Tax Answers

Redundancy Tax Free Threshold 2011

Redundancy Tax Free Threshold 2011

Your redundancy payment

Your employer may make a redundancy payment to you to compensate for ending your employment. This may be part of a redundancy package, which can include payments made for reasons other than your redundancy. The table below shows some examples of these payments and when tax and NICs
are payable.

Payment: Redundancy payment

Do I pay tax? Only on the amount above £30,000

Do I pay National Insurance? No

Payment: Unpaid wages

Do I pay tax? Yes

Do I pay National Insurance? Yes

Payment: Bonus payment

Do I pay tax? Yes

Do I pay National Insurance? Yes

Payment: Occupational pension

Do I pay tax? Yes

Do I pay National Insurance? No

Your employers will deduct tax and NICs using the guidance HMRC provide. They should also give you a form P45 Details of employee leaving work when you leave.

Items other than money

Anything else you receive which is not money is converted into a cash value for tax and NICs purposes. If these items were given to compensate for your redundancy, the cash value counts toward the £30,000 tax–free limit.
Contact your employer or HMRC if you want more information about tax and NICs on your redundancy payment or the payments included in your redundancy package.

If you think you have paid too much tax, you should contact your tax office to claim a refund. They will tell you what information to provide and if there are any forms you need to complete.

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Tax Efficient Directors’ Remuneration

Tax Efficient Directors’ Remuneration

Marginal tax rates can now be very high. Ask most people what is the marginal tax rate for a high earner and they will probably say 50%. But taking account of the reduction of the personal allowance it can now be 60% for a narrow income range. Add employee’s NI and that comes to 62%, with another 13.8% employer’s NI on top. 75.8% tax is rather more than 50%. It is therefore no wonder that many business owners are looking again at more tax-efficient methods of extracting cash from their businesses.

One way, of course, is to close the business down and take the cash. For the owners of many small and medium sized businesses this could mean a marginal tax rate of only 10% thanks to the now significantly increased entrepreneurs relief. If your client is considering this option, make sure he or she is aware of all the rules relating to this relief and does not do anything to reduce or even eliminate it entirely. I have heard of some business people repeating this exercise several times in succession with “phoenix” operations, although I would suggest this is likely to attract the rather careful attention of HMRC.

Shifting income from one spouse to the other can be another popular tax planning move. Provided one is careful this can be very effective, particularly since HMRC lost the Jones v Garnett case on appeal to the House of Lords. The principles established in Young v Pearce still apply, however, so make sure your client does not, for example, try to set up a structure where he owns all the ordinary shares and his wife owns a class of shares with only a right to dividends.

Dividend waiver can still work, whether the purpose is to transfer income between spouses or simply to reward one shareholder to the exclusion of others. As with most tax-planning measures, there are pitfalls of which your clients must be aware. Buck v HMRC clearly established that a dividend waiver could constitute an element of bounty, in which case it would not obtain the desired tax result. This would be the case where it could be shown that as a result of the waiver one or more shareholders was able to receive a higher dividend, as was the situation in Buck. A client going down this route must make sure the dividend declaration and waiver follow all the proper procedures, including ensuring the full dividend without a waiver would have been legal and payable.

Dividend versus bonus is still an important consideration. Despite all the changes in both personal and corporate taxation a dividend is still usually more tax efficient than a bonus payment. As long as the individual is a director and has no written or implied employment contract, it should be possible to pay most or all of the required earnings as dividends rather than salary or bonus without falling foul of the Minimum Wage regulations. Beware, though, of the very recent decision in HMRC v PA Holdings Ltd. This case has established that HMRC can treat a payment as both earnings and a distribution in certain circumstances, and then levy National Insurance even though in tax law it is recognised as a dividend. This particular case was rather special, with very clear tax avoidance mechanisms which the Revenue were anxious to counter, but it has established a rather dangerous precedent. Most commentators believe it should not impact on normal use of a dividend v bonus strategy, and if for some reason your client’s tax inspector disagrees you should quote to him NIM02115 in his own manual, which states:

“Dividends are derived from a shareholding and not employment. They cannot therefore be classed as earnings and do not attract NICs.”

