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Setting aside income in the form of savings is important for us all, to provide for the unexpected or to build up a nest egg that we can enjoy in retirement. Given that the earnings from which our savings come have already been taxed, people often object to the fact that any return they enjoy on their investments will usually be taxed again.
Tax Planning
Interest paid to individuals by banks and building societies will have tax deducted at 20%. If you do not pay tax you can sign a form to have the interest paid gross. If you have suffered tax but are not liable for it, you can make a repayment claim. |
In this section we consider what are the most tax efficient investments to make.
Pensions
Pensions are one of the most tax efficient forms of saving. A higher rate taxpayer can contribute £100 to an approved pension fund at a cost of only £60 and investment income and capital gains will accrue within the scheme largely tax free.
An individual is entitled to tax relief on personal contributions in any given tax year up to the higher of 100% of earned income or £3,600. The contributions are paid net of basic rate tax and the pension provider will then recover the tax from HMRC. Higher rate relief, if appropriate, can be claimed from HMRC. Contributions of more than this can be made into a scheme but the excess will not attract tax relief.
An employer may make contributions to a scheme and a deduction from profits may be available to the employer.
Despite these generous reliefs there are controls which serve to limit very high levels of contribution. These are complex but, put simply, they will give rise to a tax charge if annual contributions result in an increase in pension rights for a year of more than £215,000 (for 2006/07) or if the value of the fund when benefits are taken is greater than a lifetime allowance which, for 2006/07, is £1.5 million.
When the pension is taken, the fund must be used to buy a life annuity. However, part of the fund, normally 25%, may be used to take a cash free lump sum.
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Tax free savings
Individual Savings Accounts (ISAs)
ISAs are free of income tax and capital gains tax. There are maximum investment limits which apply for each tax year but, over several tax years, large investments can be made. The ISA can be in stocks and shares, cash or life insurance but most ISA providers invest solely in stocks and shares (maxi or mini). Banks and building societies provide mini cash ISAs.
| Individual Savings Accounts |
| 2006/07 |
£ |
| Overall investment limit - |
maxi ISA - |
|
7,000 |
|
mini ISA - |
stocks shares and life insurance
|
4,000 |
|
|
cash |
3,000 |
|
Note that if, say, a cash mini-account is opened, no maxi-account can be opened in the same tax year so that only a mini stocks and shares ISA can be opened. 16 and 17 year olds are able to open mini cash ISAs.
Other tax efficient investments
The following investments work in varying ways. You should consider your needs in detail before entering into any commitments.
National Savings products
There are a number of products, taxed in different ways, but some, such as savings certificates, are tax free.
Premium bonds
Another national savings product, premium bonds are tax free and you could win £1m! By their nature, returns are volatile. However, prizes total 3% of the premium bonds in issue so that, statistically, a large investment (maximum £30,000) should yield something similar to this. 3% is equivalent to a gross return of 5% to a higher rate taxpayer.
Single premium insurance bonds
These provide a useful means of deferring income into a subsequent period when it may be taxed at a lower rate.
The Enterprise Investment Scheme (EIS)
Income tax relief at 20% is available on new equity investment (in qualifying unquoted trading companies) of up to £400,000 in 2006/07. Capital gains tax exemption may be given on sales of EIS shares held for at least three years. If the proceeds realised on the sale of any chargeable asset (eg quoted shares, second homes, etc) are reinvested in EIS shares, the gain on the disposal can be deferred.
Venture Capital Trusts (VCT)
These bodies invest in the shares of unquoted trading companies. An investor in the shares of a VCT will be exempt from tax on dividends and on any capital gain arising from disposal of the shares in the VCT. Income tax relief currently at 30% is available on subscriptions for VCT shares, up to £200,000 per tax year, so long as the shares are held for at least five years (three years for shares issued before 6 April 2006).
