UK: Budget 2012 – Personal Tax Highlights

Robin Hood or the Sherriff of Nottingham? 21 March 2012

"Taxes should be simple, predictable, support work, and they should be fair. The rich should pay the most, and the poor least." "I regard ... aggressive tax avoidance – as morally repugnant." First with his quote of Adam Smith and then in his own words setting out the Government's stance on anti-avoidance rules, the Chancellor set the theme for his third Budget.

The build up to today's Budget was attended by even more fevered speculation than usual following an extended period of leaks from within the Treasury as the Coalition members jockeyed for position. Would it be a Robin Hood budget, with the Chancellor announcing mansion, wealth and tycoon taxes or would he play the Sherriff of Nottingham, cutting expenditure further to allow him to reduce the 50% income tax rate? The answer, in the event, is both.

The Budget has a clear focus on anti-avoidance, continuing much talk of unacceptable tax planning with a worrying conflation between avoidance and evasion. Coupled with the announcement that retrospective legislation may be wielded against 'aggressive and abusive' structures, we are all going to have to get used to planning in an increasingly uncertain environment. That said, there is a need for legitimate planning to be recognised as such and for taxpayers to have certainty as regards what can be put in place without risk or fear of challenge. Especially telling is the fact that a number of property holding structures, not established for SDLT avoidance purposes, may well now have to be unwound to mitigate the effects of punitive taxation that may otherwise be imposed.

Today's announcements contain much to digest for individual taxpayers and we have examined the highlights below.

Anti-avoidance

General anti-avoidance rule (GAAR)

The introduction of a General Anti Avoidance Rule ('GAAR') is hardly surprising in the context of the Budget. This was first mooted after the last election, with the report prepared by Graham Aaronson QC having being submitted in December 2011. The idea of having an overarching rule setting out the parameters of what is and what is not acceptable tax planning has an appeal and a potential intellectual elegance. It borrows heavily from other jurisdictions including Australia, and hopefully we can learn from their experiences.

As ever though, the devil will be in the detail. While the basis of the rule proposed in the report has much to commend it, questions remain. Aaronson characterised the GAAR that he proposed not as an anti-avoidance rule per se, but as an 'anti-abuse' rule designed not to catch tax planning, but only the most egregious schemes. Perhaps this will be the same as the aggressive tax avoidance that the Chancellor finds morally repugnant?

Who will determine what planning is and is not subject to the rule, how will it interact with existing (and in many cases far reaching and highly complex) legislation and case law, and whether there is to be a clearance procedure, so that those carrying out legitimate tax planning can rest assured that the might of the GAAR will not be invoked against them? These and many questions remain, and we very much hope they can be resolved during the consultation process. Certainly there is much to be said for a clearance procedure, and it would be a great shame if a lack of HMRC resource to staff this means that instead taxpayers will have to contend with a period of uncertainty as to whether legitimate planning is accidentally caught.

Restriction on the use of tax reliefs

While the expected restriction on pension relief did not materialise, the 'tycoon tax', which it had been speculated was the Lib-Dems' price for agreeing to the cut in the 50% rate was manifest in a restriction on the ability to claim income tax reliefs.

From April 2013, for taxpayers seeking to claim more than £50,000 of otherwise uncapped reliefs, those will be capped at 25% or £50,000 (whichever is greater) of their income in any year. This will restrict the ability of individuals to offset trading losses and potentially the ability to claim gift aid on charitable donations.

Tax rates

Income tax

Much of the pre-Budget speculation surrounded the possible abolition of, or reduction in, the 50% rate of income tax – the Chancellor duly delivered, promising a reduction in the 50% rate to 45% for 2013- 14.

Personal allowance and tax thresholds

One surprise in this year's Budget is the abolition (over a period of years) of the age related personal allowance, with pensioners making their own sacrifice to simplicity.

As widely anticipated, the personal allowance will be increased further to £9,205 in 2013-14, closer to the long term goal of £10,000. This is offset for higher rate taxpayers by a reduction in the basic rate limit of £2,125 to £32,245. Those earning more than £100,000 will be disappointed to see that the disproportionate effect of the removal of their personal allowances highlighted by the Mirrlees review has not been addressed.

