Tax Planning

A recent review of Capital Gains Tax suggests changes that could rake in £14 billion in additional revenue for the Treasury. We look at the implications for you.

Chancellor Rishi Sunak has earned lots of praise for his wide-ranging and unprecedented measures to help the UK combat the damaging effects of the coronavirus lockdowns. But already he is looking at ways to pay for them. One recent review of Capital Gains Tax (CGT) has recommended cutting the annual CGT allowance, and changing the rates at which CGT is taxed – moves which could earn billions of pounds for the Treasury, but could result in headaches and higher taxes for many of us.

What is CGT?

CGT is the tax people are expected to pay on the profit they make when they sell or dispose of an asset. The tax is calculated on the gain that is made rather than the total amount received. For CGT purposes, ‘chargeable’ assets will include property that is not your main home, shares that are not held in an ISA, and most personal possessions valued at more than £6,000 (with the exception of cars).

What is the annual CGT allowance?

Everyone is entitled to an annual CGT allowance of £12,300. This means that you will only have to pay CGT if the gains you have made on your assets are above this amount. So, if you sold shares at a profit of £15,000 this year, you would only pay CGT on £2,700 (the amount over the annual allowance).

What is the CGT rate?

According to the Treasury, some 265,000 individuals in the UK paid a combined total of £8.3 billion in CGT in the 2017/2018 tax year (the latest available figures). By comparison, in the same tax year, more than 31.2 million taxpayers paid a combined £180 billion in income tax. Higher rate taxpayers are expected to pay CGT at 28% on gains made from residential property, and at 20% on gains from other chargeable assets. Basic rate taxpayers usually pay CGT at 18% on residential property gains, and at 10% on other assets. But that could all be set to change.

The CGT review

In early November, the Office of Tax Simplification (OTS) published its eagerly anticipated report into CGT, commissioned by Rishi Sunak back in July. The report suggests that current CGT rules are “counter-intuitive” and have created “odd incentives” in several areas. It noted that the annual exemption could also “distort investment decisions”, pointing to 2017-18 tax year data showing that 50,000 people reported net gains just below the annual threshold.

Among the report’s findings, it suggested that the government should consider reducing the £12,300 annual CGT allowance, reducing it to between £2,000 and £4,000. It also suggested aligning CGT rates more closely with Income Tax, in a move that could raise up to £14 billion for the Exchequer. For higher rate taxpayers, that could mean the CGT tax rate increasing from 20% to something closer to 45%.

Who should be worried about changing the CGT rules?

The OTS proposals would most likely affect individuals with second homes, as well as those with large share portfolios sitting outside of tax-efficient ISAs. The proposals are also likely to cause bigger problems for owners of small companies who hold large sums of cash within their business with the aim of using the cash as a pension when they retire. The OTS also suggested that business owners should pay Income Tax rates on share-based remuneration and earnings retained in their companies. Other recommendations included changing Entrepreneurs’ Relief — recently renamed ‘Business Asset Disposal Relief’ — with an allowance focused on business owners approaching retirement.

How concerned should you be?

Firstly, there is no guarantee that these OTS proposals will end up as legislation. Yes, Rishi Sunak is keen to raise money to fill the fiscal hole left by the Covid-19 crisis. But any far-reaching CGT reforms are likely to prove unpopular with voters, and in particular those entrepreneurs and small business owners that do so much for the UK economy – and have faced such a difficult 2020. For now, the Treasury is keeping its cards close to its chest, saying only that “The government’s priority right now is supporting jobs and the economy”.

Secondly, it is very difficult to make future tax revenue calculations based on a ‘discretionary’ tax such as CGT. If the annual allowance is set too low, or CGT rates are too high, it may encourage individuals to hold onto their assets instead of selling them. If fewer people end up paying CGT, then the Treasury may find their hoped-for additional tax revenue predictions were over-optimistic, and that the CGT reforms have discouraged taxpayers from selling their assets and “distorted investment decisions” even further.

What actions should I be thinking about?

It is hard to predict what the Chancellor will ultimately decide, but with a coronavirus vaccine due for widespread distribution in 2021, it is fair to assume that the government’s attention will be turning from supporting jobs and the economy towards attempting to pay down some of the debt that has been run up this year. So, we feel now may well be a sensible time to undertake a review of your existing investment portfolios, to consider your CGT position and ensure your investments are as tax-efficient as possible.

In particular, this is a good time to focus on investments that have been held for some time, which may carry substantial gains. Whilst CGT is only one consideration when deciding on appropriate changes to an investment portfolio, the result of the OTS review may well mean that now is an ideal opportunity to consider existing investment portfolios in light of potential changes to come.

