Death and Taxes: Why all the confusion?

A recent survey by Canada Life found that most people affected by inheritance tax (IHT) weren't aware of the nil-rate threshold after which the tax becomes due. The insurer found that among adults over the age of 45 with assets in excess of £325,000, 70% did not know the threshold for the standard nil rate band (£325,000), up from 61% in their 2016 survey.


There were some other interesting findings that fell out of the survey:

• 55% of respondents did not know the rate of IHT (40%) on death;
• 38% did not think their main home was liable for inheritance tax;
• only 32% know the annual exemption amount they are entitled to (£3,000); and
• only 40% of those surveyed were aware that vehicles, life insurance policies not held under trust, agricultural land, business assets and non-exempt gifts in the last seven years can be liable for IHT as part of an estate on death.

Having looked at the survey, I personally find the lack of knowledge it reveals is very worrying. It means that there are a lot of people out there who will not be taking advantage of the available reliefs, or worse blindly entering into a transaction that actually worsens their tax position!

H M Revenue & Customs latest figures show receipts from IHT have hit a record high, payments totaling £4.84bn in the 2016/17 tax year. For reference in 2009/10 IHT receipts were a mere £2.4bn. Whilst some of that growth has clearly been driven by house prices since the 2007/08 crash, particularly in the South East, one can't help but wonder if in part it is due to the lack of knowledge highlighted by Canada Life's research. (Personally, I also think the witchhunt on "tax avoidance" has made a lot of people nervous about doing any kind of tax planning whatsoever)

It is, however, worth pointing out that last month the government announced plans to review the ‘complex’ IHT system in the UK, tasking the Office of Tax Simplification (OTS) to make recommendations about possible reforms. Although, having been a tax adviser for as long as I have I remain skeptical about the OTS actually making any headway with simplifying the IHT code...

So, what's your "Exit Strategy"?

As you'll have gathered from my blog back in the spring “Looking for the door?” an "Exit Strategy" is now less and less likely to mean physically selling off your business to a third party. I would argue it's possibly even less likely to mean a management buyout too. To explain why I'll bring you back to a question I've asked before:

"If I sold my business, would the money I got provide me with the same level of income as my business does?"

If it does, then great let's go sell your business and live the dream, that being, of course, a residual income in retirement without all the worry associated with running a business in later life. If however, the truth of the matter is that it won't (especially with ongoing all time low-interest rates) then we need to look at some alternatives.

There is, of course, the tried and tested method of loading your pensions with cash and/or commercial property, but in recent years we've seen the limits on pensions greatly diminished. Not saying it's a bad idea, but it's probably only part of the solution for most. Or one can try to build up a portfolio of assets (investments and property) outside of the business to replace the income your business generates. The problem is, if you're already thinking of exiting your business, it's probably too late to implement such conventional ideas.

Let me throw a Virtual Hand Grenade (or VHA) into the conversation for a moment: How about keeping your business?

We've already established that your business is your greatest income producing asset, so quite simply I ask why are you letting it go? Most businesses, if structured in the right way really don't need you (the business owner) to make them tick. I know this is a very different way of thinking about your business, and for many of us, it is akin to the children leaving home. After all, you've most likely started your business, nurtured it and watched it grow, and now I'm asking you to watch it leave home and head off into the big wide world without you...

BUT, if you have the right people, the right systems, the right structure, and drive all of that through the right incentives then stepping away (without giving it away) becomes easier to do, and you get to keep the income. Sounds like something worth talking about doesn't it? I've helped my clients, friends, and family all re-evaluate the way they've looked at this particular conundrum, and though it will often produce different answers for different people it does help widen their options significantly. If it could work for you, i.e. a business which generates a continued income without that business being dependent on you to drive it, isn't that a conversation worth having?

Trusts? HMRC wants you...

Today I've been trying to use HMRC's new Trust Registration Service. In and of itself the process is laudable, and one hopes that it will bring great transparency to the UK where tax and trusts are concerned. Hopefully, it will also dispel the "Daily Mail" myth (other news publications are available) that trusts are only used by those seeking to avoid tax.

So, what did I think in practice when working through the new system:

1. For new trusts, it's pretty straightforward. However, we now require far more data for beneficiaries, including their dates of birth and NI numbers. So, there is a little bit of annoyance factor in having to go back to the clients and ask for details we've not been used to asking for before.
2. Existing trusts, however, are a nightmare, especially where the original inter vivos settlor has since passed away. Have you tried getting an NI number or a passport reference for someone who died several years ago? Families and advisers just haven't retained that data as it wasn't needed back then when the trusts were set up. There are also other questions being asked that the current trustees and/or advisers will simply not know the answers to if the trust is long established.

