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July 2015 UK Budget

Private Clients - 08 Jul 2015

In the first all Conservative UK Budget for a decade, Chancellor George Osborne announced a number of measures which directly impact internationally mobile individuals with a UK connection.

Non-Dom Changes

Non-Domiciled Changes Regarding The Arising Basis Of Taxation
In line with expectations, the Chancellor George Osborne has announced that there will be significant changes to the taxation of non-UK domiciliaries.

These will apply in two areas and are set to take effect from 6 April 2017, subject to consultation both on the implementation of the changes and draft legislation.

The First Set Of Changes
These will be aimed at individuals who have been resident in the UK for long periods of time and who are currently able to benefit from using the remittance basis of taxation if they wish to do so. The new proposals mean that individuals who have been resident in the UK more than 15 out of the previous 20 tax years will be deemed domiciled in the UK for all tax purposes – i.e. in relation to Income Tax, Capital Gains Tax (CGT) and Inheritance Tax (IHT). As a result of these changes, affected individuals will not be able to use the remittance basis of taxation once they have been in the UK for more than 15 out of 20 tax years and will therefore have to pay tax on their worldwide income and capital gains as they arise. Further, as set out above, the point at which an individual becomes deemed domiciled in the UK for IHT purposes will shift to an earlier point than at present, so that individuals will be subject to IHT on their worldwide assets once they have been here for more than 15 out of 20 tax years instead of over 17 out of 20 tax years. There will be a consultation on whether split years of residence will be taken into account in determining the number of years an individual is treated as UK resident for the purposes of this test, or whether only complete tax years of residence will count towards the total.

Once an individual has acquired a deemed UK domicile under the new rules, they will only be able to lose their deemed UK domicile if they spend more than five tax years outside the UK. If an individual who became deemed domiciled having been here for 15 years subsequently leaves the UK for more than five years and then returns to the UK, as long as they do not intend to remain permanently in the UK they will be able to spend a further 15 years in the UK before they become deemed domiciled once more.

If the individual has set up an offshore trust prior to becoming deemed domiciled under the new rules, those trusts will retain their ‘excluded property’ status. However, they will be subject to UK tax on any benefits, capital payments or income received from those trusts on the arising basis following the fifteenth year of UK residence. There will be consultation on the relevant income tax and capital gains tax provisions due to their complexity, including rebasing elections introduced under Finance Act 2008.

The Second Set Of Changes
These will apply to individuals who are UK domiciled at birth. This would be acquired either through a UK domiciled father if the individual’s parents are married at the date of that individual’s birth, or through the individual’s UK domiciled mother if the parents are not married at that point.

Saving for your Pension

There were two pension related announcements in the Budget.

  • The introduction of a tapered annual allowance for individuals with income in excess of £150,000, and
  • A consultation on the future of pensions related tax relief.

Reduction In The Annual Allowance For ‘High Earners’
The tapered annual allowance is not a surprise. Details of this measure were set out in the Conservative Party’s election manifesto. However, two aspects of the measure were not explained at that time. We now know that the effective date for this rule change will be 6 April 2016. Additionally, we have details of the technical transitional rules which will make this possible.

The underlying objective of the government is to “control the cost of pensions’ tax relief” whilst ensuring that it is “fair and affordable”. That translates as, the government believes that under the old rules a disproportionate percentage of the total relief benefited far too small a group of taxpayers.

Key Highlights

  • There will be a new concept of ‘adjusted income’ when dealing with pension contributions.
  • Adjusted income is earnings before any deduction for pension contributions.
  • Once adjusted income exceeds £150,000 a taper applies to the normal £40,000 annual allowance for pension contributions.
  • Where adjusted income falls between £150,000 and £210,000, the normal £40,000 limit is reduced by £1 for every £2 that adjusted income exceeds £150,000.
  • e.g. if adjusted income is £200,000, that number exceeds the £150,000 threshold by £50,000. Accordingly the annual allowance is reduced by £25,000 to £15,000.
  • No further tapering applies thereafter, so any person with adjusted income in excess of £210,000 has an annual allowance of £10,000.
  • Special rules will prevent individuals who are normally low earners from being hit by a tapering of relief in a year when earnings spike for reasons outside their control. However, to prevent abuse of this rule, an anti-avoidance measure will target salary sacrifice arrangements entered into on or after 9 July 2015.
  • A similar tapering of relief applies where the £10,000 money purchase annual allowance has been substituted for a person’s normal £40,000 annual allowance.