If you are interested in discussing your investments or tax planning with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice.

We take a closer look at Business Property Relief, a little-known but incredibly useful planning tool when it comes to reducing inheritance tax, as well as explaining how it can be used alongside trusts for small business owners.

Did you know HMRC collected a staggering £5.2 billion in inheritance tax last year? In fact, every year, thousands of bereaved families find themselves facing an unexpected tax bill on their inheritance.

A quick reminder of inheritance tax facts

Inheritance tax is paid on the value of your estate when you die. Your estate could include your home, any other properties, savings and investments, and also any life insurance policies held in your name. Your estate will be completely free from inheritance tax if you leave it all to your spouse or civil partner. However, there may be an inheritance tax bill if you choose to leave some of your estate to family or friends.

If your estate is valued at less than £325,000 (known as the nil-rate band), there’s no inheritance tax to pay. However, your beneficiaries will be expected to pay inheritance tax at a rate of 40% on everything over that threshold. It’s important to remember that the inheritance tax due on your estate is paid by your beneficiaries (the people you choose to leave your estate to). They must pay the inheritance tax bill within six months of death being recorded.

Homeowners can also claim the ‘residence nil-rate band’, an additional allowance introduced in 2015. Provided the family home is left to direct descendants (children or grandchildren) a further £175,000 of inheritance tax relief can be claimed on the value of the estate. For married couples, any unused available reliefs can be transferred to the surviving spouse, meaning that it’s possible for a married couple to pass on an estate valued at £1 million, provided the family home is left to their kids or grandkids.

Could Inheritance Tax changes be on the cards?

There’s increased speculation that inheritance tax reliefs could be changing. The government’s response to the coronavirus – including furloughs for workers, business loans and grants and even ‘eat out to help out’ meal deals have cost the Treasury billions and blown a hole in the public finances.

As a result, there are concerns that Chancellor Rishi Sunak could be looking to claw back some of his ‘giveaways’ by closing some tax reliefs – with inheritance tax firmly in his sights. So, now might be a good time to think about ways to invest your money while making it exempt from inheritance tax – starting with Business Property Relief.

Understanding Business Property Relief

First introduced back in 1976, Business Property Relief (BPR) was brought in to make it easier for family business owners to pass on the ownership of the business to their descendants without leaving them with a large inheritance tax bill. But since then, BPR has expanded, and is viewed as a tax relief that encourages investment into trading UK businesses. Shares in a BPR-qualifying company can be passed on to beneficiaries free of inheritance tax. However, BPR only applies to trading businesses that meet HMRC’s qualifying criteria.

It’s worth knowing that you don’t have to be a business owner to be able to invest in BPR-qualifying companies, and there are a number of good investment management companies that give investors the opportunity to invest in portfolios of companies that qualify for BPR. As long as the investment has been held for at least two years, and is included as part of the estate, it can be passed on to the beneficiaries free of inheritance tax.

The key benefits of using BPR for estate planning is that it is flexible. Other ways of planning for inheritance tax – such as making lifetime gifts or placing money in a trust – means that you lose control over the assets. But if you’re considering investing in a portfolio of BPR-qualifying companies, it’s important to understand the risks involved. Your capital is at risk, and you may get back less than you put in. Shares in unlisted companies can also be more volatile and harder to sell.

Trusts explained

Setting up a trust can also help you to pass down more of your assets to your beneficiaries. Trusts are particularly useful where large sums of money are involved, where family relationships are a little complicated or where you don’t want children or grandchildren to receive the money until they reach a certain age.

There are many different types of trusts to choose from, but discretionary trusts are the most popular. Discretionary trusts are usually set up to provide money for a group of beneficiaries – for example, children or grandchildren, but a trustee is appointed to be responsible for managing the assets.

Any assets placed into a discretionary trust will be deemed outside of the estate for inheritance tax purposes, provided the person who set up the trust lives for a further seven years. However, inheritance tax may be payable (1) when the trust is created, (2) every ten years (known as ‘periodic’ charges) or (3) when trust assets are paid out to beneficiaries.

Combining BPR with a trust

If you’re a small business owner and you are planning on leaving your business to your spouse, you might want to consider combining Business Property Relief with a discretionary trust. This is a good way to ensure your estate will remain free from inheritance tax for your children and grandchildren, as well as for your spouse.

It is possible to arrange for shares in the business that qualify for BPR to be placed into a discretionary trust. A trust is a legal entity in its own right, which means that the trust ‘owns’ the business, rather than the surviving spouse. If the spouse chooses to sell the business, it won’t trigger a tax bill as the trust will own the proceeds of the sale, rather than the spouse.

