Pre-Budget Report 2009 commentaries - Personal tax & trusts

"The commentaries below are written in general terms. Details can also be found in our downloadable Pre-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

Several significant changes to take effect from 2010/11 were announced in April’s Budget, including:

taxpayers with ‘adjusted net income’ exceeding £100,000 per annum will suffer a reduction to their personal allowance of £1 for every £2 in excess of £100,000. The maximum reduction is the full amount of the personal allowance;
a new higher rate of tax of 50% will apply to taxpayers with income over £150,000 per annum (42.5% for dividend income);
the rate applicable to trusts will increase to 50% (42.5% for dividend income).

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

In the PBR speech the Chancellor announced a proposed freeze in April 2012, for one year, in the point at which people start paying income tax at 40%. This will affect those with incomes over £43,000.

For National Insurance Contributions (NIC), with effect from 6 April 2010, the Lower Earnings Limit (LEL) which is linked to the basic state pension will increase by £2 to £97 per week. All other rates and thresholds for 2010/11 will remain unchanged with the exception of Class 2 for Volunteer Development Workers, which will increase by 10p to £4.85 per week.

The 2008 PBR announced that with effect from 2011/12 the main rate of Class 1 employees’ contributions and Class 4 NICs would be increased by 0.5% to 11.5% and 8.5% respectively, the Class 1 employer rate would be increased by 0.5% to 13.3% and the increased rates would also apply to Class 1A and Class 1B contributions. The additional rate of Class 1 and 4 NICs would also be increased by 0.5% to 1.5%.

It is now proposed that, from 20/11/12, all rates will be increased by 1% not 0.5% giving the following totals:

Main rates:

Class 1 employees 12%

Class 4 9%

Class 1 employers, Class 1A and Class 1B 13.8%

Additional rates:

Class 1 employees 2%

Class 4 NIC 2%

In order to compensate the lowest earners, the primary threshold and the lower profits limit will be increased by £570 for 2011/12 so that the increase only affects those earning over £20,000.

The proposed changes to personal tax rates, allowances and limits and NIC rates and thresholds are set out in Appendix 1.

Comment

The further increase in National Insurance contributions from April 2011 will affect all employers, employees and the self-employed alike. The increase in the primary threshold and lower profit limits will provide a small measure of relief for the lowest earners, and the real impact of the measure will be felt by the higher earners, particularly when coupled with the 50% tax rate for income in excess of £150,000.

Furnished holiday lettings

The Government has published draft legislation and guidance on the withdrawal of the special rules which apply to the taxation of furnished holiday lettings (FHLs) anywhere in the EEA not just in the UK.

The existing rules will cease to apply from the commencement date which will generally be 6 April 2010 for individuals and 1 April 2010 for companies. Specifically, this will mean that:

losses will only be off-settable against profits from property businesses rather than being off-settable 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 commencement date and will continue to be available on items not used within the property eg mower, computer;
the normal wear and tear allowance for furnished residential property of 10% of rents will be available;
no roll-over of chargeable gains will be available after the commencement date where either the asset disposed of or acquired is a FHL although gains rolled into FHL acquisitions pre-commencement will not come into charge until the property is disposed of;
no hold-over of chargeable gains will be available on gifts which are FHLs;
entrepreneurs’ relief, (which reduces the rate of capital gains tax from 18% to 10% on £1,000,000 of lifetime gains) will not apply to the disposal of a FHL business;
no capital loss can be claimed on irrecoverable loans to FHL businesses, where the loan was made after the commencement date;
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; and
no changes are proposed to the inheritance tax treatment of FHLs.

Comment

The draft legislation and guidance has been published despite vocal opposition from the accountancy profession, the tourism industry and trade organisations. The guidance confirms worst fears and the examples show that almost any FHL business will be caught, however large and however many extra services are provided. The argument that the holiday let business is labour intensive and more akin to the hotel business has fallen on deaf ears as has the argument that the tourism industry will be irretrievably damaged since FHL owners will take the easy option and sell up or let on a longer term basis. The loss of capital allowances is particularly unfortunate since the high standards demanded by the modern tourist require a high level of investment. The significant reduction in tax relief could well tip the balance.