The annual allowance is not applied against pension contributions made by an individual during a particular UK tax year. Instead, measurement actually applies against contributions made by that person during their Pension Input Period (PIP) for that particular pension scheme. PIPs often involve periods that are not coterminous with the UK tax year. You apply the annual allowance against the PIP which ends during the UK tax year in question.

In the absence of special transitional provisions, this arcane PIP rule would have caused havoc with the introduction a tapered annual allowance. For example, if your PIP involved the period 1 May to 30 April of the following calendar year, then the PIP to be considered in 2016/17 (the first year of taper) would be for the period 1 May 2015 to 30 April 2016. In the two months of that PIP which preceded the Chancellor’s announcement of taper relief, you might legitimately have contributed £40,000. However, the rule change could mean a tapered allowance for 2016/17 of as little as £10,000. That would have resulted in an excess contribution of £30,000 through no fault of your own.

The government’s way of dealing with this potential mess is to bring a sensible reform to the rules concerning PIPs.

  • All PIPs open on 8 July 2015 are closed on that date.
  • The next PIP runs from 9 July 2015 to 5 April 2016
  • Starting in 2016/17 all PIPs will run concurrently with the UK tax year.

That change will make the subject of pension contributions much easier to understand in future. The transitional rules are to be as follows:

  • Everyone gets an annual allowance of £80,000 for the current tax year, 2015/16
  • To apply this, the 2015/16 tax year is split into two notional parts:
  • 6 April 2015 to 8 July 2015 – “pre-alignment tax year”
  • 9 July 2015 to 5 April 2016 – “post-alignment tax year”
  • Where the £80,000 allowance has not been used in the “pre-alignment tax year”, then there is a carry forward to the “post-alignment tax year” of the lower of the unused amount or £40,000.
  • If there is any unused annual allowance from the three previous tax years, this can be brought forward under the usual rules.

Changes to IHT Treatment of UK Residential Property

Under present rules, individuals who are domiciled or deemed domiciled in the UK are subject to UK Inheritance Tax (IHT) on their worldwide assets. Those who are not UK domiciled or deemed domiciled are only subject to IHT on their UK assets, so that foreign assets such as shareholdings in non-UK companies or other overseas assets are not within the scope of IHT.

It is proposed that all UK residential property which is owned by non-UK domiciled or non-UK deemed domiciled individuals will become subject to IHT where the property is owned through an offshore structure such as an overseas company, which usually shelters the UK residential property from the ambit of IHT as the non-domiciled individual is treated for IHT purposes as owning the shares in the foreign company which owns the property, instead of the property itself. Similarly, trustees of non-resident trusts which own UK residential property through overseas companies will become subject to IHT on the underlying UK property.

The new proposals will allow for the value of the UK property inside the corporate (or similar) structure to be subject to IHT in the same way as it would be for UK domiciled individual. The measure will apply equally to let properties and properties who are occupied by their ultimate beneficial owners.

This new ‘look through’ provision will apply only to UK residential property held through opaque structures and will not apply to any other UK assets held through opaque structures, or non-UK assets.

There will be consultations on these measures, particularly on the interaction with Annual Tax on Enveloped Dwellings (ATED) and the potential costs of de-enveloping.

Partnerships and Corporation Tax

The new government has recognised the economic benefit of cutting the main rate of corporation tax from 28% in 2010 to the current 20%. From April 2017, this will be reduced further to 19% with a further cut to 18% effective from April 2020. Together with the changes in dividend income tax rates and allowances, a re-assessment of profit extraction and business entity may be required dependant on profit expectations – this is particularly pertinent for US taxpayers with check-the-box elections to consider. The economic cost of so-called ‘tax motivated incorporation’ is projected to reduce by £500 million a year as a result of these changes.

As the temporary increase to the Annual Investment Allowance (AIA) on qualifying investment in plant and machinery was due to expire at the end of 2015, a permanent allowance of £200,000 per annum has been introduced, effective from 1 January 2016.

Currently, large companies in the UK paying tax by instalments do not start paying until the seventh month of their accounting period. This is comparatively later to most other G7 countries so from April 2017 companies with profits greater than £20 million will have to pay their instalments four months earlier. This effectively means all corporation tax will have been paid by the end of a 12 month accounting period.

The current rules on the purchase of intangible assets can allow corporate profits to be reduced following an acquisition of business assets as opposed to an outright share purchase. Therefore, a measure to remove corporation tax relief on writing off the cost of purchased goodwill and customer related intangible assets has come into immediate effect.