Ready to have a conversation?

It’s not always easy to talk about what happens when you pass away. But you should have those conversations while you can, instead of leaving things till it’s too late. Estate planning can be complicated, and tax rules and tax reliefs are also subject to change. It’s important to sit down with one of our qualified financial planners who can explain the different options available to you, and work out a plan that will give you and your family peace of mind.

If you are interested in discussing your financial plan or investment strategy with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice.

Inheritance Tax is still a concern for many families, despite the new Main Residence Nil Rate Band adding up to £350,000 to the standard IHT threshold.

Making gifts or using Trusts usually take seven years to become completely free from Inheritance Tax (IHT). But an investment in a Business Property Relief (BPR) qualifying company can be passed down to beneficiaries free of IHT on the death of the shareholder, provided it has been held for at least two years at that time.

At FAS, we are strong advocates of using Trusts as well as BPR investments to mitigate a potential IHT liability and always give full consideration to both options when discussing Inheritance Tax Planning with our clients.

Don’t Give Away More Than You Can Afford

Trusts are a specialist planning tool that may not be suitable for everyone. We have prepared this guide to address some common questions, concerns and pitfalls that can arise when considering Trusts.

Remember, a Trust is a completely separate legal entity. Once you have gifted an asset into a Trust, it is no longer yours. In most cases, you cannot receive any benefit from the asset.

If you are thinking about gifting money into Trust, think about how much you would be prepared to give away without the Trust structure.

The main benefit of a Trust is that it gives you some control over how and when the gift is distributed. So, if you’re sure that you want to set aside £100,000 for your grandchildren, but don’t want them to receive it as a single lump sum when they turn 18, a Trust could be the answer.

But if there is a chance you will need the £100,000 to pay care home fees, a straightforward Trust won’t help with this.

There are certain Trusts which allow you to retain some access to the capital or to draw an income. These are known as Gift and Loan Trusts and Discounted Gift Trusts. However, these carry some restrictions, and may not be as effective for IHT purposes as a full Trust.

Trustee investments should be considered as part of your wider financial plan. A simple cashflow projection can help you decide how much you can afford (and are prepared) to give away.

It’s Not Just for Gifts

A Trust can be set up even if you don’t have any money to gift.

The simplest way to use Trusts in IHT planning is to ensure that your life insurance is payable into a Trust. This offers the following advantages:

• No IHT when the benefits are paid out
• No IHT on second death, as with the benefits in trust, the surviving spouse’s Estate has not increased in value
• Benefits are paid out more quickly, bypassing probate procedures
• Life policies can be set up for family protection, or specifically to cover an IHT liability.
• Pension death benefits and employer death in service plans can also be paid into trust.

Absolute or Discretionary?

An Absolute Trust (or Bare Trust) works in the same way as a gift. The asset is earmarked absolutely for one or more beneficiaries under the terms of the Trust. There is no scope for the Trustees to apply their discretion.

This means that once the Trust is in place, you no longer have any control. However, the gift will drop out of your Estate after 7 years. The investment is taxed as if it belongs to the beneficiary.

A Discretionary Trust, as the name implies, allows more control over the investment. The Trustees can decide how and when to distribute the money. The beneficiaries can also be changed or selected from a particular group.

However, a Discretionary Trust offers certain disadvantages:

• If the gift is over £325,000, IHT of 20% applies immediately. A further 20% is then due if you die within 7 years.
• Further IHT charges apply every 10 years. This is broadly 6% of the value over £325,000, with adjustments made for any withdrawals taken.
• Exit charges may also apply when money is distributed from the Trust.

These points can mostly be mitigated with proper planning. But considering that larger Trusts in particular may incur additional fees in respect of legal and tax advice, a Trust can prove very expensive.

IHT is Not the Only Tax

Discretionary Trusts are subject to higher rates of tax than individuals.

Income is taxed at 20% on the first £1,000 only. Thereafter, income is taxed at 45% – an individual would need to earn £150,000 before paying this rate of tax.

If the Trust realises a capital gain, the first £6,000 is exempt from tax. This is half of the allowance available to an individual investor. Any gains over this amount are taxed at 20%, the same rate payable by a higher rate taxpayer.

Detailed planning is required to make sure that the strategy works, taking all taxes and costs into account.

The Investment Strategy Matters

The portfolio selected for a Trust investment may be different from an individual’s own funds.

It could be appropriate to use a higher risk portfolio on a Trust, to maximise the growth potential so that the money can last for several generations. Alternatively, the money might be required in the short term to provide an income, in which case a lower risk strategy would be suitable.

