Professional Connections Newsletter – Q3 2021

Welcome to our inaugural Professional Connections newsletter.

In this edition, we offer some strategies to minimise different types of tax in years to come.

Although, while arranging your clients’ affairs to save tax is an important part of financial planning, it is not the only part. It is also essential that any tax planning strategy that is being considered also makes commercial sense.

In this newsletter, we only cover tax planning opportunities open to UK resident individuals.

Income tax rates and allowances for 2021/22

The basic, higher and additional rates of income tax for 2021/22 remain at 20%, 40% and 45% respectively.

The basic rate limit for 2021/22 rose to £37,700 (except in Scotland). The threshold at which a taxpayer starts paying additional rate tax is unchanged at £150,000.

The personal allowance for 2021/22 increased to £12,570.

The point at which an individual is liable to higher rate income tax is £12,570 + £37,700 = £50,270.

These figures are now frozen at these levels until the end of the tax year 2025/26.

The dividend tax rates for 2021/22 are:

• 7.5% (dividend ordinary rate);
• 32.5% (dividend upper rate); and
• 38.1% (dividend additional rate).

However, on 7th September, the Government announced that these dividend tax rates will all increase by 1.25% from 2022/23, to 8.75%, 33.75% and 39.35% respectively.

The dividend nil rate band remains at £2,000.

Maximising the use of all of a couple’s allowances, reliefs and exemptions – ideas for consideration

• Redistribute investment capital to a spouse or civil partner with a lower income so that the income generated is taxed on them instead, to maximise effective use of any personal allowance, personal savings allowance and 0% savings band, dividend allowance, and basic rate tax band. No capital gains tax (CGT) or income tax liability will arise on transfers between married couples or civil partners living together or where the asset to be transferred is an investment bond. However, any transfer must be done on a ‘no-strings-attached’ basis to ensure that the correct tax treatment applies. This means investments must be fully transferred with no entitlement retained by the transferor.
• Reallocate dividend income for couples who run their business through a company. Where they are planning to transfer shares to achieve this, it is important that any share transfers are made by way of an unconditional gift with full voting, capital and income rights – the transfer will not incur CGT where the couple are living together and are married or registered civil partners.
• Reinvest in tax-free investments, such as an ISA, so that taxable income is replaced with tax-free income.
• Reinvest in tax-efficient investments that generate no income and so will not contribute to the loss of the personal allowance, such as:
  • Investment bonds from which a 5% tax-deferred withdrawal may be taken each year, for 20 years, without affecting the personal allowance calculation; or
  • Unit trusts / OEICs geared to producing capital growth, but not where unit trust / OEIC dividends are reinvested, or accumulation unit trusts / OEICs, as the dividends still count as income and will affect the personal allowance even though they are not received by the investor. As for all financial planning, a careful balance needs to be struck between investment appropriateness and tax effectiveness. While performance through capital growth is obviously tax attractive, reliance on growth at the expense of income can introduce (possibly unacceptable) risk.
• Where possible, a couple should try to ensure that they both have pension plans that will provide an income stream in retirement that will enable them to use both of their personal allowances.
• Individuals who are taking a pension under flexi-access drawdown should consider managing their taxable income to maximise the tax reliefs and allowances currently available, if they are not already doing so.

NICs for 2021/22 and 2022/23

For 2021/22, the starting point for the payment of Class 1 NICs by employees rose to £184 per week (£9,568 per annum).

The lower earnings limit for 2021/22 went up to £120 per week (£6,240 per annum).

Earnings between the lower earnings limit and the primary threshold protect an entitlement to basic state retirement benefits without incurring a NICs liability.

Company directors should consider whether to take advantage of this rule for themselves and other family member employees, as should owners of unincorporated family businesses employing other family members.

The upper earnings limit for 2021/22 increased to £967 per week (£50,270 per annum). The Class 1 percentage for standard-rated employees is currently 12%.

Earnings in excess of the upper earnings limit are currently subject to a 2% charge on the employee.

The employer rate for 2021/22 is 13.8% on all earnings in excess of the ‘secondary threshold’ which is £170 per week (£8,840 per annum).

Class 4 NIC is charged at 9% on self-employed profits between £8,840 and £50,270, and is 2% on all profits above £50,270.

All of these NIC rates will be increasing by 1.25% for the tax year 2022/23 under a new Health and Social Care Levy (HSCL). From 2023/24, NIC rates will return to their 2021/22 level and the HSCL will become a separate 1.25% charge applied to all employed and self-employed earnings. However, unlike NICs, from 2023/24 the HSCL will be paid on the earnings of employees and the self-employed above state pension age (SPA) – currently 66. At present only employers pay NICs on employees beyond SPA.

