Income Tax

On the face of it, income tax is a fairly straight forward concept and most individuals will be aware of the different income tax bands and rates.

The tax is in fact quite complex and there are various traps at different income levels which need to be taken into account. For example:

Personal Allowance – All tax payers are entitled to a personal allowance of £7,475 before paying any income tax. However, for those earning above £100,000 per annum, this is reduced by £1 for every £2 over this level. This means the allowance is lost in it’s entirety at £114,950 – an effective rate of tax of 60%.

Age Allowance – The personal allowance is increased to £9,940 for those over age 65 and £10,090 once age 75 is attained. However, any income over £24,000 will again reduce this by £1 for every £2 down to the regular £7,475 level. This means an effective rate of tax for 30% for many pensioners.

Child Benefit - The Government will withdraw Child Benefit payments from all households containing at least one higher rate taxpayer by 2013. This currently means that earning £1 over £42,475 could result in losing Child Benefit of up to £1,752.40.

In order to reduce taxable income to avoid falling foul of the above or to minimise the amount of higher or additional rate tax paid, we can employ a number of strategies. The suitability of these will depend completely on your individual circumstances and our advisers can talk you through the options to reach the most appropriate conclusion.

Pensions

Paying into a pension attracts income tax relief meaning that in effect the government also contributes to your pension. If you have an individual pension your contributions are paid into your fund after tax has already been charged. To offset this, the taxman contributes an amount depending on your tax status subject to HMRC limits. Whether you are a basic or higher rate taxpayer, for every £80 you pay into a personal pension the taxman will add £20.

If you pay higher rate tax, at the end of the tax year you can claim back a further 20% through self assessment. In this case the additional £20 claimable means the cost to you would only be £60. Those paying tax at the additional rate of 50% would enjoy a further 10% on top of this. Lansdown Place are more than happy to guide you through this process.

Even if you do not pay tax you can still benefit from tax relief on contributions you make but only up to a limit of £2,880. The taxman will add 20% on this to make the total £3,600. There is no tax relief for contributions over this amount.

Individual Savings Accounts (ISA)

ISAs provide investors with the opportunity to build up assets which are not subjected to income tax within a holding or upon withdrawal. Cash and a broad range of investments such as Unit Trusts and OEICs can be held and there is no restriction on when or how much money can be withdrawn.

No more than the annual amount limit (£10,680 for 2011/12) can be paid in and the amount that can be in cash is restricted (£5,340 for 2011/12). Any amount not used for cash can be used in a stocks and shares ISA.

Investment Bonds

The underlying funds of Investment Bonds are subject to tax on income. However, any ‘income’ you need can be achieved by selling units. Current legislation allows 5% of the capital to be withdrawn for up to 20 years with no immediate liability to income tax. Withdrawals in excess of 5% are only taxable if they take you into the higher rate income tax band. This makes them useful for higher rate tax payers who expect to become basic rate taxpayers in future, for example at retirement.

Investment Bonds can also be held offshore and many funds are operated by subsidiaries of well-known onshore institutions. Income distributing offshore funds pay their income gross which is particularly attractive to non-taxpayers.

An offshore investment is one which is held, literally, offshore, i.e. not under United Kingdom jurisdiction. If you invest in an ‘onshore’ bond then the fund manager will be liable to pay UK income tax on the underlying fund, which as well as being non-reclaimable, will also hold back the growth of your investment. An ‘offshore’ bond is liable for no UK income tax and therefore grows virtually tax-free at a potentially higher rate.

Offshore investment bonds do not generate income and hence generate no UK income tax liability until the proceeds are brought back onshore. That is not to say that you can necessarily avoid paying UK tax. You may still find you will have to pay some but, with careful planning, you can control when you pay.

If you are living abroad currently, or you plan to move abroad during the life of your investment, you may well object to paying UK-based taxes, especially as these are non-recoverable, and therefore an offshore bond enables you to invest without any liability to UK taxes.

Venture Capital Trusts (VCT)

VCTs are highly tax efficient collective investment schemes designed to provide private equity capital for small expanding companies and capital gains for investors.

Tax reliefs are different for investors in new shares issued by VCTs and investors who purchase second-hand shares, for example on the stock market. For second-hand shares, the relief comes in the form of exemption from income tax on dividends on ordinary shares in VCTs. There are also capital gains tax benefits.

For new shares, the same reliefs are available, and in addition income tax relief at the rate of 30% is available on the amount subscribed for the shares up to £200,000 in a tax year if they are held for at least 5 years

Enterprise Investment Schemes (EIS)

The EIS offers income tax relief to investors who subscribe for shares in qualifying companies. An individual with no more than a 30% interest in the company can reduce his income tax liability by an amount equal to 20% of his share subscription. The minimum subscription is £500 per company and the maximum per investor is £500,000 per annum. This gives a maximum tax reduction of £100,000 each tax year.