As the Christmas & New Year festivities subside for another year, now is a good time for individuals to consider what simple steps they can take to minimise their tax liabilities.
Directors / shareholders of Limited Companies probably have the most opportunities available, but there is certainly some scope for tax planning for the self-employed and employees.
We will take the opportunity of outlining some of the key planning opportunities that individuals may wish to consider in the run up to the end of the 2011/2012 tax year.
A useful starting point is to look at allowances and tax bands.
The Personal Allowance
This is the amount of gross income an individual can receive before paying tax for the 2011/2012 year it is £7,475
The Basic Rate Tax Band
This is the amount of taxable income over and above the personal allowance, which is just taxed at the basic rate (20%). For the 2011/2012 year it is £35,000 which means that an individual can earn £42,475 of gross income before paying higher rate Income Tax.
The Higher Tax Rate
Income over £42,475 and up to £150,000 is taxed at 40% and taxable income above £150,000 is taxed at 50%
The Personal Allowance Taper Level
This is the level of gross income an individual can have before his personal allowances start to be tapered away at £1 for every £2 of additional income. It is set at £100,000 and means those individuals whose income is between £100,000 and £114,950 face an effective marginal tax rate of 60%
The Capital Gains Tax (CGT) Threshold
This is the level of capital gains an individual can make in a tax year before paying Capital Gains Tax (CGT). For the 2011/2012 tax year it is £10,600. This will remain frozen at this level for 2012/2013 also. Capital gains are added to income and CGT is charged at 18% for basic rate taxpayers and 28% for higher rate taxpayers. A reduced rate of 10% can be claimed in respect of gains on certain business assets.
The Lower Earnings Limit (LEL)
This is the minimum salary a person can earn in order for that year to count towards his state retirement pension. For the 2011/2012 tax year it is £102 per week (for each of the 52 weeks) or £5,304 for a director who is employed for the whole year. An individual needs 30 such years to qualify for a full state pension.
The Primary Earnings Threshold (PET)
This is the level of earnings at which National Insurance (NI) becomes payable. For the 2011/2012 tax year it is £139 per week, or £7,225 per annum. Above that level employees NI is calculated at 12% and the self-employed pay 9%. Employers pay NI at 13.8% above the Secondary Threshold which is £136 per week or £7,072 per annum.
The Upper Earnings Limit (UEL)
This is the level of earnings at which the employee’s liability drops from 12% to 2% and the liability for the self employed drops from 9% to 2%. For the 2011/2012 tax year it is £817 per week or £42,475 per annum.
Tax Planning Opportunities
We list below some areas where individuals may find that they can reduce their liabilities by taking action now.
Salaries for Owner Managers
Most small Limited Company directors are aware that they will probably benefit from a low salary / high dividend profit extraction. But what is the optimum level of salary? The problem is that for a director with no non-company income, personal allowances are lost if salary is below £7,475 but National Insurance is paid if salary exceeds £7,225. So which is best, £7,475 or £7,225? The answer is £7,225, so a director drawing a salary of say £700 per month would benefit by not drawing salary for February and reducing March salary to £225, perhaps compensating for lost income with an additional dividend.
Optimum Dividend Levels for Owner Managers
A small company director with no non-company income can receive gross income of £42,475 before paying higher rate tax. Dividends are received net of a Notional 10% tax and so dividends should be divided by 0.9 to convert to gross income. For a director receiving a salary of £7,225, dividends of £31,725 will exactly use his basic rate tax band (assuming no non-company income).
At a higher level a person with gross income between £100,000 and £114,950 will face the 60% tax trap. Assuming no other income and a salary of £7,225, dividends of £83,497.50 will take gross income to £100,000. The marginal rate on net dividends just in excess of this will be 43% compared to a 25% rate where income is just below £100,000. So it is well worth trying to ensure that gross income, including dividends, does not fall between £100,000 and £114,950. This point is equally relevant to employees and the self employed who have earned and other gross income close to £100,000 and who also receive dividends perhaps from listed shares.