Consideration should be given to salary sacrifice. There can be significant advantages where an employer operates a salary sacrifice scheme, allowing personal pension contributions to be converted to an employer contribution by swapping salary for pensions. The additional benefit of this is the NICs savings for both employer and employee, made by reducing salary. The benefits of salary sacrifice will be even greater from 2022/23 onwards, due to the NICs increase/HSCL. For employees, they will save an additional 1.25% on any of their earnings they choose to give up. Employers will save the same and may be willing to pass some or all of this onto the employee.

Making use of the Employment Allowance

For 2021/22, eligible employers are able to reduce their employer Class 1 NICs by up to £4,000 for the tax year – the Employment Allowance.

One of the existing restrictions is that this relief cannot be claimed if the director is the only employee paid above the £8,840 threshold. However, if a company employs, say, husband and wife directors where both earn above the £8,840 threshold, the employment allowance remains available. Please see HMRC’s guide ‘Single-director companies and Employment Allowance: further guidance’.

This means that they could, for example, both take a salary of £12,570, to potentially use their respective personal allowances and reduce their NIC bill to £Nil by benefitting from the Employment Allowance.

Capital gains tax (CGT)

In the March 2021 Budget, the Government announced that the annual CGT exempt amount for individuals and personal representatives would be frozen at its 2020/21 figure of £12,300 until the end of the 2025/26 tax year. The annual exempt amount for most trusts is £6,150.

CGT planning – ideas for consideration

• Use the CGT annual exemption (which cannot be carried forward, so will otherwise be lost). If the annual exemption is not regularly used an individual is more likely to reach a point where some of his or her gains are subject to CGT. In using the CGT annual exemption, unfortunately, a gain cannot simply be crystallised by selling and then repurchasing an investment – the so-called bed-and-breakfast planning – as the disposer must not personally reacquire the same investment within 30 days of disposal. However, there are other ways of achieving similar results, such as by acquiring the same investments within an ISA or a SIPP, or similar investments within a fund, or by one spouse/civil partner selling an investment and the other spouse/civil partner separately buying the same investment.
• Use planning strategies available to married couples/civil partners, by, for example an individual, who is a higher or additional rate taxpayer, transferring assets (by an outright and unconditional lifetime transfer) into their spouse’s/civil partner’s name to utilise that spouse’s/civil partner’s annual exemption on subsequent disposal. This will mean that, between them, the couple can realise capital gains of £24,600 each year with no CGT. (In transactions which involve the transfer of an asset showing a loss to a spouse or civil partner who owns other assets showing a gain, care should be taken not to fall foul of the CGT anti-avoidance rules that apply – money or assets must not return to the original owner of the asset showing the loss).
• Use pension contributions to reduce the tax on the capital gain – either whereby the basic rate tax band is increased by a grossed up personal pension contribution (where tax relief is given at source), or whereby a pension contribution paid gross reduces taxable income, thereby freeing up some of the basic rate tax band, e.g. an occupational pension contribution deducted from salary before tax or an AVC to an occupational pension scheme.
• CGT deferral – it may be worthwhile, if possible, spreading a disposal across two tax years to enable use to be made of two annual exemptions. However, if deferring a disposal, it should also be borne in mind that some announcement from the Chancellor is possible on CGT in the 27 October 2021 Autumn Budget, as he asked the Office of Tax Simplification (OTS), in July 2020, to carry out a review of CGT. Based on the first report published by the OTS, on 11 November 2020, the Government might look to introduce proposals, such as taxing capital gains at the same rates as income (which could mean more than a doubling of the current tax rates in some instances), reducing the annual exempt amount, and/or removing the rule which gives a CGT free uplift to market value on death.

Inheritance tax (IHT)

According to HMRC’s latest statistics, IHT receipts for April to August 2021 are nearly £2.7 billion, which is £0.7 billion higher than in the same period a year earlier. Annual IHT receipts for 2020/21 were £5.3 billion, having reached a peak of £5.4 billion in 2018/19. The residence nil rate band (RNRB), which took effect from 2017/18, is believed to have been the reason for a dip in 2019/20 and only a gentle rise in 2020/21.

Back in March, the Office for Budget Responsibility (OBR) projected 2021/22 IHT receipts to reach £6 billion, rising to £6.1 billion for 2024/25 and £6.6 billion for the following year. However, with the IHT take for the first five months of this tax year already at nearly £2.7 billion, it’s possible that the final total for 2021/22 could be well above the OBR’s estimate.

Whilst the RNRB of £175,000 per person may provide some respite from potential IHT liabilities remember that:

• this only applies on deaths occurring after 5 April 2017;
• it will not help people whose estate exceeds £2.35 million (£2.7 million on the second death);
• it will not now increase again until at least the 2026/27 tax year.