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Capital gains tax (CGT)
Introduction
Tax Planning
Consider spreading the sales of assets such as shares or valuable antiques over several tax years. Shares giving rise to a gain of, say, £24,000 would result in no tax if sold over three years compared to more than £6,000 if sold in one year by a higher rate taxpayer. |
Making the most of your investments requires some understanding of CGT. CGT arises on the sale of most assets and, subject to various reliefs and exemptions, is payable on the difference between the sale proceeds and the original cost.. The first £8,800 of gains, for 2006/07, are tax free. The rate of tax will be 10%, 20% or 40% depending on your income chargeable to income tax in the year of sale.
| Taper Relief |
Number of complete years asset held after 5.4.98 (including ‘bonus’ where relevant)
|
Taper for non-business assets
% |
Taper for business assets
% |
| 1 |
0 |
50 |
| 2 |
0 |
75 |
| 3 |
5 |
75 |
| 4 |
10 |
75 |
| 5 |
15 |
75 |
| 6 |
20 |
75 |
| 7 |
25 |
75 |
| 8 |
30 |
75 |
| 9 |
35 |
75 |
| 10 or more |
40 |
75 |
Some assets are exempt from CGT such as motor cars (including classic cars), personal goods such as jewellery or antiques sold for less than £6,000, UK government bonds and, crucially, your only or main home.
Taper relief
Until April 1998 the gain on a disposal was reduced by an allowance for inflation called indexation allowance. Assets sold now, and bought before this date, will still attract some indexation allowance up to April 1998. After this date a taper relief was introduced.
Taper relief is a percentage reduction in the capital gain and depends on the number of complete years of ownership of the asset after 5 April 1998. A bonus year can be added for non business assets where the asset was acquired before 17 March 1998. The rates of taper relief are shown in the table.
Example
Fred bought a Nevinson painting in 1990 for £10,000. He sold this in December 2006 for £91,000.
The gain is £81,000 (ignoring indexation allowance). The taper relief will be £28,350 (35%). He has owned it for eight complete years since 5 April 1998 but because he owned it on 17 March 1998 a bonus year is added to make nine.
The gain is £52,650 before the annual exemption.
Business assets
Business assets, which qualify for the higher rate of taper relief, currently include:
- an asset used for the purposes of an individual’s (or partnership’s) trade
- an asset owned by an individual but used in the individual’s qualifying trading company
- property let to any trade
- all shareholdings in unquoted trading companies (whether or not the shareholder works in the business)
- all shareholdings held by full-time or part-time employees in quoted trading companies
- shareholdings in quoted trading companies where the shareholder is not an employee but can exercise at least 5% of the voting rights
- shareholdings held by full-time or part-time employees in non-trading companies provided they and their associates do not own more than 10% of the company.
Example
John started his own computer software company in 2001 subscribing for 1000 £1 shares. In October 2006 he sold his shares to a large plc for £1.9m.
The gain is £1,900,000 - £1,000 = £1,899,000. Taper relief is 75% because John has owned the shares for more than two years in an unquoted trading company. This reduces the chargeable gain to £474,750. If John is a higher rate taxpayer he will pay CGT at 40% on the taxable gain. The tax is £189,900 ignoring the annual exemption.
As can be seen this equates to 10% of the gain.
However, the definition of what constitutes a business asset has changed since 1998 and this can mean that the full 75% is not available. Please talk to us if you are contemplating the sale of any business asset.
Main residence
An individual’s or married couple’s only or main residence is exempt from CGT. The exemption extends to grounds of up to half a hectare. Larger grounds may also be exempt.
Tax Planning
If you have two or more homes you can elect which one is to be your main residence. Your decision can be crucial. Contact us for advice if this affects you. |
The sale of a part of the garden or grounds for development may also be covered by the exemption.
Subject to exceptions, periods of absence are chargeable but, if the main residence was let during absences, as a result of which a charge arises, a ‘letting relief’ may apply to reduce the chargeable gain.
Relief is given on only one residence at any one time. However, once it is established that a particular home is the main residence, the last three years of ownership will always be exempt, even if another home has become the principal home during this time.
Example
Joe has a house in Kingston which is his principal private residence and which he has owned for eight years. Fed up with commuting he buys a flat in central London and elects for this to be his main residence. Exactly five years later he sells his home in Kingston.
The Kingston home is exempt for the first eight years whilst he was living in it and for the last three years because, even though he had another home which was his main residence during this time, the last three years is always exempt provided the home in question qualified as the main residence at some point.
11/13 of the gain on Kingston will be exempt from capital gains tax. If, two years later, he sells the flat and moves elsewhere, the whole of this gain will be exempt.
The main residence exemption can be complex and often causes a good deal of misunderstanding. Please contact us for further advice before making transactions in property. |