The comment that the inheritance tax rules have not changed is small comfort since last year HMRC changed its view as to whether FHLs would qualify for business property relief and now considers that they are property investment businesses and therefore unlikely to qualify.

The guidance fails to consider apart-hotels nor does it cover what happens when a FHL commences in 2009/10 so that the 12 month qualifying period runs into 2010/11.

At this stage, we do not know whether the draft legislation will become law; it will be included in the 2010 Finance Bill but that will necessarily be abbreviated so that it can be enacted before Parliament is dissolved prior to the 2010 election.

Capital gains tax: private residence relief and adult placement carers

Property, including the family home, is a chargeable asset for capital gains tax (CGT) purposes. There is, however, a specific CGT relief to exempt from tax gains on the only or main residence of an individual. The rules can be complex and there are potential restrictions on the amount of relief available.

Prior to the changes announced in the 2009 PBR main residence relief could be restricted purely as a result of an individual providing accommodation in their only or main residence for adults in need of care under an adult placement scheme. The changes announced provide that for disposals on or after 9 December 2009 the individual’s entitlement to the CGT exemption on their only or main residence will not be restricted as a result of part of the dwelling house being used by a person pursuant to an adult placement scheme.

The problems stemmed from the fact that the contract entered into with the local authority might provide that one or more rooms in the dwelling-house have to be set aside exclusively for the use of the adult in care. Having to set aside part of the dwelling-house such that it could not be occupied by the individual is an issue for main residence relief purposes because:

the CGT exemption only applies to parts of the dwelling house occupied as the individual’s only or main residence; and
the legislation specifies that the exemption is not available where part of a property is used exclusively for a trade, business profession or vocation.

In both cases the CGT exemption would only be available with respect to the appropriate part of the gain relating to the property occupied as the individual’s only or main residence.

The changes provide that for the purposes of the main residence relief qualifying conditions the occupation by the person pursuant to an adult placement scheme is:

disregarded when considering the individual’s occupation of the dwelling-house; and
does not amount to the use of that part of the dwelling house exclusively for the purposes of a trade, business profession or vocation.

Comment

The changes to the legislation are welcome and will be good news for adult placement carers. We would, however, say that it is likely that many such individuals would not have realised that the contracts they were entering into with the local authorities could result in a restriction in their main residence relief entitlement. We would like to see the changes being given retrospective effect rather than, as in the draft legislation, only having effect in relation to disposals occurring on or after 9 December 2009. Backdating these favourable changes would seem equitable as it appears clear that there was no intention that adult placement carers should suffer a restriction in their entitlement to main residence relief.

Inheritance tax: nil rate band

Finance Bill 2010 will maintain the limit of the inheritance tax (IHT) nil rate band (the amount that can be left through an individual’s estate free of IHT) for 2010/11 at the 2009/10 rate of £325,000.

Finance Act 2007 had originally provided for a rise to £350,000 for the 2010/11 tax year.

Comment

The promise to increase the threshold was originally made in 2007 and with the benefit of hindsight it seems this may have been premature. However since then the Government has introduced legislation that will enable the unused exemption of one spouse/civil partner to be transferred to the other and that will have removed a large number of estates from the tax net. The Chancellor clearly thought that the proposed increase could be deferred for the time being particularly bearing in mind that the values of many assets will have been depressed by the economic crisis.

Film tax relief

Legislation will be introduced in Finance Bill 2010 affecting film production companies with production spends spread over two or more accounting periods and some overseas expenditure.

Currently, the legislation can operate to restrict the available tax credit where there is an increased spend in the second or later periods.

The new legislation, with effect for accounting periods ending on or after 9 December 2009, will revise this unintended anomaly.

Comment

This minor amendment simply corrects a ‘quirk’ in the existing legislation.

Income tax treatment of shared lives carers

Legislation will be introduced in Finance Act 2010 to establish a new income tax relief for qualifying Shared Lives Carers, similar to the current Foster Care relief, with effect from 6 April 2010.

The relief will consist of a tax free allowance, and carers whose Shared Lives earnings are less than the tax free allowance will not be taxed on their income from providing Shared Lives care. Those carers whose Shared Lives earnings are more than the tax free allowances have the option to choose a simplified method for calculating their profits based on:

their total receipts from providing care less the tax free allowance; or
their actual profits computed using the normal tax rules for businesses.