The IHT nil rate band will also remain frozen, at £325,000, until 5 April 2026, increasing the amount of IHT collected by HMRC to substantial levels, particularly as house prices and investment values increase. People whose estates may be affected should therefore take early action.

IHT planning – ideas for consideration

Individuals who wish to transfer wealth on to the next generation should consider making full use of their £3,000 annual exemption. If this was not fully used in the last tax year (2020/21), it can be used now provided the donor first fully uses their annual exemption for this tax year (2021/22). So, for somebody who has made no gifts, they can make gifts of £6,000 within their annual exemptions now.

For those who have income that is surplus to their needs, it may also be appropriate to establish arrangements whereby regular gifts can be made out of income in order to utilise the normal expenditure out of income exemption. An ideal way of achieving this is to pay premiums into a whole of life policy in trust to provide for any IHT liability. Individuals that can afford to make substantial gifts out of income may like to get that planning up and running sooner rather than later – in the hope that if a rule change does occur, existing arrangements will be protected.

Larger gifts could also be considered. Where ongoing control of the assets gifted is required, a discretionary trust will be useful, but care needs to be exercised so as not to exceed the available nil rate band. If the investor needs access to cash from the trust and IHT efficiency, a loan trust or discounted gift trust should be considered.

Pensions

One of the subtle tax increases introduced in the March 2021 Budget was a freezing of the pensions lifetime allowance until 5 April 2026 at its 2020/21 level of £1.0731 million. Like any freezing of an allowance, it is designed to produce extra tax as inflation and/or economic growth drag more taxpayers over the fixed threshold.

The number of people being caught by the lifetime allowance has increased sharply in recent years. The latest data, for 2018/19, shows an average tax charge of nearly £40,000. The lifetime allowance freeze is set to increase both those falling foul of the lifetime allowance tax charge and the average amount they pay.

The tapered annual allowance

In 2021/22, where an individual has threshold income of more than £200,000 and adjusted income of more than £240,000, their annual allowance is reduced by £1 for every £2 of excess income, up to a maximum reduction of £36,000. An individual with income of £312,000 or more will only have an annual allowance of £4,000. Any contributions in excess of this will be subject to the annual allowance charge. The annual allowance charge is a stand-alone tax charge but the purpose of it is to remove the tax relief benefit that the contribution will have received.

For these purposes the test is to see if an individual’s adjusted income exceeds £240,000.

However, a person may be subject to these provisions if, for example, he or she has income of £220,000 and a pension provision of more than £20,000 is made for him or her via an employer contribution in a particular tax year.

This could cause some concern for people who have income that hovers around £200,000 whose employers intend to make substantial pension provision – possibly by paying a contribution to make use of the unused relief for previous tax years.

To cover such situations, the rules provide that for the taper to apply the individual must have a threshold income of at least £200,000. An individual whose income falls below the threshold income level will not be subject to the tapering provisions. Individual pension contributions (not employer) can be deducted to determine threshold income (although salary sacrifice arrangements set up after 8 July 2015 will be caught as will earlier salary sacrifice arrangements that require the individual to make an annual declaration).

For those affected, the impact of the annual allowance charge (likely to be 45% for those impacted by tapering) together with income tax on benefit withdrawals of up to 45%, can result in a very high effective rate of income tax.

For previous tax years these taxpayers could have been entitled to higher annual allowances depending on their income levels and the tax year. This could mean that individuals caught by the taper could pay the maximum for 2021/22 and then make contributions in respect of unused relief from earlier tax years.

Subject to not exceeding the lifetime allowance, it therefore makes sense for individuals who are affected by the tapered annual allowance to:

• pay the maximum contribution for this tax year, which will be dependent on their threshold and adjusted income in 2021/22, but will not be less than £4,000, and

• pay a contribution in respect of any carried forward annual allowance for the tax year 2018/19. There may also be some allowance available to carry forward from 2019/20 and 2021/22 if either, or both, of those year’s contributions were less than any tapered allowance.

Pension planning for family members

Individuals should consider making a net pension contribution of up to £2,880 (£3,600 gross) each year for members of their family, including children and grandchildren, who do not have relevant UK earnings. The £720 basic rate tax relief added by the Government each year is a significant benefit and the earlier that pension contributions are started the more they benefit from compounded tax free returns.

Articles on this website are offered only for general information and educational purposes. They are not offered as, and do not constitute, financial advice. You should not act or rely on any information contained in this website without first seeking advice from a professional.

Past performance is not a guide to future performance and may not be repeated. Capital is at risk; investments and the income from them can fall as well as rise and investors may not get back the amounts originally invested.

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Sources: Techlink