Finally, a client may wish to consider using the loan write-off route. A loan is made to a director, and is then written off just before nine months after the company year end (this timing avoids the Section 455 charge which would otherwise apply). At the point the loan is written off it is treated for tax purposes as if it were a dividend. But it has the advantage that as it is not a dividend the company does not have to worry about whether there are distributable profits, nor address the complications of dividend waivers if there are other shareholders who will not receive a similar benefit. It also has the cash flow advantage that it is not treated as income in the client’s hands until the date it is written off, rather than the date it was received. This could buy up to two additional years before the tax on this payment falls due. And it may also be possible for the company to claim corporation tax relief as well, which would certainly not be the case with a dividend payment. Such corporation tax relief is by no means certain, as the company will need to show this expenditure was for the purpose of the trade, but a good accountant may well get the Revenue to accept that it was part of the director’s remuneration package, in which case the deduction will apply, making this an extremely tax-efficient method of payment.

Published: October 7, 2010
Author: Graham Dragon
Category: Tax
Permalink: Tax Efficient Directors’ Remuneration

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2011 Budget – Client Review Meetings Essential

2011 Budget – Client Review Meetings Essential

This year’s budget has brought a number of changes which make it essential for clients to meet with their adviser and review financial strategies.

As usual, this e-mail is not a comprehensive review of the budget, as you will find many such reviews elsewhere. Rather it is an extract of items you might find useful to discuss with some of your clients.

Corporate Clients and Business Owners

Corporate clients will no doubt be pleased with the reduction in the main corporation tax rate, which is going down from 28% to 26% in April 2011, and then by a further 1% each year until it reaches 23% in April 2014. Small companies will benefit from a 1% reduction to 20% this year, but there is no indication there will be any further reductions in line with the main rate reductions.

Any clients whose companies profit from patents will also be pleased to hear that those profits will only be taxed at 10% rather than 26% or 20%.

Owners of small and medium sized enterprises can also now benefit from a very generous research and development tax break. This has been increased from 175% to 200% from April 2011, and will increase again to 225% from April 2012. Many companies miss the opportunity for this tax break entirely, not realising just how wide the R&D definition can be. Maybe you should meet with your corporate clients’ accountants to see whether those clients can obtain additional benefits here.

All these reductions in corporation tax should mean there will be more money to invest. This investment may be in future company growth, but the company’s financial adviser should certainly be ready to suggest other investment possibilities.
A relaxation in the associated companies rules is very welcome. Where two connected individuals own separate companies these will now only be treated as associated if there is a significant commercial interdependence between the companies. This means, for example, that there is no longer a potential tax problem with a husband and wife each owning a company when those two companies are not connected in any way.

When your clients sell their business they should benefit from Entrepreneurs Relief on the first £10,000,000 gain. This will be taxed at 10% rather than 18% or 28%. This relief is a lifetime limit, but as it has now doubled it is likely many business owner clients will get two or more bites at the cherry unless they build very substantial value into their businesses.

High Earners

High earners who divert their earnings through trusts and take interest free loans from those trusts should be warned the writing is on the wall for such schemes, which have been specifically highlighted in the budget.

Non-Domiciles

Non-Domiciles who have been resident for at least seven out of nine years have to pay a tax charge of £30,000 in any year in which they wish to take advantage of the remittance basis of taxation. This will now increase to £50,000 if they have been resident for twelve years or more. Now would be a good time to review your long term resident non-domicile clients to see whether it is still advantageous for them to retain the remittance basis.

Remember that this is an annual decision. Whereas one year they may wish to pay the charge, in another year it may be to their advantage simply to pay the tax on their worldwide income. Or, of course, shift that income into tax exempt vehicles!

You should note that in his haste to encourage business growth the Chancellor has introduced a possible loophole for you and your non-domiciled clients to explore. If remitted income is used to invest in a UK business it will not be treated as remitted for tax purposes.

Investors

Property investor clients can be caught by the rules on connected property purchases for stamp duty land tax purposes. These rules can trap the unwary into paying higher stamp duty rates even for low value properties. Such investors will benefit from proposed reforms to base the tax on the mean value of the properties rather than the gross aggregate value.