The relief will replace the existing simplified arrangements which can be continued to be used in the meantime.

The tax free allowance will be available per household, and consist of:

£10,000 fixed amount per year;
£200 per week (or part week), per placement aged under 11; and
£250 per week (or part week), per placement aged 11 or over.

Where there is more than one carer in the household, the household may still only provide care to a maximum of three Shared Lives placements, and the allowance will be shared equally between the carers. If the carer is entitled to both Foster Care relief and Shared Lives carers, only one £10,000 fixed amount per year may be claimed.

Comment

This new relief, whilst welcome, is unlikely to affect many taxpayers.

Seafarers’ Earnings Deduction

Seafarers’ Earnings Deduction, which can provide 100% relief from tax for the earnings of a UK resident seafarer carrying out duties wholly or partly outside the UK provided the individual is ordinarily resident in the UK, is to be extended from 6 April 2011 so that it is also available to seafarers who are residents of an EU or EEA state.

Comment

This measure is being introduced to ensure that the provisions are compatible with the EU Treaty as the current regime is likely to discriminate against seafarers who are foreign nationals who are unlikely to be ordinarily resident here.

Inheritance tax avoidance

The Government has announced that legislation will be introduced to counter, with immediate effect, two tax schemes which were designed to avoid the charge to inheritance tax (IHT) on transfers into a relevant property trust. Draft legislation and explanatory notes have been published.

The first scheme avoided the IHT charge on property transferred into trust through the individual purchasing the interest in the trust rather than transferring assets into the trust. Broadly, the draft legislation provides that where an interest has been purchased at full value that interest will be treated as part of the purchaser’s estate. This means that on their death the value of the trust interest will be aggregated with their death estate and IHT payable. The legislation also provided that there will be a chargeable transfer if the interest comes to an end during the individual’s lifetime. The amendments have effect in relation to an interest in possession to which a person becomes entitled on or after 9 December 2009.

The second scheme reduced the IHT charge by arranging for the transactions to fall within the rules relating to reversionary interests in trusts. Broadly, the scheme made use of the fact that certain reversionary interests are part of a person’s estate in order to reduce the value of the transfer into the trust and, therefore, the amount on which the initial IHT charge could bite. The draft legislation refers to the following individuals as “relevant reversioners”:

a person acquired the beneficial entitlement to the reversionary interest for a consideration in money or money’s worth; or
the settlor or the spouse/civil partner of the settlor is beneficially entitled to the reversionary interest.

There is a deemed chargeable transfer of value where the entitlement to the reversionary interest comes to an end by virtue of a relevant reversioner becoming entitled to an actual interest in possession in the relevant property.

In addition there will be a chargeable transfer should there be a transfer of a reversionary interest in relevant property to which a relevant reversioner is beneficially entitled.

The amendments have effect in relation to reversionary interests to which a relevant reversioner becomes beneficially entitled on or after 9 December 2009.

Comment

The specific measures announced are targeted at blocking specific IHT avoidance planning that HMRC has become aware of.

There was, however, a short paragraph in the press notices stating that the Government “is also examining wider solutions to the problem of trusts being used to avoid inheritance tax charges.” As HMRC’s own commissioned research (HMRC Research Report 25) has shown for the majority of individuals who establish trusts tax is not the driving factor. It is more about having the ability to control assets for example:

passing them on to children or grandchildren;
providing for a beneficiary in a particular way;
withholding assets until children reach a certain age; and
ensuring money stays within the ‘bloodline’.

At the time of the trust modernisation consultation in 2005 and early 2006 it seemed to be accepted that there should be a level playing field such that from a tax perspective it was neither advantageous nor disadvantageous to hold property within a trust as opposed to personally. However, legislative changes since then have in a number of ways tilted the balance against trusts. Given the importance of trusts for non tax purposes there should be a return to the idea of there being a level playing field. This initiative by the Government to counter what it perceives as unacceptable IHT tax avoidance by a minority should not result in the majority suffering. It is, therefore, to be hoped that there will be substantive consultation before any measures are decided upon.