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Sarah Laing CTA considers the tax breaks currently available for married couples and civil partners and the future availability of such financial incentives. 

Sarah Laing

Marriage tax breaks

Tax breaks to support marriage are back on the political agenda, with the Conservatives considering a £20 a week incentive. This announcement has rekindled the debate inside the tax profession and out, as to whether certain financial incentives should be available exclusively to married couples.

In response to hearing about the Conservative’s proposals, Chas Roy-Chowdhury, head of taxation at the Association of Chartered Certified Accountants (ACCA), said: “A public debate about the UK tax system is always a good thing but the big question is whether tax incentives or tax discouragements alter people’s social behaviour. We would suggest that the UK Government and opposition parties look at the experiences of other tax regimes which do offer some form of incentive to married couples to establish possible impacts and take the debate further.”

According to the Office for National Statistics, 370,022 weddings took place in England and Wales in 1980, compared to 283,012 in 1995 and 244,710 in 2005 - the latest figures available. So would a tax break of around £20 a week encourage more people to get married or stay married? Supporters say it strengthens families, while critics see it as discriminatory and a waste of money.

Ironically, it was the Conservatives under John Major who began cutting the married couple's tax allowance in 1994/95. It was finally abolished by a Labour government in 2000, except for those born before 6 April 1935.

Married couple’s allowance

Although still referred to in the legislation as ‘married couple’s allowance’ (MCA), the allowance was extended to apply to civil partners from 2005-06 onwards (ICTA 1988, s. 257AB, REPLACE ed by SI 2005/3229, now dealt with in ITA 2007, s. 46). The allowance for 2007–08 is £6,285, but where one spouse or civil partner is aged 75 or over at any time in the tax year, the allowance is increased to £6,365.

In the case of a married couple whose marriage was entered into before 5 December 2005, the allowance was claimed by the husband and the amount due was reduced if his income exceeded a prescribed limit (£20,900 for 2007-08).

Where the marriage or civil partnership was entered into on or after 5 December 2005, the claimant is to be the spouse or civil partner with the highest income for the tax year concerned. Where the parties to the marriage or civil partnership have the same total income for the year, they need to specify by making an election who is to be the claimant for that year. The allowance will be restricted if the claimant’s income for the year exceeds the specified amount.

The allowance is given for the year in which the 65th or 75th birthday (as appropriate) falls, or would have fallen but for earlier death in that year. Unlike the personal allowance, the married couple’s allowance is not given as a deduction from total income. Instead, relief is allowed at the rate of 10 per cent of the amount of the allowance by means of a reduction in the claimant’s income tax liability.

Abatement of MCA

The married couple’s allowance is subject to abatement where the claimant’s income exceeds the income limit of £20,900 for 2007–08.

It is always the claimant’s income that determines the level of abatement (if any). This is so even if it is the other spouse or civil partner’s age that has given entitlement to the higher level of relief. However, the married couple’s allowance is only subject to restriction once the claimant’s personal allowance has first been reduced to the standard level.

The abatement process cannot reduce the married couple’s allowance below the standard amount of that allowance for 1999–2000 and earlier years, or below an equivalent amount for subsequent tax years based on indexation of the 1999–2000 figure of £1,970. For 2007–08, that indexed figure is £2,440. Any abatement utilised in reducing the claimant’s personal allowance cannot also be used to reduce age-related married couple’s allowance.

Transfer of allowance

For couples who married before 5 December 2005, MCA was allocated to the husband in the first instance. For those marrying or entering into a civil partnership on or after that date, the allowance is given initially to the spouse or civil partner with the highest income for the year. Married couples who married before 5 December 2005 may nevertheless come within the new rules by making an election under ITA 2007, s. 44.

However it is possible for the other spouse or civil partner to make a unilateral election to claim one-half of the minimum married couple’s allowance, (i.e. a claim of £1,220 for 2007–08). The minimum allowance (of £2,440 for 2007–08) can also be transferred in full to the other spouse or civil partner if a joint election is made. The effect of the transfer is that the other spouse or civil partner is entitled to an income tax reduction in respect of part of the married couple’s allowance and the allowance available to the claimant is correspondingly reduced.

Elections have to be made either before the start of the first tax year to be covered by the claim, or within the first 30 days of that tax year, provided that HMRC had been notified in writing of the intention to make the claim before the start of the tax year. In the tax year in which the marriage or civil partnership was entered into, an election to transfer the allowance could be made in the year concerned. Elections are made using HMRC form 18. The election remains in force for succeeding tax years until it is withdrawn.

Two other circumstances which can cause these elections to cease are:

• if the spouse or civil partner died, the election ceases in the tax year in which death occurred;
• if the couple or civil partners separate, any election ceases to have effect in the following tax year, unless they were reconciled, which would restore the original election back into force.