Taxation is an important factor. Using an Investment Bond as a wrapper for the investments can be effective, as there are no tax implications unless money is actually withdrawn. This means that funds can be switched within the bond without worrying about Capital Gains Tax. Similarly, interest and dividends produced within the funds are not only free of tax, but do not need to be declared on a tax return.

Bond withdrawals can result in unintended tax consequences, so it is always best to speak to one of our Financial Planners before proceeding.

A Trust can be an effective way of mitigating an Inheritance Tax liability, but you should always take financial (and sometimes legal) advice to ensure it is the right course of action.

Please do not hesitate to contact a member of the team if you would like to find out more about Inheritance Tax Planning.

Keeping wealth within the family is desirable but not always easy to plan. There is a myriad of Inheritance Tax (IHT) rules to mitigate and these are often complicated and subject to change. As Financial Planners, we are here to help clients navigate this complex landscape and leave a meaningful legacy for their loved ones, without paying unnecessary tax.

In this short guide, our financial planning team will be sharing some ideas on how clients with complex estates can leave their wealth to younger generations.

The Nil-Rate Band

The Inheritance Tax (IHT) threshold, also known as the nil-rate band (NRB) refers to the threshold after which you start paying IHT (usually 40%) on the value of your estate. In the 2019-20 tax year, this is set at £325,000 and includes the value of your home. So, if your estate is worth £500,000 when you die, then £175,000 is potentially liable to be taxed at 40%.

However, there are a number of IHT rules which can affect your threshold, and how much you pay. First of all, married couples and civil partnerships can inherit any unused IHT allowance from their deceased spouse. If they have not previously used any of this allowance, then the surviving spouse can effectively “double” their IHT threshold to £650,000.

Secondly, there is also an important caveat regarding your home. If you pass on your family home to direct descendants (e.g. children or grandchildren) when you die, then you can raise your IHT-free threshold using an additional nil-rate band (ANRB). In 2019-20, this allows each individual to pass on an extra £150,000, tax-free.

Again, married couples and civil partners can combine their ANRBs to potentially shield £300,000 of property value from the tax man. It’s also worth noting that this threshold will be raised to £175,000 in April 2020, which could allow couples to pass a £1m estate to their direct descendants completely free of IHT. For many people living in the South East this is welcome news in light of rising property prices, which might have tipped their estate over the IHT bar.

Pensions

It may sound strange to focus on pensions in an article about estate planning, but they can be a vital tax-saving tool. Under current rules, your pension is excluded from the value of your estate for IHT purposes, allowing you to potentially pass hundreds of thousands of pounds to your loved ones without these funds being potentially liable to IHT.

However, you do need to be careful with this and we recommend speaking to one of our experienced financial planners to ensure your pension is properly integrated into your estate plan. For instance, final salary pensions rarely (if ever) can be inherited by children, although there are often reduced benefits for a surviving spouse. Your state pension, moreover, cannot be passed down to your children or to your husband, wife or partner.

It is those with defined contribution pensions who can primarily make use of this part of the IHT system. Even then, however, there can be tax implications. If you die before the age of 75, for example, then under current rules your beneficiaries can receive any pension funds tax-free. If you die after this age, however, then it might affect their Income Tax bill (possibly pushing them into a higher tax bracket).

Other areas

There are a range of other IHT-mitigation tactics open to people with complex estates, depending on your personal circumstances:

• For those interested in small businesses or startup investing, the Enterprise Investment Scheme (EIS) may be worthwhile considering. Here, you can invest up to £1m per tax year into EIS-qualifying companies and receive up to 30% tax relief against your Income Tax bill. Provided you hold your EIS shares for at least two years, these can also be passed down to beneficiaries, IHT-free.
• Trusts can be a great way to reduce IHT whilst retaining a degree of control over your assets. Not only can this help to protect your child’s legacy if your surviving partner decides to later remarry, a Trust can help you control how the money is spent on you children and grandchildren. However, make sure you seek independent financial advice before committing to a Trust, as these come in different forms with a variety of rules.
• Life insurance is also an option to consider, as the payout from your policy can be used to cover a potential future IHT bill. Bear in mind that you need careful financial planning if you are considering this, as the insurance policy itself can be included in the valuation of your estate (e.g. if it is not properly written into a Trust). You also should speak to us to ensure whether an insurance policy makes financial sense for you. In some cases, it might be cheaper to simply pay the future IHT bill than pay for the policy.

Do give us a call if you wish to discuss this area of advice in more detail!