A Guide to Tax
or individuals, there are three main taxes to consider:
- Income tax
- Capital gains tax
- Inheritance tax
When planning for your financial future, it is important to understand the characteristics of each type of tax so that you can structure your finances in a tax-efficient way.
Income Tax
Tax is payable on the amount of your income (earned and unearned) less allowances. Everyone is given a personal allowance on which no tax is payable.
This allowance increases at age 65 and again at age 75. Married couples’ allowance only applies where at least one partner was born before 6 April 1935.
You need to be clear as to how your investments affect your tax position. For example if the level of your income falls below the total of your allowances, investments should be made in areas where gross returns are obtainable, or at least where tax is recoverable. If you are a higher-rate taxpayer, the most appropriate investments are likely to be those which produce tax-free returns or capital growth with minimal interest or dividends.
If you are self-employed there are expenses which you can offset against your income. This can result in a significant reduction in your tax bill.
Independent Taxation
The earnings and investment income of a husband and wife are taxed separately at their individual rates, so that a wife’s investment income is taxed at her own rate without regard to
her husband’s. Careful thought needs to be given, therefore, as to the name in which investments are made. If investments are held jointly, they are normally deemed to be held on a 50/50 basis.
Capital Gains Tax
This tax is payable on profits made on the disposal of assets (e.g. shares, unit trusts, a second property). There are certain exceptions, most notably your main residence and Gilts (Government stock). Each individual is entitled to an annual exemption and currently transfers between husband and wife are free of tax.
Indexation relief (which allows for inflation) is available for gains made up to April 1998. Chargeable gains realised after 5 April 1998 are subject to a tax relief which tapers according to how long you have owned the asset. Investors who have owned the assets, apart from business assets, for 2 years or less will get no taper relief, whilst those who have owned assets for at least 10 years will have to pay tax on 60% of their gain. The earliest date of ‘ownership’ for this purpose is 6 April 1998, except for assets bought before 17 March 1998 which will be treated as if they had been owned since 5 April 1997.
Business assets enjoy particularly favourable relief - reference should be made to an accountant for full details.
For disposals on or after 6 April 2008 there will be a single rate of capital gains tax of 18%. As part of this new system the annual exempt amount (currently £9,200) will remain in place, but taper relief and indexation allowance will be withdrawn. For disposals before this date the current rules will continue to apply, both for individuals and trustees.
It is possible to offset losses against gains. You should aim to sell assets in a year where you have few other gains. If you have already used up your annual exemption you may wish to defer disposals until after 5 April.
Inheritance Tax
When you die your chargeable estate is valued. This is basically the value of property and investments, less any debts, and excluding certain exempt assets (such as assets left to your spouse, charity or approved national causes). Tax is then levied on any sum in excess of the IHT exemption which is usually amended at each Budget. From 9 October 2007 it has been possible to add the proportion of unused nil-rate band from the first death to the surviving spouse or civil partner's own nil-rate band when they die. This can effectively double the current allowance where one nil rate band would otherwise have been wasted.
‘Potentially exempt transfers’ are gifts that do not give rise to an immediate liability, but which carry an underlying charge to tax that crystallises if the transferor dies within seven years of making the gift. If you survive for the full seven years, no tax is payable. Most lifetime transfers to individuals (not covered by the annual IHT exemptions) are potentially exempt. You should plan to use all of the available exemptions before making this type of gift.
The impact of Inheritance Tax can be reduced significantly with careful planning and by the careful construction of a Will.
Self Assessment
The Inland Revenue usually dispatches self-assessment forms immediately following the end of the tax year to be assessed.
Do not leave everything to the last minute, if you miss the final filing deadline of 31st January following the end of the tax year, you will leave yourself open to interest, penalties and surcharges. There is, however, a lot to be said for submitting a return before the 30 September initial deadline - this will guarantee the completion of the tax calculations by the Inland Revenue and will give you the option of having small tax underpayments collected through PAYE coding adjustments.
Tax Tips
- Make sure that you use personal income tax reliefs and capital gains tax allowances, wherever possible, consistent with your own investment objectives.
- Divide both assets and income between husband and wife to take full advantage of the independent taxation rules.
- Make use of all your entitlements to invest in tax efficient investments such as ISAs and National Savings.
- Consider your options carefully before paying off your mortgage.
- Ensure that your investments are correct for your personal circumstances and sufficiently flexible to allow for changes in family finances and circumstances and tax legislation.
- Review investments each year in the light of Budget changes. What is right for this year may not be next year.
- Advance planning can significantly reduce potential liability to inheritance tax, but take care to ensure that gifting money is not done at the expense of your future financial security.
- Make sure the Trustees of your occupational pension scheme hold an up to date Nomination form setting out to whom you wish any lump sum benefit paid.
- Retain all tax papers, interest details, P60, P11D, etc in a safe place so that you can complete tax returns promptly and accurately.
- Check tax assessments and notices of coding for accuracy. If in doubt, contact the tax office for clarification.
An initial review is offered on a no charge and no obligation basis.