Because for marriages and civil partnerships entered into on or after 5 December 2005 the entitlement to the allowance in any year goes to the spouse of civil partner with the highest income, it would seem that an election under s 44 (for one-half of the minimum allowance) must lapse automatically if the spouse/civil partner making the unilateral election in year one becomes the one with the highest income in year two. This is because the election is to be made by the spouse/civil partner who is not entitled to the allowance. If in year two the spouse/civil partner who made the election in year one now becomes entitled to the allowance in his or her own right, then he or she cannot make a an election for year two.

A further complication can arise with such elections, because they have to be made before the start of the tax year concerned. It could well be that where the married couple or civil partners have fluctuating incomes it will be impossible for either party to know whether they are the one entitled to the allowance or the one able to submit an election.

Where the allowance had been transferred in full to the other spouse or civil partner, the original claimant could subsequently claim the benefit of one-half of the associated income tax reduction in respect of the minimum allowance. On a joint election, the full income tax reduction could have been transferred back to the husband.

Transfer of unused allowances

In addition to the transfer of part of the allowance by election, it is also possible for a claimant to transfer any part of the allowance that he or she is unable to utilise due to a lack of income tax liability in the year.

Where the claimant is unable to take advantage of the full income tax reduction to which he or she is entitled, the unused part of the allowance can be transferred to the claimant's spouse or, from 2005–06, civil partner, provided that spouse or civil partner gives notice to HMRC. Likewise, where the spouse or civil partner is unable to utilise fully any income tax reduction in respect of the married couple’s allowance to which he or she may have been entitled, the unused reduction could be transferred back to the original claimant. To be effective, notices have to be given not later than five years from 31 January next following the tax year to which they relate.

Other breaks on offer

Marriage still offers some tax planning opportunities which are not available to those who are not married, although increasingly the legislation refers to “partners” rather than “spouses” - the relatively new rules governing tax credits are a good example of this.

Previously, the general rule for jointly held property was that husband and wife were treated as equally entitled to the income, irrespective of their contribution to the source. However, this rule was amended by Finance Act 2004 in respect of shares held in close companies. Distributions (usually dividends) from jointly-owned shares in close companies are no longer automatically split 50:50 between husband and wife but are taxed according to the actual proportions of ownership and entitlement to the income. With regards to other unearned income, it is possible to make a declaration specifying the shares in which the spouses do in fact beneficially enjoy the income. The declaration must relate to both the income and the capital, and both income and capital must be shared in the same proportions.

The 50:50 rule can work to a couple’s advantage. A wife may not want her penniless husband to become equally entitled to her money. She might transfer it into the joint names of herself and her husband, while retaining a 99 per cent beneficial interest in the property. If they do not make the necessary declaration, the income will be split 50:50 for tax purposes, thus using up the husband’s personal allowances and lower rates of tax.

A husband can of course simply give income-producing assets to his wife or vice versa. The gift must not come with strings attached or the anti-avoidance rules will bite. In particular, the gift must:

• carry the right to all the income from the asset;
• not be “wholly or substantially a right to income”, ie the capital must be transferred;
• not be subject to conditions, and
• not be capable of reverting to the donor.

Assignments of employment income will not work for income tax purposes. The successful self-employed entrepreneur, however, should seriously consider taking his or her spouse into partnership. It is understood that HMRC no longer look at such arrangements with such disfavour as previously. Presumably they now accept that modern husbands and wives are capable of carrying on business together. It is nevertheless prudent to ensure that there is adequate documentary evidence both of the partnership’s existence and of the way in which it is conducted. There should be a partnership agreement and minutes should be kept of the partnership meetings. There should be a separate partnership bank account.

With regards to capital gains tax (CGT), a married couple has an annual capital gains tax exemption of £18,400 a year - compared to £9,200 for a single person. If properly planned, this would allow a couple to share the gains from a house sale or sale of shares.

Spouses are even more independent of each other for inheritance tax (IHT) purposes than for income tax and CGT. Each spouse is entitled to a full range of exemptions and reliefs. The income tax and CGT requirement that the spouses should be living together does not apply. For IHT purposes a couple remain married until the decree absolute.

Marriage is of great advantage in IHT planning. The exemptions for wedding gifts are high: £5,000 for a parent of either party, £2,500 for grandparents, £1,000 for anyone else.

After marriage, transfers between spouses are exempt. The only exception is where the recipient spouse is domiciled outside the UK. There is then a £55,000 ceiling on the amount that can be transferred tax free. Transfers above this limit are PETs and will be wholly exempt if the donor survives seven years from the date of the gift. In any event, after 20 years the recipient spouse will be treated for IHT purposes as domiciled in this country if she or he has been resident here for 17 of the last 20 tax years.

Interestingly, other European Union countries deal with married couples quite differently for tax purposes. For example, in 2006, the Swiss government announced it would offer tax breaks for married couples who are classed as an ‘economic unit’. In France, tax allowances focus on the income of the “head of the household”, and in Germany, there is a basic tax allowance for “persons assessed jointly”.

Conclusion

Anyone tempted into marriage by a welcome £20 a week extra should bear in mind that with the average cost of a wedding running at around £17,000 it will take at least 16 years of married bliss to offset the tax break!

The above article was first published in CCH Weekly Taxes.