November 2005 Newsletter
We have covered some of the property related dilemmas faced by couples about to marry (or enter into a civil partnership after 5 December 2005). We have also highlighted the dangers of failing to take account of the tax rules applied to "Agency Workers", the use of Nil Rate Band Trusts for inheritance tax planning and a quick reminder of the benefits of stakeholder pensions for minors.
We were going to include an article this month on the changes to the Construction Industry Scheme to be introduced April 2006. You will be relieved to know that this has been set back a year, the changes will not now be implemented until 6 April 2007!
Property decisions and tax - on marriage
All comments that follow apply equally to married couples and partners registered under the Civil Partnership Act (from 5 December 2005).
One of the most critical pieces of tax planning for couples prior to marriage concerns property.
If both parties own their own home prior to marriage then a choice needs to be made as only one of the properties can qualify as a tax exempt principal private residence after marriage.
Factors that can influence the best tax strategy include:
- Are both properties to be kept after marriage, or one sold shortly afterwards?
- Should the properties be owned jointly or continue to be owned separately?
- If retained what are the future plans for the second property after marriage - will it be let?
- Which property has the most equity, and so on?
After marriage any transfer of property between partners is free of both Capital Gains Tax and Inheritance Tax. Typical tax planning objectives might be:
Capital Gains Tax
- If both properties are retained, and the non-principal private residence is let post marriage, then no capital gains tax will apply on a sale up to three years after marriage.
- Whatever the decision, to keep a second property or to sell, it is likely that actions will have to be taken after marriage. This being so it is vital that proper elections are made to choose which property is to be considered the couple's main residence for tax purposes. This involves signing and lodging the appropriate piece of paper with the tax office. This only applies if both properties are actually used as residences.
- These elections can be varied. There is also a two year time limit for filing which starts from the date of marriage in most cases.
Inheritance Tax
- Depending on the mix of assets in each parties ownership, moving properties into joint ownership can help to equalise estates and reduce overall tax risk.
- Marriage or formal partnership should trigger a visit to your advisors to revise your wills. This again should aim to equalise your joint or separate ownership of property and other assets. See the separate article we have written this month on the use of Nil Rate Band Trusts.
So if you are planning to marry, or enter into a civil partnership, please call so that we can make the most of the tax benefits available.
Agency Workers - some danger areas
What is an agency worker?
If you supply labour only to your clients, your relationship with your subcontractor is likely to be that of employer and employee. You may need to stop tax and national insurance from their pay.
For instance if you are a contractor and your client asks you to build a house, then any subcontract labour that you use can be dealt with under the construction industry rules as long as the workers present a correct CIS4 certificate.
However, if your client decides to build the house himself and asks you to supply a plumber (rather than merely introduce him), then you would be considered an agent, and the plumber your agency worker. Even if the tradesman had a valid CIS4 certificate you would still need to stop tax and national insurance on the wages paid to him for that labour only contract.
Of course this sort of situation is not restricted to the construction industry but to most business contracts where a supply is made on a labour only basis.
The rules apply if your subcontractor is a sole trader or a partnership. The rules DO NOT apply if your subcontractor is a limited company.
If you trade on a labour only basis and use subcontract labour to do the work, then potentially the Agency Worker tax rules may apply. Please call if you would like us to review your contracts to ensure that you are keeping the right side of the legislation.
Interesting tax consequences of a 50:50 split!
References in this article to husband and wife, also apply to partners
subject to the Civil Partnership Act.
Inheritance Tax
- Shares in Private Limited Company
The following
two paragraphs provide an interesting example where the taxable value of a
gift of shares may be less than the market value!
Consider a
small trading company that has been valued at £1m. There are two
shareholders Mr X and Mr Y who both own 50% of the issued share capital.
Common sense would indicate that their individual shareholdings are worth
£500,000. Whilst this would be the case should they actually sell the
business, different rules would apply if they considered gifting their
shares.
Inheritance tax looks to the value lost by the person
making the gift, not the value gained by the person receiving the gift. If
Mr X gifted his shares to his son, he would be transferring a minority
interest. (51% is needed to exert control.) For valuation purposes a
minority interest may be subject to a discount of between 20% to 30% of
the market value. So a gift could be made worth £500,000 and be treated by
the Revenue as valued at say £400,000 for inheritance tax purposes.
Income Tax - Property ownership and rental
income
Should a property be owned by more than one
person it is normal practice to agree the percentage share owned when the
property is bought.
If our Mr X and Mr Y also jointly owned a
rental property it would suggest that not only would they split the profit
or loss on sale of the property equally, but would also share rental
income arising from the ownership in the same
proportion.
However the Revenue will accept a split of rental
income at variance with the ownership of the property as long as all
parties agree. So Mr X could be allocated 90% of the rental income and Mr
Y 10%. This is a useful strategy to consider but it does not apply to a
husband and wife who own a rental property.
In husband and
wife situations it may be sensible for one party to receive the bulk of
the rental income and pay tax at lower rates - thus creating an overall
increase in post tax income for the family. But to gain the Revenue's
approval the couple must own the property as tenants in common, and the
percentage owned by each party has to be the same as the division of
rental profits. So if Mr A and Mrs A own a rental property as tenants in
common, 90% owned by Mrs A and 10% by Mr A, rental income and profits can
only be split 90:10.
Income Tax - Husband and
wife owned businesses
If a husband and wife team run
a small limited company, or trading partnership, and each own 50% of the
shares or rights to share of profits, they need to be mindful of the
"settlements legislation" particularly where there are few assets in the
business.
If Mr X owns 50% of the business but does 90% of
the work in the business, the Revenue can use existing legislation to
restore a commercial balance to the situation. In this example the Revenue
could argue that as Mr X does 90% of the work then he should receive 90%
of the dividends/share of profits distributed by the business.
This area of tax law is currently being tested by the Arctic
Systems case, a House of Lords decision is pending. But as current
legislation could be applied, shares of business income between husband
and wife need to reflect the underlying commercial reality. A 50:50 split
on paper does not prevent a challenge by the Revenue that other divisions
should be applied.
Inheritance Tax planning that still works
There have been a number of anti-avoidance provisions enacted in recent times that have stopped the benefits of a number of complicated inheritance tax planning schemes.
However the use of a Nil Rate Band Trust, as part of a properly executed will, is still a perfectly legal and workable tax planning tool.
Essentially the trust allows married couples (and, from the 5 December 2005, couples registered under the new Civil Partnership Act) to use up their individual exempt estate values for inheritance tax purposes. Presently the exempt estate value is set at £275,000. Without the use of this planning tool it is possible that on the first death up to £275,000 of exemption may be lost.
There are risks to be avoided which can be achieved by using a particular type of variant trust.
If you would like more details of this scheme please call.
Tax Diary November/December 2006
1 November 2006 - Corporation tax due for companies with a tax liability for the trading year ending 31 January 2006.
19 November 2006 - PAYE and NIC deductions due for month ending 5 November 2006. (If you pay your tax electronically the due date is 22 November 2006)
1 December 2006 - Corporation tax due for companies with a tax liability for the trading year ending 28 February 2006.
19 December 2006 - PAYE and NIC deductions due for month ending 5 December 2006. (If you pay your tax electronically the due date is 22 December 2006)
30 December 2006 - If you file your 2006 Tax Return via the Internet you must send it back by this date if you want the Revenue to consider collection of outstanding tax for the year through your tax code. This will only be possible where you owe less than £2,000.