Higher earners need to move quickly in order to maximise tax relief against a high top rate of income tax before it falls to 45% on 6 April 2013.
The current top tax rate is 50% for income above £150,000, but unless there is a major surprise in this week’s Budget it will be reduced to 45%. This will leave people in this tax bracket slightly better off. The flip side is that after 5 April, tax reliefs will save taxpayers less. What is more, there is an effective rate of tax of 60% on incomes between £100,000 and £116,210 due to the loss on personal allowances.
Busy executives and professionals might struggle to find time for financial planning, but there is still the chance to act now to avoid over-paying the tax man.
Here are four ideas on reducing the exposure to the current top tax rate before it disappears in a few weeks:
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1. Make donations to charities to maximise their value:
To maximise the value of gifts to charities you should bring forward any donations so you obtain maximum tax relief for their benefit. You will be the main person who benefits and the charity will benefit from improved cash flow.
Generally, there are two main ways you can donate, either by utilising Gift Aid or by making gifts of quoted shares (or other assets such as land).
A cash donation worth £1,000 to a charity (£800 from you and £200 from the Treasury) will actually cost you £500 this year, after income tax relief, but £550 next year. However, if you don’t accelerate donations into this tax year all is not lost. You can carry back, into this tax year, donations made between 6 April and the date you file this year’s tax return, provided that is before 31 January next year.
You can also give land or quoted shares to charity and claim both income tax and capital gains tax (CGT) relief. For example, you have shares worth £1,000 which you bought years ago for £1. If you sell them (or indeed give them away to anyone except a charity or your spouse), you’ll pay CGT of £280. Instead, you can decide to give them to charity. There’s no CGT to pay and you can claim income tax relief worth £500. That income tax relief will be worth £50 less after 5 April.
If you’d sold the shares and donated the after-tax proceeds to charity instead, your donation would have been worth only £900 to the charity and you would have reduced your income tax bill by only £270. If you have shares or land that a charity might want, it’s worth doing the maths to see whether cash or assets works best.
2. Pensions relief:
Boosting your pension by £1,000 will cost you just £500 net of tax relief this tax year but £550 after 5 April. The precise way in which the relief is given, depends on how you make your pension contributions and what type of pension scheme you contribute to.
Pensions have been a political football match in recent years and the rules for calculating the maximum amount you can contribute are highly complex. You can go back to earlier years in determining how much you can pay into your pension and I suggest that if you have spare cash and have not maximised your pension contribution, that you obtain a projection of what can be paid as soon as possible.
3. Business expenses – bring them forward if a sole trader or partnership
If you are a sole trader or are in a partnership, it is worth ensuring that you bring forward any expenses to the current tax year so that relief is at 50%.
It may also be worth accelerating capital expenditure on assets which will qualify for capital allowances. There are a number of variables including the period to which you draw up your accounts, so you should check the effect of accelerating expenditure with your accountant.
4. Investments relief – make use of SEIS
You could use investments such as Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) if you are happy with the risks involved.
The SEIS is useful as the tax relief allowances are almost unbelievably generous, but the amounts that can be invested are relatively low. The legislation is complex and it can be easy to get it wrong.
There has been a significant rise in people wanting to invest in a business being established by someone they know, or who they have been referred to, which may qualify for SEIS. Even if the business fails, the various tax reliefs could cover the entire cost of the investment. The risk is getting the set-up wrong and falling into one of the traps in the legislation.
If you realise large capital gains and are a 50% taxpayer who invests in a business which qualifies for SEIS, you can invest £50,000 and so receive £25,000 income tax relief and £14,000 CGT relief. The £50,000 investment therefore costs £11,000. If the business fails there is further relief for the loss of your investment, which could mean that you’ve effectively reduced your tax bill by the cost of your investment. If the business soars in value and you sell after 5 years for £2 million – you receive the whole lot tax free.
It should be noted that this is not aggressive avoidance– you are simply claiming reliefs which you are entitled to under statute and which the Treasury, in many cases, positively encourages.
Allan Holmes is head of tax and trusts at leading national law firm Dickinson Dees, whose wealth management practice advises wealthy individuals and families on the full range of investment planning, tax and wealth protection issues.