax of 50% (from April 2010) and current rate of CGT of 18%, then the increased lifetime limit may seem yet more ungenerous.

Furnished holiday lets (FHLs)

There was no specific reference to FHLs in the Budget but draft legislation to abolish the FHL rules was published in the autumn. On 19 March 2010 Stephen Timms signed off an Impact Assessment which supposedly showed that the changes would have little adverse impact on tourism. The legislation is therefore likely to be included in the Finance Bill.

The very significant lobbying by the Tourist Industry and the professions has been to no avail but the Conservative Party has said that it will reverse the changes if elected. It no doubt has an eye to a number of marginal constituencies in the South West.

In summary, the main changes are:

  • losses will only be offsettable against profits from property businesses rather than being offsettable against other income or gains;
  • FHL income will not count as relevant earnings for the purpose of calculating the size of tax deductible pension premiums;
  • capital allowances will not be available on expenditure on plant and machinery or fixtures and fittings in the property, but can continue to be claimed on capital allowance pools that exist at the date of change and will continue to be available on items not used within the property eg. mower, computer, etc;
  • the normal wear and tear allowance for furnished residential property of 10% of rents (less certain deductions) will be available;
  • no rollover of chargeable gains will be available after the date of change where either the asset disposed of or acquired is a FHL, although gains rolled into FHL acquisitions prior to the change will not come into charge until the property is disposed of;
  • no holdover of chargeable gains will be available on gifts which are FHLs, but partial holdover will be available depending upon the relative length of the qualifying and non-qualifying period of ownership;
  • entrepreneurs’ relief (which can reduce the rate of capital gains tax from 18% to 10% will not apply to the disposal of a FHL business, but as the business will be deemed to be disposed of at 5 April 2010 so that the sale of the underlying properties within three years may still qualify;
  • no capital loss can be claimed on irrecoverable loans to FHL businesses where the loan was made after the date of change;
  • the substantial shareholding exemption will not apply to companies which have FHL businesses;
  • FHLs will continue to be subject to business rates;
  • FHL income will still be subject to VAT if the registration limit is reached;
  • no changes are proposed to the inheritance tax treatment of FHLs.

Comment

A Parliamentary debate took place on Property at which FHLs were one of the topics discussed. The Government Spokesperson provided a number of examples which showed that in some cases the taxpayer would be better off with the changes. This is possible if examples are carefully chosen but in general the taxpayer will be considerably worse off, in particular from the withdrawal of capital allowances and the capital gains tax benefits.

Inheritance tax nil rate band

The 2009 PBR announced legislation to freeze the IHT nil rate band for 2010/11 at £325,000.  This freeze will now be extended for a further four years and will therefore have effect for chargeable IHT events made up to 6 April 2015. 

The nil rate band was originally due to rise to £350,000 for transfers made on or after 6 April 2010.

Comment

The nil rate band has historically risen in line with inflation.  Taking into account average property values and other assets and investments held at death, freezing this allowance is likely to bring many more estates into the IHT net during the next few years.  This will affect couples whose joint assets are worth over £650,000, and with the IHT rate currently at 40% this may result in a significant further financial burden, especially for those whose wealth is wrapped up in property with little liquid cash.