As I have said, HMRC launching the TRS is a laudable aim (which I believe has the best of intentions, although I do worry about how HMRC will use the data they collect). However, in practice, the information being asked for about existing trusts is in some cases simply not available. This prevents further progress with the registration of that trust, there is simply no option to bypass the requirement and file a part complete registration.

This will cause huge problems for agents and trustees trying to get this done by 31 January 2018, a problem that has been massively compounded by HMRC releasing the agent access months behind schedule but not extending the deadline for registration.

HMRC

I think we need a rethink on the deadline for this!

Things may go up as well as down...

I am of course talking about interest rates, following today's increase by the Bank of England from 0.25% to 0.50%. A minor change some will say, and I'm largely inclined to agree, but a good many will underestimate the impact of such a small percentage increase, which is, in fact, a 100% increase in the base rate. Sensationalistic, I hear you say? Yes, that was my intention...

There will be lots of noise made today and in the coming days about a change of direction by the Monetary Policy Committee no doubt. However, let us not lose sight of where interest rates are, how long they've been there and where they have come from (thanks to www.economicshelp.org and the ONS for the attached graphic).

We have experienced record low levels of interest for an equal record level of time during a period of a record level of central bank input. In effect, what we have seen over the last 10 years has been artificial. It's been an economy on life support!

So, in essence, we should see this as a positive move, yes? Well, that's a much more difficult question. Largely interest rates are increasing due to inflation outstripping wage growth. As with all things, economics requires that things have an equal and opposite reaction. This increase is in effect a measured step on a path to ensuring that consumer prices don't rocket as a result of a lower sterling. Now, I'm no economist, and better minds than mine will articulate this in a far more accurate manner, but in short, the interest rate rise would appear to be a result of the negative economic news.

The impact of all of this, of course, depends on which side of the fence you sit. Those with hefty mortgages will lose out, whilst those with savings will stand to see some modest benefits.

Of the 8.1 million households with a mortgage, 3.7 million, or 46%, are on either a standard variable rate or a tracker rate, so less than half will be immediately affected. Even then, according to UK Finance, the average outstanding balance is £89,000 which would see payments increase by between £11 and £12 a month. So the initial impacts are minimal on household budgets. What should be of more concern is that this will not be the only increase, and one would expect to see steady rises over the next 2 to 3 years.

It is also important to note that the Bank estimates that almost 2 million mortgage holders have never experienced a rate rise. All of this is, of course, risible if you can remember the double-digit interest rates from the 70' and 80's. However, it's impact should not be underestimated with ever spiraling house prices and mortgage levels.

As for savers, well, we'll have to sit tight and see what the high street banks offer in way of increases. As usual, I'd expect them to lag behind in terms of both amount and timing in relation to mortgage rates.

Looking for the door?

At Haines Watts I talk to a lot of business owners about their options when it comes to exiting their businesses. The traditional thinking has always been to reach a point where they no longer want to drive their business day-to-day and then to sell it to a third party, or possibly even entertain an MBO. They can then take the cash and sail off into the sunset...

However, more and more I find I'm helping to teach them to think about their business and their exit from it in a different way. Essentially this takes a simple change of mindset. Whatever their business or source of wealth is it is merely a tool to facilitate their lifestyle, it is an investment (albeit an investment of their blood, sweat, and tears). I get them to ask themselves this question:

"If I sold my business, would the money I got provide me with the same level of income as my business does?"

More often than not the answer is no, it won't. So, if we take a step back, and look at it in the same way that they would approach their normal business dealings what should they do? With some, the answer is staring them in the face, and they have taken most of the steps they need to already. For others, it's a case of helping them get the building blocks right to allow them to step away from their business. Of course, I am talking about keeping their business and making the transition from director-shareholder (and in some cases general dogsbody) to that of a retired director-shareholder. To put it simply, just because you no longer work in your business 5/6/7 days a week does not stop you from enjoying the profits it generates!

So, how do you do it? Well, I'll save that for another time...

2017: New Year's Resolutions...

It's been a little while since I've been regularly commenting in my blog, and my posts have been a bit hit and miss as to when they go up. All rather remiss of me I know, and that's why in the New Year it is one of my resolutions to become more active in writing about tax again with the aim of publishing at least one tax blog every month. Not the most thrilling resolution I'm sure, but 2017 is likely to be one of the most eventful years in taxation that we have seen in some time!


For starters, we have May and Hammond (our new Prime Minister and Chancellor of the Exchequer, if only Boris Johnson's surname was Clarkson it would be uncanny), the latter of whom will be delivering his first Budget speech on 8 March 2017 this year. Hopefully this will pass without the prerequisite tomfoolery of their namesakes on Amazon Prime!