The government has continued to legislate against the perceived tax avoidance for individuals involved in investment fund structures. After introducing legislation earlier in the year regarding ‘disguised fee income’, the next item on their agenda affects individuals who receive a sum chargeable to capital gains tax which is linked to the successful performance of a fund i.e. carried interest. This new measure, effective immediately, will seek to ensure that individuals are taxed on their true, economic gain where planning steps have been designed to lower their effective tax rate. Currently, co-invest gains made on an arm’s length basis will not be affected but one would expect this to be subject to future scrutiny. Furthermore, a consultation will be published on technical changes to limited partnership legislation that may have further ramifications for the fund management and private equity industries.

Other consultations announced today include the future of company distributions and further clarity on the introduction of the General Anti-Abuse Rule (GAAR) penalty.

Taxation of Dividends

The system of dividend taxation has been reformed significantly in this Budget, partly justified as simplification and partly as a move to disincentive “tax motivated incorporation”. The 10% notional tax credit that was introduced in 1999 as a fallout from the abolishment of Advance Corporation Tax (ACT) has now also been abolished.

Instead, a new £5,000 tax-free dividend allowance will work alongside a similar allowance for savings income announced in the last Budget (dividends paid into ISAs and pensions will be unaffected). From April 2016, the income tax rates on dividends will be increased for all taxpayers by 7.5% – the new rates will now be 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers. A common tax planning strategy for small companies to extract profits by paying a minimal salary (utilising the personal allowance) and dividends (utilising the basic rate income tax band) will now have an additional tax charge as a result of these changes.

Employment Tax Changes

The main changes for employers in the Budget were in respect of the Employment Allowance and the minimum wage. On the minimum wage, the Chancellor announced there would be a new National Living Wage of £7.20 for employees aged 25 and older taking effect from April 2016. This represents an increase of 70p per hour for those eligible employees (currently the National Minimum Wage for employees aged 21 and over is £6.50 an hour). The Chancellor also announced that it is the Government’s intention for this new wage to rise to £9 an hour by 2020.

While this may effect some employers, for example those with domestic staff, the Chancellor also announced that the Employment Allowance (EA), which essentially gives up to a £2,000 allowance against employer’s NIC, will be increased to £3,000 with effect from April 2016. The Chancellor also said that single director companies with no other employees will no longer be able to claim the EA, possibly a reaction to an arrangement that was recently brought to public attention.

The Chancellor also hinted at changes in respect of IR35, the intermediaries legislation for tax and NICs that may apply if you are working for a client through an intermediary, and a consultation has been published in respect of removing tax relief on travel and subsistence expenses in respect of journeys to regular client sites for employees working through personal service companies or umbrella companies.

Restricting Finance Cost Relief for Individual Landlords

Individuals who receive rental income from residential property in the UK or elsewhere, and incur finance costs (including mortgage interest), currently receive full relief for these expenses at their marginal UK income tax rates i.e. up to 45% for additional rate taxpayers.

Today’s Budget proposes to restrict the relief on this expense to the basic rate of income tax, currently 20%. This restriction is being introduced gradually from 6 April 2017.

The deduction from property income (as is currently allowed) will be restricted to:

  • % of finance costs: 75   Year: 2017/18
  • % of finance costs: 50   Year: 2018/19
  • % of finance costs: 25   Year: 2019/20
  • % of finance costs: 0     Year: 2020/21

Individual landlords will be able to claim a basic rate tax reduction from their income tax liability on the portion of finance costs not deducted in calculating the rental profit. In practice this tax reduction will be calculated as 20% of the lower of:

  • Finance costs not deducted from income in the first four years after 6 April 2017;
  • Profits of the property business (i.e. cannot increase or create a loss in the year);
  • The total income (excluding savings income and dividend income) that exceeds the individual personal allowance in the tax year.

Any excess finance costs may be carried forward to subsequent years if the tax reduction has been limited to 20% of the property business in the tax year.

The effect of this change is likely to mean an increase in taxable profits from the worldwide letting of residential property. UK resident taxpayers from overseas letting a residence in their home country are likely to become subject to higher levels of income tax in the UK, subject to the availability of the remittance basis or foreign tax credits.

Rent-A-Room Relief
An often overlooked income tax relief that has remained unchanged for the last 18 years is rent-a-room-relief. This currently allows individuals that rent out a room in their residence, as well as B&B or guest-house operators who trade from their own home, a flat rate exemption for any rental income received up to a certain limit. This long standing relief reduces the administrative and tax burden for individuals in these circumstances.

With effect from 6 April 2016, the relief will increase from £4,250 to £7,500 and is likely to increase the number of landlords benefiting from this relief. It may also prove attractive for parents who purchase homes for student children and for the children who let the property to fellow students.

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