Top Whack - Mazars - United Kingdom

The planned increase to the top income tax rate has alarmed many. Stacy Eden advises on easing the pain.

23/02/2010

Since the Government unveiled its plans to raise the top rate of income

tax from 40 to 50% on April 6 this year for those earning more than £150,000, efficient tax planning has become a major topic of conversation, the like of which we haven’t seen since the 1970s.

For a generation that has grown up with the relatively 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-crunched present 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 merely unlawful.

Use companies

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 and say within the law?

The most obvious way of reducing your tax bill is to consider converting income into capital. There are undoubtedly some aggressive schemes out there and caution is always commended 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 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 to 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.

Leave the country!

Moving abroad could also be on the cards for some property investors once the new higher rate comes into existence this April.

The increase could be enough to tip the balance personal circumstances permitting.

Nonetheless, relocating a property business outside of the UK does not come without its challenges, unless a major decision has been taken to redirect the business into overseas property interests rather than UK ones.

Following 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.

Tax breaks

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.

Defending income

Although high earners are unhappy with the planned 50% rate, their anger will not prevent it becoming a reality on April 6.

Over the last 20 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 is more crucial now than ever.

This article appeard in the Jan/Feb 2010 issue of Residential Property Investor (magazine of the Residential Landlords Association).