The countdown starts now - Mazars - United Kingdom

The planned increase to the top rate of income tax to 50% has set the cat amongst the pigeons. Stacy Eden, head of property and construction at international accountancy firm Mazars, underlines some of the options available to property investors ahead of its introduction on 6th April 2010.

19/01/2010

Since the Government unveiled its plans to raise the top rate of income tax from 40-50% next year for those earning more than £150,000, efficient tax planning has become a major topic of conversation the likes of which haven’t been seen since the 1970s. For a generation that has grown up with the benign 40% rate, the rise comes as a significant blow, and one which speaks volumes about the battered state of public finances.

In terms of taxation, the gloomy 1970s and the credit crisis-stricken Noughties are a world apart, the main difference being the much more draconian regime that now exists and HMRC’s completely different stance towards tax avoidance. In fact, a new term has emerged, avoision, which blurs the lines between tax evasion, which is clearly illegal and tax avoidance, which is unlawful.

In the context of the new higher rate, what can savvy property owners, or even passive investors, do to reduce the impact of the increase?

The most obvious way of reducing your tax bill is to consider ways of converting income into capital. There are undoubtedly some aggressive schemes out there and caution is always recommended as they will almost certainly be scrutinised by the taxman – clearly, such strategies are not for the fainthearted.

However, there are a number of sensible options out there that will appeal to the more cautious in nature. For instance, take properties that are owned through a company. In these cases, the rental stream can be accumulated within the company to avoid paying the new higher 50% tax rate. In addition, when a property sale is anticipated, the company can be sold, rather than the underlying property, the upshot being that the amount received is taxed at the lower capital gains tax rate of 10-18%.

Another structure that is currently being put in place results in individual properties being owned by limited liability partnerships (LLPs), with individual and corporate members. In this way, individual members can take the profit share they require and only pay income tax on that amount. The balance is then allocated to the company, and consequently corporation tax is only paid on the profit accumulated within the business.

When this approach is taken, investments are made through the ‘moneybox company’, which is exposed to much lower rates of corporate tax.

Moving abroad could also be on the cards for some property investors once the new higher rate comes into existence on 6th April. The increase could be enough to tip the balance – personal circumstances permitting. Nonetheless, relocating a property business outside of the UK doesn’t come without its challenges unless a major decision has been taken to redirect the business into overseas property interests rather than UK ones.

Following the changes to the recent Finance Act, the issue of non-domicile must be carefully considered. Anyone in this position should seek early advice on maximising the tax return from their status.

Although property may form the backbone of many investment portfolios, the tax hike is encouraging investors to look elsewhere for tax breaks. Put simply, we expect to see an increased uptake in venture capital trusts and enterprise investment scheme investments as these strategies give tax relief on the amount invested, as well as the ability to grow tax-free in certain circumstances.

Unfortunately, property investment is not permitted in such vehicles, but it can offer a different dimension, and in some cases well needed diversification, to an individual’s asset base. This is particularly relevant when the loss in tax relief on pension contributions is considered.

It is also worth keeping in mind that interest on certain types of debt is tax deductible, for example, when debt is incurred in acquiring let property. Following HMRC guidance, it is also possible to refinance debt and as a consequence gain tax relief on the interest. Where there is a mixture of qualifying and non-qualifying borrowings, it is well worth taking a closer look at whether, and to what extent, the rescheduling of that debt can be carried on to obtain tax relief. With low interest rates, this hasn’t been a particularly high priority, but as tax rates go up, so will the return from carrying out this kind of rescheduling exercise.

Property owners should also take into consideration that the larger the amount they manage to keep out of the taxman’s hands, the more inheritance tax an estate will bear if it becomes invested or accumulated. This is why it is vital to plan ahead and not to lose sight of other useful tax planning measures.

Although high earners are unhappy with the planned 50% rate, this will not prevent the move from becoming a reality on 6th April. Over the last twenty years, the UK has moved from being a nation of tax planners to a nation of wealth creators. This new rate of income tax puts property investors back at square one: defending as much of their income as they can from the taxman, rather than focusing their energies on maximising wealth.

As ever, tax is becoming an increasingly complex issue and the need to appoint advisers, seek early advice from tax specialists and to have a coherent tax mitigation strategy in place are more crucial now than ever.

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About Mazars:

A jpg image of Stacy Eden is available on request.

Mazars is an international firm specialising in audit, tax and advisory services that operates as an integrated partnership in 50 countries worldwide.

In the UK, Mazars is the eighth largest partnership in terms of audit fee income, has the fastest growing tax practice amongst the Top 20 firms.

The firm employs more than 1,100 people and has over 110 partners based in 18 offices throughout the UK.