Be aware, however, that the Chancellor has thrown down the gauntlet on stamp duty land tax avoidance schemes. If your clients are using any of the numerous schemes out there they should take advice on whether or not they will still work.

EIS tax relief will increase from 20% to 30% from April 2011. Also, from April 2012 the investment limit will increase from £500,000 to £1,000,000 per annum. This makes it even more worthwhile exploring such investment opportunities with your clients.

A hidden danger lurks here however. The budget has hinted at changes which will probably make EIS and VCT investments riskier than many such investments have been up to now.

Other Matters for Individual Clients

The Approved Mileage Allowance Payment has increased from 40p to 45p per mile for first 10,000 miles. In the current economic climate many employers will probably choose not to increase the rate they pay employees for business mileage. If any of your clients are in this position make sure they know they can claim an additional tax benefit from HMRC.

It has been announced the state pension will be reformed such that it will be above the threshold for the means tested pension credit. This means clients who are not already close to retirement should be able to invest in private pensions without worrying that their private provision could erode state benefit entitlements.

Any clients who leave at least 10% of their estate to charity will find the inheritance tax charge on the remainder will be 36%, not 40%. If the client does not particularly wish to leave anything to charity this is not a strong enough reason to do so, as their non-charitable beneficiaries will only receive 57.6% of the total after tax rather than 60% (ignoring, of course, the first £325,000). But it is certainly worth bearing in mind if your client has any intention of leaving anything at all to charity.

If any of your clients are taking advantage of the tax free meals for cyclists, tax free luncheon vouchers, or tax free late night taxis, they should be aware all these reliefs will disappear in 2012.

Finally, in case you were worried that relevant life policies were being axed, this is not the case. One of the 43 tax reliefs being abolished is relief for life assurance under employer financed retirement benefit schemes. This is not the effective income tax relief your clients can get simply by writing their life insurance in a relevant life policy trust. Rather, it is a similar antiquated relief to the life assurance premium relief which will also be abolished some time after April 2012. You can therefore confidently continue recommending relevant life policies where appropriate. And perhaps also consider rebroking any policies which will soon lose their premium relief.

Published: March 25, 2011
Author: Graham Dragon
Category: Tax
Permalink: 2011 Budget – Client Review Meetings Essential

Excess Pension Contributions

Excess Pension Contributions

A number of writers have recently suggested it can be tax efficient for higher rate taxpayers to make pension contributions in excess of £50,000.

As a general case I do not really agree that this is so, but I will outline the argument and go through the maths here so you can make up your own mind. At the end of this article I will show you some exceptions where, however, such a strategy could work.

Tax relief on excess pension contributions

Imagine your client has a salary of £60,000 and his employer pays £50,000 a year into his pension. His marginal tax rate is 40%. As £50,000 a year is already going into a pension he will face an Annual Allowance Charge (AAC) on any additional money he personally puts in.

You recommend he set up a new pension now and invest £8,000 net in it. The scheme will claim £2,000 from HMRC, so he now has £10,000 invested. You also recommend he make an immediate claim to HMRC for the £10,000 pension investment, asking them to increase his tax code now. In the current tax year he will therefore obtain £2,000 personal tax relief (i.e. 40%, less the 20% already claimed within the pension). At this point, his £10,000 pension investment has cost him £6,000. This is exactly what he would have expected before the restrictions were placed on large pension investments.

As he has only just set up this new pension, the Pension Input Period ends not in this tax year but in the next tax year. He will be charged 40%, or £4,000, on his excess pension contribution, but not until he submits his tax return for next tax year. Ultimately, it will have cost him exactly £10,000 to have £10,000 invested in his pension, but in the meantime he will have had the cash flow benefit of an extra £2,000 from the Revenue – some of which he could have had for over two years, depending on the timing.

All of the £10,000 invested in his pension will grow in a tax favourable environment, and there will be no further penalties to pay. The fact that he has exceeded his annual allowance does not mean he must pay tax or other penalties on that growth.

Is this a REAL benefit?

As far as it goes, everything in this argument is absolutely correct. But is it really an advantage to your client? The problem here is the tax he will have to pay when he takes the money out at the other end.