Corporation tax

Corporation tax rates also fell, with the main rate falling to 24% in 2012-13 (a further reduction from the 25% that had been announced) and to 22% by 2014, bringing it closer to a long term goal of aligning the main rate of corporation tax with the small companies rate and the basic rate of income tax.

Ownership of UK residential property

The Chancellor promised that he would come down like a ton of bricks on the practice of buying property through companies and delivered in spades. Structuring the purchase of high value UK residential property to secure IHT protection and SDLT savings has long been a hot topic for both UK domiciled and non-UK domiciled individuals.

Non-UK domiciled and non-UK deemed domiciled individuals have often sought to shelter the value of UK property from IHT through the use of non-UK corporate ownership. This simple technique effectively moves the situs of the economic value of the UK property offshore and so takes it outside of the scope of IHT. However, this common planning has for some years been fraught with difficulties. Without great care and discipline being exercised, very often an IHT liability is swapped for an unpalatable annual income tax charge and a corporation tax liability on sale. Relief from capital gains tax for gains on an individual's principal residence is also lost where this approach is adopted.

Changes to the IHT treatment of trusts introduced by Finance Act 2006 restricted further the use of planning through offshore structures to mitigate potential UK tax exposures.

The SDLT cost of UK property acquisition is significant (although perhaps not out of step with acquisition costs in other developed countries). Despite tightening of the rules over recent years, planning opportunities remained. The national press over recent months has shown particular interest in the SDLT 'avoidance' opportunities created by corporate ownership. Put simply, where shares in a company holding UK property are acquired, no SDLT is payable.

Other opportunities to reduce or extinguish SDLT liabilities have also continued to exist. In line with his general crack down on tax avoidance, the Chancellor has responded to these longstanding planning techniques with far reaching amendments.

Increase in the rate of SDLT

For transactions in 'residential' properties worth more than £2 million with an effective date (usually completion) on or after 22 March 2012, the rate of SDLT will be 7%. Transitional rules will ensure that, where completion of a purchase takes place on or after this date, but contracts were exchanged before, the old rates will be applicable.

Penalty rate for corporate ownership

For transactions with an effective date of today, the purchase of residential property worth more than £2 million by 'certain non-natural persons' will attract SDLT at a penal rate of 15%. From 6 April 2013, it is proposed that 'large annual charges' will be levied in respect of residential properties worth more than £2 million where they are already held by non-natural persons.

'Non-natural persons' will include companies, collective investment schemes (including unit trusts) and partnerships in which the non-natural person is a partner. There will be exclusions from the charge for property developers and corporate trustees in certain circumstances. What those circumstances will be are not yet clear.

Crack down on anti-avoidance

In addition, with effect from today, there will be a wholesale crack down on SDLT avoidance schemes. Whether this will involve targeted legislation or an extension of the GAAR to encapsulate SDLT remains to be seen. There will also be targeted legislative changes in respect of the 'sub-sale' rules, with a view to preventing avoidance.

Capital gains tax

The charge to CGT is to be extended to gains realised on disposals by 'non-resident non-natural persons' of UK residential property. This change is inconsistent with the current basis on which CGT is levied. Non-UK resident individuals currently pay income tax in respect of UK source income (whether through withholding tax or otherwise) but the CGT framework has to date been based on charging gains by reference not to the source or situs of the gain, but the residence and domicile status of the taxpayer.

It should also be noted that the same gain, if realised by an individual occupying the property as his principal residence, would not be subject to CGT.

How far the definition of 'non-resident non-natural persons' will extend remains to be seen. Will the definition follow that of the new SDLT rules? Will non-UK resident trustees be caught? If so, many structures with no tax mitigation motivation (and indeed no actual tax saving) may be caught. These changes will apply from 6 April 2013 and are subject to consultation. Whilst this gives individuals time to review their current holding structures, the final detail of the rules may not be available for some time.

