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Mark McLaughlin CTA (Fellow) ATT TEP explains why forthcoming tax changes may result in pitfalls and potential tax liabilities.

Mark McLaughlin

One Budget or two?

It seems to be the Government’s policy these days to announce important tax changes on at least two separate occasions each year. The Spring Budget has been the traditional time for new tax rules. However, in recent years the Pre-Budget Report has also been used to announce forthcoming tax changes, although often with effect from the date of the announcement. If this policy continues, it would seem sensible to rename these events the ‘Spring Budget’ and ‘Autumn Budget’ respectively. Then at least we can mentally prepare for two onslaughts each year on the tax legislation front!

The Pre-Budget Report 2007 on 9 October 2007 was no exception. Major tax changes were announced, some of which were effective from 9 October 2007, while other changes take effect from 6 April 2008, subject in both cases to legislation to be introduced in Finance Act 2008. There is therefore a period of uncertainty (probably up to Summer 2008) until Finance Act 2008 becomes law. However, it appears that the prospective changes could have a detrimental effect on some taxpayers, and create unforeseen tax liabilities for others. This article highlights some possible problem areas.

IHT nil-rate bands

On an individual’s death, their estate is generally chargeable to Inheritance Tax (IHT). However, their estate is broadly entitled to a ‘nil-rate band’ of 0 per cent. For 2007/08, the nil rate band is £300,000, increasing to £312,000 from 6 April 2008. Any value above the available nil-rate band is liable to IHT at 40%.

A welcome surprise for many taxpayers was the proposed introduction of a claim to allow the transfer of any unused nil-rate band on a person’s death to their surviving spouse or civil partner. This allows a larger nil-rate band to be applied against the survivor’s estate. A nil rate band is available to both husband and wife (or civil partners). This potential ‘doubling up’ of the nil-rate band applies on the death of the surviving spouse on or after 9 October 2007.  

Unfortunately, that unused proportion of the  nil-rate band of the first spouse to die is only available on the survivor’s death. Lifetime gifts are also liable to IHT, at a rate of 20%. Thus, for example, a widow who incorrectly tries to use more than one nil-rate band in a lifetime gift (e.g. by gifting funds to a family trust) will be faced with a possible unexpected IHT liability. Care is required when dealing with any new tax rules. However, this is especially the case when the relevant legislation has not yet become law. The expression ‘act in haste, repent at leisure’ springs to mind where tax rule changes are concerned!

CGT simplicity

The most significant tax change announced in the Pre-Budget Report 2007 for many individuals was the proposed introduction of a new single rate of Capital Gains Tax (CGT) of 18% for disposals from 6 April 2008, coupled with the withdrawal of indexation allowance and taper relief. 
  
There will be winners and losers as a result of these changes. The worst affected by the initial proposals include those who have owned chargeable business assets for a considerable period of time. Any indexation allowance and taper relief which has accrued during their period of ownership will be lost if the asset is sold after 5 April 2008.

Some taxpayers may be tempted to take action before 6 April 2008 to improve their CGT position. For example, one suggestion already put forward is for individuals to transfer assets to a trust for themselves. This triggers a disposal at market value for CGT purposes, on which indexation allowance and/or taper relief can then be claimed as appropriate. The trustees acquire the assets at market value, and may deduct this base cost from sale proceeds on a future disposal after 5 April 2008, with the gain being taxable at 18% (subject to an annual CGT exemption, if available). 

However, there are a number of points worth bearing in mind before undertaking such planning by 5 April 2008. Firstly, as mentioned the proposed CGT changes will probably not become law until some time after the asset disposal. By that time, the tax rules may have been changed for the better (stranger things have happened!). Secondly, it may be worthwhile comparing the tax position both with and without such planning action – for example, in some cases the tax differential may make the costs of setting up and running a trust seem less than worthwhile. Thirdly, there may be other taxes to consider as well, including a possible 20% lifetime IHT charge upon transferring the property into trust, to the extent that the asset value exceeds the available nil rate band. Fourthly, unless the trustees are selling the asset shortly after its transfer, a CGT liability may arise upon disposal to the trust, with no sale proceeds from which to pay this tax.   

The time delay between the proposed CGT rule changes being announced on 9 October 2007 and their introduction on 6 April 2008 gives taxpayers the opportunity to take steps to improve their tax position. This fact will probably not be lost on the Government, although it remains to be seen whether any action will be taken to combat tax savings.

Residence and domicile

Individuals who are resident in the UK but domiciled abroad are also faced with higher UK tax liabilities from 6 April 2008. ‘Non-doms’ can use the ‘remittance basis’ of taxation (i.e. overseas income and gains are only taxable in the UK when remitted here). However, the rules allowing for a remittance basis to apply are set to change from 6 April 2008. When a non-UK domiciled individual has been resident in the UK for seven years, the remittance basis will only be available upon payment of an additional tax charge of £30,000 a year. Otherwise, they will be taxed on all their worldwide income and gains, whether or not those income and gains are remitted to the UK.

Taxpayers who have already been resident in the UK for seven years at 6 April 2008 will soon need to consider their options. Unfortunately, for those individuals who cannot afford the £30,000 tax charge there will be no alternative than to relinquish the remittance basis and accept UK tax on worldwide income.

An unfortunate aspect of this proposed new tax charge is that it will least affect wealthy non-UK domiciled individuals, for whom £30,000 a year is perhaps a drop in the ocean. In other words, in some cases the availability of the remittance basis will be determined by the individual’s ability to pay. Many foreign nationals who come to work in the UK for an extended period (perhaps sending most of their earnings back home) will soon be exposed to UK tax on income from both here and their home country. Will those individuals fully appreciate and understand the rule changes and their new tax obligations in the UK? It is not difficult to envisage non-doms accruing tax liabilities in this country, giving rise to tax debt problems.

Taxpayers beware

These days, the UK tax system seems to change on such a regular basis that it is very difficult for tax professionals to assimilate them all, let alone taxpayers. A full understanding of the implications of tax changes is clearly important, in order to prevent unexpected and unwelcome pitfalls. Those taxpayers who take action to mitigate tax liabilities in anticipation of forthcoming tax changes run the risk of being caught out by changes to the proposed legislation, although no doubt some will consider this a risk worth taking. 

Mark McLaughlin CTA (Fellow) ATT TEP is a Consultant to TaxDebts (www.taxdebts.co.uk), who assist taxpayers with outstanding tax problems. This article is reproduced with the kind permission of TaxDebts.