Tax Allowances

Tax Allowances - Use them or lose them

by Ashley Clark, Director - March 2010

Maximising use of a couple’s allowances, reliefs and exemptions

Planning to maximise the use of a couple’s allowances, reliefs and exemptions has become much more important following the Chancellor’s announcement that the top rate of income tax will increase to 50% for those with taxable income of more than £150,000; and the introduction of an effective rate of 60% on income between £100,000 and £112,950 caused by the withdrawal of the personal allowance. For such people, who are married or have a registered civil partner, the tax savings available by diverting income into the lower income partner’s name will be even more substantial. But don’t forget the tax savings are still attractive for the increased number of people who will be 40% taxpayers and, for them, income tax saving opportunities still exist for married couples who carry out appropriate planning.

Most of these strategies need a full tax year to deliver maximum effect so these suggestions may serve more as a reminder for planning for the coming tax year than as a means of saving tax this year. The appropriate type of tax planning to adopt will depend on the type of income a person enjoys ie. earned/business income or investment income.

(A) EARNED INCOME

(i) Employment income

(a) Employers could pay bonuses and dividends before 6 April 2010 - except to certain bankers of course!

(b) Employers could consider paying, say, three years' worth of salary and bonus this tax year to top employees, who then loan the money back to their employer in return for an agreed rate of interest over the three-year period.

(c) Employers could consider paying salaries in the form of interest-free loans, which may then be written off if and when the top rate of tax reduces. This will involve a benefit in kind charge on the interest not paid – albeit at a fairly low current rate.

(d) There are a number of ways to reward employees through share option schemes on which capital gains tax at (currently) 18% is paid as opposed to up to 50% tax on income.

(ii) Owner/directors of a private limited company

Points to consider for 2010/11 for these people are:

(i) Where married couples run their business through a company, it will be sensible for salary payments or dividends to be shared as evenly as possible. Following the taxpayer's success in the case of Jones v Garnett (2007) - the so-called “Arctic Systems” case - the Government's income-shifting proposals have been put on hold for the time being.

(ii) In the run up to next year's tax increases, owner/directors will no doubt consider maximising the salary and dividends taken out of the business before 6 April 2010, thereby paying tax at 40% and 32.5%, rather than at 50% on income and 42.5% on dividends over £150,000 after 5 April 2010. Any such “advanced” payments can be lent back to the business if a cash flow challenge exists.

(iii) Tax relief on pension contributions is to be restricted for those with high incomes – see page 6.

(B) INVESTMENT INCOME

Where a higher rate taxpaying spouse owns investments, income from these may suffer tax at a rate of up to 40% or 32.5% (if dividends). These rates could be as high as 50% and 42.5% respectively from 6 April 2010. Therefore, subject to practical considerations, the transfer of investments to a lower or non-taxpaying spouse can save tax and increase overall net of tax investment returns. To be effective, such transfers must be outright and unconditional.