Inheritance tax

Despite the fact that offshore corporate ownership is a device typically aimed at IHT mitigation, it appears that there will be no changes to the IHT treatment of UK residential property held through a corporate 'envelope'.

Non-UK domiciliaries and the remittance basis of taxation

Inheritance tax

The amount that UK domiciliaries can pass to their non-domiciled spouse or civil partner, currently capped at £55,000 is set to be increased in 2013 to an amount equal to the nil rate band ('NRB' – currently £325,000) and then pegged to the NRB. The Government will also consult on measures that will allow non-domiciled individuals to elect to be treated as domiciled in the UK for inheritance tax purposes, allowing them to claim a full spouse exemption, but at the expense of their own assets being within the scope of IHT. This change will come as a welcome relief to that class of taxpayers who had previously been denied the exemption.

The remittance basis charge

As previously announced, from 6 April 2012, UK non-domiciliaries who have been resident in the UK for 12 or more years will continue to be able to enjoy the benefit of the remittance basis of taxation, but at the higher cost of £50,000 per year in addition to tax due on income or gains arising in or remitted to the UK. The lower £30,000 charge will be retained for those non-domiciliaries who have been resident in the UK for at least 7 years but fewer than 12 years.

Investment in the UK

While it was confirmed that the exemption for investment of untaxed monies into UK businesses by nondomiciliaries will be brought in from 6 April 2012, no further amendments to those rules were announced today. The Government will continue to consult on the extension of the relief to partnerships and on the other aspects. Non-UK domiciliaries will await the publication of the Finance Bill with keen anticipation.

UK residence rules

Statutory residence test

The Government has reaffirmed its commitment to the introduction of a statutory residence test from April 2013. Draft legislation, which is expected to be similar in form to that previously announced, is expected shortly.

Ordinary residence

One aspect of the consultation on residency rules was the question of whether the concept of 'ordinary residence' should be retained or abolished. Simplification seems to have won the day and as part of the reforms of the residency rules, 'ordinary residence' will be abolished from 2013.

Inheritance tax

Reduced inheritance tax rate for charitable donations

As previously announced, the reduced IHT rate of 36% for estates where 10% or more is left to charity will apply from 6 April 2012. Nil rate band The nil rate band will remain frozen for the lifetime of this Parliament, but thereafter will rise in line with the CPI.

The taxation of trusts

A review of the IHT charges that apply to many trusts on distributions and every ten years has been announced with a view to simplifying the fiendish calculations that currently determine the rates at which IHT is levied on these events.

Charities

Charities may well come to regard the 2012 Budget and the introduction of the cap on income tax reliefs to 25% of an individual's income as a significant attack on their funding. This measure will particularly affect large donations made by philanthropists, who may have donated amounts significantly in excess of their annual income and will now see the tax relief and incentive for giving reduced.

This measure and the rules to be introduced that will reduce the rate of inheritance tax for estates leaving 10% to charity may together have the effect of encouraging delaying giving until death, creating a significant funding gap for charities.

The Budget contains a glimmer of hope in that the Government stated its commitment today to explore with philanthropists ways to ensure that this cap will not have a significant impact on charities; we can only hope that this will result in greater incentives for lifetime giving to be introduced sooner rather than later.

Other changes

Entrepreneurs' Relief

Entrepreneurs' relief will be extended to shares acquired through Enterprise Management Incentive Schemes. This is a welcome change that will bring many employee/shareholders within the reduced rate of capital gains tax, from which they had hitherto been largely excluded.

Avoidance schemes closed

A number of anti-avoidance measures were announced today, including:

  • A scheme under which UK domiciliaries purchased interests in offshore excluded property trusts will be blocked. These measures will also apply to existing structures.
  • A particular form of 'cluster policies' that allowed for the disproportionate allocation of gains between linked insurance policies will be treated as a single policy.

UK/Switzerland Tax Agreement

The UK Swiss Tax Agreement, which set out the basis on which the UK would recover unpaid tax on funds held in Swiss banks, has been amended to harmonise it with the EU Savings Directive following a complaint from the European Commission and to ensure that it is only the accounts of non-domiciliaries which escape inheritance tax going forwards.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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