The New Year will also bring with it ramifications for European and global markets as we see Brexit gain pace in the spring and the arrival of President Trump in the White House. I'm sure there will be no end of commentary over these particular events in early 2017, which will undoubtedly have differing effects on business generally. The former (Brexit) could see some major changes to the UK's tax legislation, but it remains to see what Donald Trump will do for trans-Atlantic tax harmony.

On another level we will also see further developments on MTD (Making Tax Digital, not Match of The Day) as we stride ever closer to digital integration with HMRC, and lets not forget of course the notification process for those with overseas assets and property.

Yes, 2017 should prove to be a most interesting year...

Share the wealth (but keep it in the family)

For many years the typical way for a higher rate tax payer to cut the amount of tax they pay on their personal income has been to transfer shares in their company to their spouse who, for example, may be a non or lower rate tax payer. With many owner managed businesses remunerating the owners through a combination of low salary and dividends this has historically meant paying little to no tax on around the first £80,000 (approx.) for a married couple (or civil partners). This has of course become more important following the changes to the dividend tax regime from 6th April 2016.

It should come as no surprise therefore to learn that HM Revenue & Customs have consistently tried to deter and stop this "income shifting" over the years.  Many of you will no doubt be familiar with the machinations of the Arctic Systems case. However, so far, not much has changed and no new laws have been introduced to tackle income shifting. So if you are considering transferring shares to your spouse as a way to mitigate your personal tax exposure, you may conclude and decide to go ahead with this plan.

BUT WAIT! Read on and explore an even smarter way for you and your spouse (or civil partner) to minimise your joint tax bill.

Selling company shares?

Rather than transferring the shares, your spouse (or civil partner) could in fact buy those same shares from you. How would you fund this, I hear you ask? Well, you could refinance the mortgage on your home and your partner would use the resulting loan to buy shares from you. When you receive the money from your partner, you can use this to repay some of the original mortgage.

So far so good right? Well, there's more, the interest that you would have paid on the original mortgage would not have been eligible for tax relief, whereas the interest on the new loan (which your spouse used for the purchase of shares from you) is eligible for relief against tax.

All of which makes the process of buying shares more tax efficient – you can align income between you and your partner to help mitigate your joint tax bill, and you can claim tax relief on your interest payments! You would even be exempt from paying capital gains tax from selling the shares because the sale took place between you and your spouse (or civil partner).

Of course, nothing is easy and for this to work successfully, there are conditions that you would need to meet and hoops you would need to jump through. Of course, I would say that, I'm a tax adviser aren't I? In all seriousness though, as with most things we can do a DIY job, but would you (like Leonid Rogozov) remove your own appendix? 

Share the wealth (but keep it in the family)

For many years the typical way for a higher rate tax payer to cut the amount of tax they pay on their personal income has been to transfer shares in their company to their spouse who, for example, may be a non or lower rate tax payer. With many owner managed businesses remunerating the owners through a combination of low salary and dividends this has historically meant paying little to no tax on around the first £80,000 (approx.) for a married couple (or civil partners). This has of course become more important following the changes to the dividend tax regime from 6th April 2016.

It should come as no surprise therefore to learn that HM Revenue & Customs have consistently tried to deter and stop this "income shifting" over the years.  Many of you will no doubt be familiar with the machinations of the Arctic Systems case. However, so far, not much has changed and no new laws have been introduced to tackle income shifting. So if you are considering transferring shares to your spouse as a way to mitigate your personal tax exposure, you may conclude and decide to go ahead with this plan.

BUT WAIT! Read on and explore an even smarter way for you and your spouse (or civil partner) to minimise your joint tax bill.

Selling company shares?

Rather than transferring the shares, your spouse (or civil partner) could in fact buy those same shares from you. How would you fund this, I hear you ask? Well, you could refinance the mortgage on your home and your partner would use the resulting loan to buy shares from you. When you receive the money from your partner, you can use this to repay some of the original mortgage.

So far so good right? Well, there's more, the interest that you would have paid on the original mortgage would not have been eligible for tax relief, whereas the interest on the new loan (which your spouse used for the purchase of shares from you) is eligible for relief against tax.

All of which makes the process of buying shares more tax efficient – you can align income between you and your partner to help mitigate your joint tax bill, and you can claim tax relief on your interest payments! You would even be exempt from paying capital gains tax from selling the shares because the sale took place between you and your spouse (or civil partner).

Of course, nothing is easy and for this to work successfully, there are conditions that you would need to meet and hoops you would need to jump through. Of course, I would say that, I'm a tax adviser aren't I? In all seriousness though, as with most things we can do a DIY job, but would you (like Leonid Rogozov) remove your own appendix? 

Incentivise your key players

So, you've built up a successful business, which has grown and therefore necessitated bringing others on board to help you run it. Or perhaps you're nearing retirement, or simply wanting to slow down and let your management team take up the strain, whilst you take time to enjoy the fruits of many years hard work.