If he is still a 40% taxpayer at that point he will have to pay 30% tax (allowing for the tax free Pension Commencement Lump Sum) on the entire amount. Not just on the growth, but also on the capital he originally invested – and on which he had already paid 40% tax anyway! Depending on what happens to the remaining pension when he dies, he and his beneficiaries may end up paying even more tax than this.

In my view, this is hardly a good deal!

But this version IS a real benefit

There are, however, circumstances where such a strategy could be appropriate.

Imagine your client earns not £60,000 but £110,000. His marginal tax rate is now 60%, not 40%. He is in that narrow band where the 50% reduction in the Personal Allowance adds another 20% to the rate. He is close to retirement, and you know that when he retires you will be able to ensure he stays within the 20% band.

As before, he invests £8,000 net into a new pension, which claims £2,000 from HMRC so he now has £10,000 invested. He makes his relief claim, but this time he reduces his tax in the current year by £4,000. This is the case because his marginal rate is 60% and the pension scheme has already claimed 20%.

When he submits his self assessment return in January 2014 he will pay a 40% AAC, which means he will be paying back the £4,000 HMRC gave him this year. But he will have £10,000 in his pension scheme which only cost him £8,000.

He retires a few years later and, as we predicted, is only a 20% taxpayer when he takes his pension benefits. As he can take 25% tax free, he will effectively only pay 15% tax on the investment – on which he originally obtained 20% relief.

In this example, your client has obtained a cashflow benefit, deferred tax on his income until he is paying a lower tax rate, and obtained the benefit of tax-advantaged growth on his investment in the meantime. This really is a tax-efficient strategy. Not quite as good as pension investments used to be for high earners, but still worth considering.

There are other “tweaks” you can add to make this even more of a benefit.

For example, you may be able to play with the Pension Input Periods (PIP) to your client’s advantage. If you do this in your client’s last year of employment, as long as the company pension has a PIP ending in the current tax year, and you set up the new pension with a PIP ending in the tax year after he has retired, there will never be an excess, so the AAC will never be applied.

Also, you can quite significantly increase the benefits by using salary sacrifice, saving both your client and his company the National Insurance contributions on this new pension investment.

You could well find even a 50% taxpayer, rather than the 60% taxpayer in my example, may benefit from adopting an excess pension contribution strategy by playing the game correctly.

Conclusion

Dealing with excess pension contributions is a real minefield, but there can be significant advantages for certain clients in certain circumstances to make those excess contributions.

Do not believe everything you read. Never simply assume it is always a bad idea or always a good idea.

Start with an open mind and then do the maths for each of your high net worth clients in full knowledge of their overall circumstances. You may be surprised at some of the conclusions you reach.

Published: May 3, 2011
Author: Graham Dragon
Category: Tax
Permalink: Excess Pension Contributions

£4,250 Tax Free Income Rent A Room Relief

£4,250 Tax Free Income

Rent-a-Room Relief

Most people completely ignore the tax benefit available under Rent-a-Room Relief for one very understandable reason: they do not want to share their home with a lodger.

The legislation, however, does not say the room or rooms have to be rented to a lodger, staying there all year. If, for example, you are going away for a long summer break there is nothing in the tax legislation to stop you renting out your home to someone while you are away and keeping all the income completely free of tax.

2012 Olympics

If you live in or near London and are planning to be away in August of next year it should not be at all difficult to find someone who wants easy access to the 2012 Olympics and would pay highly for it! Even venues far from London will be attracting Olympic visitors – for example the football stadia in Glasgow, Newcastle, Manchester and Birmingham, or the marina in Weymouth. If you are anywhere near any of these you could attract Olympic visitors.

Rules for Obtaining Relief

There are four basic rules you must follow in order to qualify for the relief:

1. The room or rooms must be within your “only or main residence”;
2. The letting must be for living accommodation, not for use as an office for example;
3. The relief is limited to £4,250 gross receipts in the tax year;
4. The relief only applies to individuals, not to companies or partnerships (although it does apply where individuals share the income other than as a business arrangement, for example husband and wife).