At a higher level still, the 50% rate starts where gross income exceeds £150,000. This total would be reached by, for example, a salary of £7,225 and a dividend of £128,497.50. An individual with such an income considering a further dividend now should consider deferring that dividend until 6th April 2012 onwards.
It is, of course, well known that pension planning offers generous tax breaks. But for those whose gross incomes are expected to slightly exceed £43,875, £100,000 or £150,000, a personal pension contribution, i.e. made by themselves is well worth considering. For example, a person whose total gross income this year will be £110,000 can reduce his tax liability by £6,000 by making a gross contribution of £10,000 to a pension scheme. If he is aged 55 or over, he has instant access to 25% of this premium as a tax-free lump sum, and so he can find that he has £7,500 invested in a pension fund for a net outlay of £1,500.
As alluded to in our recent pensions articles (list), individuals with high gross incomes considering large pension contributions need to seek professional advice before making pension contribution.
Gift Aid contributions reduce gross income in exactly the same way as pension contributions.
The self-employed can reduce their taxable income by investing in plant for their business before the end of their accounting period. For example, a self employed solicitor making accounts up to 31 March 2011 who expects his profits to be £112,000 could reduce his liability by £7,200 by investing £12,000 in plant before 31st March 2012. So if he were planning to replace his computer system in the near future, there would be a tax advantage in doing so in March rather than April.
Of course no businessman should invest in plant just to obtain a tax advantage. The need to invest in plant needs to be there before tax planning is considered.
Capital Gain Tax (CGT) Planning
An individual with a share portfolio who regularly realises gains should consider disposals to increase gains for the year to close to £10,600. Where this limit is exceeded, he should consider disposing of shares standing at a loss. It is important to remember that disposals and acquisitions of the same shares within a 30-day period are matched.
Individual Savings Account (ISA) Planning
Where funds permit, individuals should utilise fully their 2011/2012 Individual Savings Account (ISA) allowance. The ISA allowance is £10,680, of which up to £5,340 may be invested into cash bank or building society deposits with the remainder being invested into other assets such as stocks & shares. Whilst tax saving is likely to be minimal given the generally low levels of interest available, nonetheless it is better to pay no tax than even a small amount. Furthermore, rates of return may be improved upon as providers often offer attractive Cash ISA rates to attract clients, although one should be aware that these headline rates may disappear after a period of typically 12 months.
Clients who may be dissuaded from investing into stocks & shares due to continuing market volatility may wish to consider ‘parking’ their investment into cash within their stocks & shares ISA, although they you should be aware that the interest received whilst invested in this manner will continue to be subject to Income Tax. An alternative is to consider phasing an investment in over a period of 6 or 12 months or during the coming 2012/2013 tax year, where the allowance will increase to £11,280, a regular monthly savings may be highly appropriate to fully utilise the ISA allowance.
Post 5th April 2012 Planning
By and large, once 5th April has passed, there is little that can be done to reduce a liability for the 2011/2012 tax year. One exception is Gift Aid. A person who makes a gift aid donation between 6th April 2012 and 31 January 2013 can carry that contribution back to the 2011/2012 tax year. To do so, he must include the contributions on his 2011/2012 tax return and file by 31st January 2013. In marginal situations, the tax saving can be high. Suppose for example an individual has a gross salary of £100,000 and a dividend of £900 net. The dividend will increase his liability by £387. If he contributed £800 net (£1,000 gross) to a charity by means of gift aid, he would eliminate this £387 liability.
Where substantial capital gains have been or are to be realised during the current tax year, investment into Enterprise Investment Scheme (EISs) may be a consideration for up to 3 years after. These are generally suitable only for the more sophisticated investor, although their appeal has been widened by the issuance of some asset backed schemes with the added security of underlying property assets.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Should you have any queries or wish to discuss any of the points raised, please feel free to contact us or Tim Warr @ Warr & Co Chartered Accountants where relevant .