As your wealth grows, so will the eagerness of the HM Revenue & Customs to take an ever-bigger slice of it. So sensible tax planning should form a part of any individual’s wealth management strategy.
Tax planning broadly falls into two parts – standard moves to make the maximum use of your basic allowances and investment in certain products that offer specific tax breaks.
The first part would involve things like a married couple ensuring that a lower-earning, or non-earning, spouse is given the lion’s share of any income-producing investments, so that they will avoid tax at the higher rate. It also means making the most of allowances such as the annual Capital Gains Tax exemption, currently £9,200.
At the moment, individuals with capital gains exceeding the current exemption level can benefit from both indexation relief and taper relief. Indexation relief reduces the size of any gain made between 1982 and 1998 while taper relief can cut the rate of tax charged on gains on what are known as business assets from 40 per cent to 10 per cent for a higher rate taxpayer. However, from April 6 the Chancellor is scrapping both these reliefs and introducing a single flat rate tax of 18 per cent, so some individuals may wish to crystallise gains before April 6 so that they are taxed under the soon-to-disappear 10 per cent rate.
Another key element of tax planning is the mitigation of inheritance tax (IHT). In the Pre-Budget Report Alistair Darling announced he was making the IHT exemption, currently £300,000, transferable between spouses, thus allowing them to escape IHT on the first £600,000 of their combined estate. But many people’s estates will be worth much more than this so additional tax planning may be required.
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Mike Warburton, senior tax partner at Grant Thornton, the accountant, says that one of the most effective ways of moving wealth out of your estate is to make a gift to an individual which is known as a potentially exempt transfer (PET). You can make a PET of any size, and provided you survive for seven years after making the gift, there will be no IHT to pay on it. On a smaller scale, you can make gifts worth a total of up to £3,000 free of IHT each year plus any number of individual gifts of not more than £250. You can also make regular gifts, with no IHT to pay provided the gifts are regular, out of income rather than capital and do not reduce your standard of living.
There also ways of using trusts to mitigate IHT, though these are usually complex operations and the Revenue is continually seeking to close down tax loopholes. As the goalposts are continually moving and it is advisable to seek the help of an accountant before setting up any trust.
After making sure you have made the most of your allowances, further tax planning is a question of using products that offer tax breaks. The most obvious one is saving for a pension, where higher rate taxpayers receive upfront tax relief of 40 per cent on every pound of gross income that they put into a pension. So a gross investment of £10,000 will actually cost a higher rate taxpayer just £6,000, (£7,800 for a basic rate taxpayer).
You can build up a substantial nest egg free of any CGT by making full use each year of your Individual Savings Account. The annual allowance is currently £7,000, which will go up to £7,200 from April 6. Dividends do not escape tax, but if you are a higher rate taxpayer, you will pay less tax inside an Isa than you would outside an Isa.
Other products to consider are Venture Capital Trusts (VCTs) and Enterprise Investment Schemes (EISs). VCTs enjoy upfront tax relief of 30 per cent on a maximum of £200,000 and there is no tax to pay on any capital gains or dividend payouts. However, to qualify for these tax breaks investors have to hold their VCTs for five years and the maximum size of companies in which VCTs can invest is now £7 million.
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Investors can put up to £400,000 into Enterprise Investment Schemes and receive upfront tax relief of 20 per cent. There is no tax on income or capital gains generated within the EIS and investors can also roll over other capital gains they have made into an EIS and defer this tax until they sell.
The drawback with VCTs and EIS’s is that they focus on very small companies (one single company in the case of an EIS) which are much riskier than traditional blue chips.