“Only or main residence” is not the same definition as for capital gains tax relief. Indeed, you do not even have to own the property and could obtain this relief for sub-letting rooms in a rented property if the landlord agreed. This means you cannot take advantage of the capital gains tax rules that allow you in certain circumstances to treat a property as being your main residence even though you do not currently live there. The rule is actually very simple in its interpretation: where would friends or correspondents normally expect to find you?

“Living accommodation” does not have to mean place of permanent residence. It would be permanent in the case of a lodger, but the law does not specify permanence as a requirement. A holiday-maker living there for only one or two weeks would be perfectly acceptable under the law. This would perhaps be an unusual application of the law, and may cause raised eyebrows in the local HMRC office, but only because most people have always assumed it only applied to lodgers and have not read the legislation carefully. If you are attracting Olympic visitors they will be there to live rather than to do anything else, albeit for a temporary period, and therefore meet the requirements.

The rule that the income from this letting should not exceed £4,250 during any one tax year is unlikely to be much of a limitation if you are simply looking at a few weeks while you are away on vacation. No doubt you would be quite satisfied with this to pay for two or three weeks occupation of your home!

If your tax inspector does try to claim you cannot use the relief for temporary lettings, ask to see where the legislation says this. It categorically does not say so. If the inspector says you cannot let the whole of your home, as then it could not be your “only or main residence”, point out that nowhere in law does it say that your home ceases to be your “only or main residence” when you go on holiday. Any grief from HMRC, and direct them to Income Tax (Trading & Other Income) Act 2005 Section 784 which dictates exactly how they must apply the relief.

Published: June 4, 2011
Author: Graham Dragon
Category: Tax
Permalink: £4,250 Tax Free Income

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Flexible Drawdown & Scheme Pensions

Flexible Drawdown & Scheme Pensions

One of the exciting changes in the new Pensions legislation was the introduction of Flexible Drawdown. Many clients object to the nanny state restricting the amount of their own money they can take out of their own pension pot. I therefore welcomed the announcement that provided they can prove they will not be a burden on the state, by having at least £20,000 a year guaranteed pension income, clients can withdraw up to 100% of their pension fund.

Most clients will have at least a Basic State Pension of around £5,000, and many will have more than this when you add in SERPS etc. So let us say that leaves a requirement of a guaranteed pension income of £15,000 a year. Does that mean clients who want Flexible Drawdown may have to sacrifice up to, say, £250,000 (depending on age, gender, and state of health) to buy an annuity?

The good news is that you do not have to buy an annuity in order to provide that guarantee. A Scheme Pension, in which the client can still control the underlying investments, is recognised as guaranteed income for the purpose of this legislation. At last our clients can have real and total control of their pension investments.

A number of companies offer Scheme Pensions, including at least one household name insurance and pension company as well as some of the actuarial companies that provide pension services. Talk with the broker consultant of your favourite pension company about ways you can combine Scheme Pensions and Flexible Drawdown to give your clients the flexibility they deserve.

Published: January 4, 2011
Author: Graham Dragon
Category: Tax

10% Tax on Extracting Cash from the Company

10% Tax on Extracting Cash from the Company

Many of you will be aware of HMRC Extra Statutory Concession C16, which can allow the shareholders to distribute the assets of the company and treat this as a capital transaction rather than income distribution. This means instead of an income tax bill they only need pay capital gains tax, and if they are entitled to Entrepreneurs’ Relief this will only be 10%.

What perhaps is new information to many of you is that HMRC is planning to replace this Extra Statutory Concession with a statutory provision, probably in April 2011. Good news, you may think. But actually, not such good news. The current plan is to restrict capital treatment only to companies whose net assets are £4,000 or less. If the proposed legislation is passed, any shareholders whose companies have higher net assets will be treated as receiving income, taxed at the higher income tax rates, rather than capital, unless they go through the expensive process of paying an insolvency practitioner to liquidate the company.

So perhaps now is the time to act for any of your clients who could benefit from this strategy.
Published: January 4, 2011
Author: Graham Dragon
Category: Tax

Will I have to pay tax?

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my friend hasnt worked for years and now she has got job but when she recieves her wage slip by post

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What is law regarding casual labour?

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