2007 Budget Commentary
30th March 2007
By now you will probably be familiar with the headline points from this year’s Budget. Whilst not wanting to add to the general avalanche of facts, figures and spin, as your financial advisers we believe that it is important for us to provide a brief and impartial summary of what we consider to be the most relevant developments.
We hope that you find this summary useful. Of course, if there are specific issues arising from the Budget that you would like to discuss then please contact us and we will be happy to assist.
General Overview
The good news is that, overall, we do not expect the measures announced in this year’s Budget to have a significant effect on the financial plans of our clients. There may be opportunities for fine-tuning at your regular review, but urgent action is unlikely to be required.
After the unexpected and seismic changes relating to the taxation of trusts in the 2006 Budget, this year was – from a financial planning perspective - a markedly quieter affair. Much has already been written of the headline cut in the basic rate of income tax and, whilst this will have a positive effect for some of our clients, the abolition of the lower rate band and the extension of the threshold on which employee National Insurance Contributions are due means that the overall effect is unlikely to be as dramatic as some newspaper headlines have suggested.
It is also worth noting that many of the changes will not come into force until April 2008 at the earliest, meaning that for the 2007/08 tax year it will be pretty much “business as usual”. The notable exception to this is the increase in corporation tax for smaller companies (more on this later).
Income Tax
As announced in the November pre-Budget report, personal allowances and tax thresholds have been increased in line with inflation.
The other news in this area is the reduction in the basic rate of tax for earned income to 20% and the abolition of the lower rate band (for earned income only) with effect from 6th April 2008. For clients who can control the level of taxable income they receive (e.g. by transferring income generating assets between spouses or civil partners) there may be some scope to modestly reduce the overall amount of income tax paid.
Since these income tax changes are accompanied by increases in the amount of income on which National Insurance is charged our initial conclusion is that these changes will be broadly neutral for most clients. However, it is important to note that the full details of these changes have not yet been published, and therefore no planning should be undertaken until all of the facts are known.
Capital Gains Tax (CGT)
The annual exemption from CGT has also been increased in line with inflation. This is good news for all clients planning to take income from their investment portfolio, and for clients wishing to adjust portfolio allocations due to changes in life circumstances. Where there is scope to transfer assets between spouses or civil partners the opportunity remains to realise gains of up to £18,400 in the tax year without incurring a CGT bill.
For most trustees, the annual exemption will increase to £4,600. Again this is good news.
Inheritance Tax (IHT)
Following last year’s announcements relating to the taxation of trusts, there is mercifully little to report this year. The nil rate band (the amount of an individual’s estate on death that is taxed at 0%) will increase to £300,000 from 6th April 2007 – with the band set to increase in stages to £350,000 by April 2010. Whilst this is a welcome development, we emphasise that such increases do not diminish the necessity of having a properly drafted will in place.
We do sound a prospective note of caution for clients who hold shares in companies listed on the Alternative Investment Market (AIM) as part of their inheritance tax planning strategy. A technical proposal in the Budget indicates that the government intends to put forward legislation to make it easier for Her Majesty’s Revenue and Customs (HMRC) to designate the AIM as a recognised stock exchange for tax purposes. If such a designation is made then this could potentially affect the favourable inheritance (and capital gains) tax status of these investments. As with all inheritance tax planning strategies, we will keep this area under close review and will inform any affected clients of future developments.
Savings and Investment
The annual limit on ISA investments will be raised to £7,200 per person (with an increase in the cash limit to £3,600) from 6th April 2008.
Also, the Budget confirmed the announcements in November’s pre-Budget report that the distinction between mini and maxi ISAs will be dropped from 6th April 2008, and that PEPs will be brought within the ISA rules; effectively meaning that PEPs will convert to ISAs.
A useful development for some clients is that as from 6th April 2008 it will be possible to convert cash ISA holdings to stocks and shares ISAs (in addition to investing new funds up to the annual limit). This opportunity may be appropriate for clients who already hold sufficient cash liquidity elsewhere. For clients holding cash ISA funds this is something that we will discuss with you at your regular review.
The government has also announced that it will be possible for Child Trust Funds (CTFs) to be rolled over into ISAs on maturity. Whilst this enhances the attractiveness of CTFs from a tax perspective, the caveat of whether it is appropriate to provide a teenage child with uncontrolled access to a potentially substantial sum of money continues to apply. Those clients considering making additional contributions to a CTF for a child or a grandchild should consult us to explore the full range of gifting options before doing so.
Pensions
As expected, the government has confirmed the tightening of legislation governing the use of Alternatively Secured Pensions (ASPs). This includes the introduction of the requirement to draw a minimum income from an ASP fund, and a tax charge on any ASP fund remaining on the death of the member which is subsequently transferred to the pension fund of other members of the scheme. Despite the supposed “simplification” of the legislation governing pensions introduced in April 2006, the decision on how one should draw pension benefits remains complex and should only be made within the context over your overall financial plan.
Pensions remain highly tax efficient mechanisms for providing an income in retirement and where appropriate we feel strongly that higher rate tax relief should be taken advantage of, particularly where we forecast that only basic rate tax will be paid on the subsequent benefits.
Corporation Tax and Remuneration Strategies
The headline cut in the main rate of corporation tax (from 30% to 28%) will come into effect from 6th April 2008. However, of greater significance for owners of smaller limited companies is the increase in the smaller company rate (for annual profits up to £300,000) from 19% to 20% next month, with further 1% increases planned for 2008 and 2009.
Given that changes to income tax and employee NIC levels do not come into effect until 6th April 2008 it is unlikely that this increase will have a material impact on remuneration strategies for business owners (the salary v. dividend debate) in the current tax year. However, it would be prudent to review such strategies in conjunction with us and your accountant before the start of the 2008/09 tax year.
The increase in corporation tax for smaller companies serves as a useful reminder that an employer pension contribution remains one of the most efficient ways to extract profit from a limited company. This is because, in addition to the employee paying no income tax or NIC on the contribution, the contribution remains a tax deductible expense for the company, and no employer’s NIC is due. The potential value of such contributions increases significantly for companies with profits approaching or in excess of £300,000 (where the marginal rate of corporation tax increases to 32.5%), as they can potentially be used to maintain taxable profits below the £300,000 threshold.
General Tax Planning
The detail of this year’s Budget was characterised by the continued drafting and refining of legislation to close loopholes and to make it harder to avoid tax by using tailored schemes to exploit inefficiencies in tax legislation. HMRC have become increasingly effective at this, and it remains our strong opinion that tax avoidance schemes are highly vulnerable to attack from them – with an ever increasing risk of scheme failure. We routinely evaluate such “tax saving” schemes for clients, and are always happy to provide objective feedback on any scheme or investment proposition that may be presented to you.
In general, it remains our strong opinion that the most effective way to achieve your long-term financial goals is to maintain a disciplined and structured investment strategy to harness the power of the capital markets over the long term; whilst making use of the various HMRC sanctioned avenues for minimising tax where appropriate.
Final Notes
This commentary is intended for information purposes only, and no action should be taken or refrained from being taken as a consequence of it without first consulting us.
This commentary is not intended to be exhaustive. In the interests of brevity we have focused only on those areas which we believe to be of most relevance to our clients. If there are other aspects of the Budget that you would like to discuss then please contact us.