Of course, the problem here is how do you ensure that those key people, the one's you'll rely on to keep you business ticking, don't jump ship, or simply decide they could go and run their own business? Well, you could always give them a pay rise, or a bonus, but we all know that is only a short term incentive. How can you truly tie these 'employees' into your business? The answer is simple, give them ownership!

"Whoa, surely you don't mean give away my business?" I hear you cry. Well, you kind of have to, but not all of it, infact only a small part of it, and if you're careful about how you do it you will lose zero control and even only 'pay out' if the business is ever sold. No, I'm not talking about financial wizardry, or being less than honest with your people, I'm talking about share options, or more specifically the Enterprise Management Incentive (EMI) share options.

A share option gives someone the right to buy your company’s shares in the future, but at a price that is fixed now. This means in effect that you are giving away none of the business you have built to date, rather what you are giving away is an option to benefit from future growth. So, if your team do more than sail the same course, and they actually grow your business, then everyone wins!

Options are very useful for business owners that wish to incentivise and retain key employees because as I have already pointed out, if the value of the shares escalates over time those employees could make a significant capital sum when they sell their shares. An EMI share option scheme provides significant tax advantages to those employees (and you as their employer). 

Quite simply, an EMI scheme is by far the most tax beneficial structure for staff, it was introduced in 2000 to assist growing companies in attracting and retaining key employees and to reward those employees for taking the risk to work for such companies.

The principal tax benefit of an EMI share option scheme is that employees do not have to pay the income tax that would normally be charged on the market value of any shares or options granted to them. If you grant shares to an employee in other ways tax would be due on their value. It's also worthy of note that because of the advance agreement available on share values granted under EMI schemes, it is usual to agree discounts of up to 80% of the actual value, which further mitigates taxes.

If employees are given options under an approved EMI scheme, they are only charged capital gains tax at 10% on the increase in value over the option exercise price (what they pay for the shares), so long as that price is at or above the market valuation of the shares on the date of granting the options. This value is agreed in advance with HMRC as part of the process prior to entering into any agreement with the employee.

"All of this is well and good" I hear you say. Yes, it is very good news for your employees (or at least those key ones you want to incentivise).

"So what's in it for me?" you ask. The answer is simple, a team that now has an incentive to run your business well, after all they now have some ownership (albeit a small percentage) and their performance directly relates to their ultimate reward, which might be a business sale, or even a full management buy out. By giving them control of their own financial destiny, your own is assured as you step back from the day to day of running your business. Sounds nice doesn't it...

Brexit: The Aftermath

Last Thursday as a nation we voted and on Friday, depending on your personal inclination, we either celebrated or despaired as a nation divided. Yes, the vote was close, 52% vs 48%, and we saw record turnouts for the referendum, certainly higher than any I can remember in recent history for the UK electorate, which should be taken as a positive if it can be turned into greater participation in our national politics.

Anyway, as you should have guessed by now this is a blog about tax (with other musings occasionally I admit), so how has our decision to leave the EU affected tax? The short answer, as of yet is that it  hasn't, and Mr Osborne's speech this morning would seem to give us a reprieve until at least autumn time when we will have a new Prime Minister and leader of the Conservative party.

So, what can we expect?

The Chancellor was quoted pre-referendum as saying we would see £15bn of tax rises, comprising a 2p rise in the basic rate of income tax to 22%, a 3p rise in the higher rate to 43% plus a 5% rise in the inheritance tax rate to 45p. There would also be an increase in alcohol and petrol duties by 5%. He also mooted that there would be spending cuts worth £15bn, including a 2% reduction for health, defence and education, equivalent to £2.5bn, £1.2bn, £1.15bn a year respectively, along with larger cuts of 5% from policing, transport and local government budgets. Yet this morning he seemed more conciliatory, stating the strength of UK Ltd and our ability to weather the storm and emerge stronger. Was this simply scaremongering to maintain the status quo? Only time will tell...

What should be of more concern are the tax impacts of leaving the EU, rather than those likely to be imposed by our Chancellor.

As a result of Brexit the UK would no longer be part of EU’s Customs Union. This raises the prospect that the EU’s customs duties could apply to imports from the UK, making it less attractive for EU companies and consumers to source goods from UK companies. The UK of course could do the reverse, and as the UK is a net importer from the EU such a move is unlikely by either party.

After a Brexit, sales of goods to and from the UK may no longer be able to use the EU’s acquisition and dispatch system (accounted for on VAT returns). Instead they would become imports and exports which would need to clear customs and incur import charges.

These are but two of the potential impacts, but the consequences of departing from fiscal union with the EU may not be as apocalyptic as we have been led to believe, however, expect a bumpy ride on the train out of Brussels...