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Tax Tip Newsletter, November 2007

 

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How to Avoid Property Tax 2007

By Carl Bayley BSc ACA

Hot off the press, the 2007 edition contains all the latest tax changes plus lots of new tax saving ideas, living up to its reputation as the Tax Bible for property investors. It's essential reading for:

How to Avoid Property Tax is crammed full of examples, tax tips and Carl's special "Wealth Warnings". Subjects covered include:

 

 

How the New Capital Gains Tax Rules will Affect You

Surprising News for Property Investors from the 2007 Pre-Budget Report

By Carl Bayley BSc ACA

Our new Darling Chancellor’s first Pre-Budget Report, delivered on 9th October 2007, has caused quite a stir in the UK property taxation world.

The biggest news is undoubtedly the shock announcement of a new single flat rate of Capital Gains Tax. The new rate of 18% is to apply to all capital gains arising on or after 6 th April 2008.

And it isn’t just a new rate of tax. Effectively, from 6 th April 2008, we will have a whole new and much simpler Capital Gains Tax regime. The new flat rate system will replace the taper relief regime introduced by Gordon Brown in 1998. From next April, we will no longer be concerned with how long an asset has been held or whether it qualifies under the rather tortuous ‘business asset’ rules – the flat rate of 18% will apply to everything.

In the immediate aftermath of the Pre-Budget Report, early commentators were swift to remark on what good news this was for property investors. The new rate of 18%, they argued, was an improvement on the effective long-term rate for sales of non-business assets by higher rate taxpayers holding property for ten years or more: 24%.

However, as is usually the case in the tax world, things are not so simple in every case.

Sure enough, most higher rate taxpayers selling residential property after 6 th April 2008 will benefit under the new flat rate regime. But many other investors are set to lose out.

The abolition of taper relief means that the ability to benefit from an effective Capital Gains Tax rate of just 10% after owning qualifying business assets for just two years will disappear. Since 2004, most commercial property has qualified as a business asset for taper relief purposes. The effective tax rate on sales of this property after 6 th April 2008 will almost double from 10% to 18% in many cases.

Qualifying furnished holiday letting accommodation also currently qualifies as a business asset for taper relief purposes. The tax rate on sales of these properties will also increase next April.

Another group of people who may lose out are basic rate taxpayers. The new flat rate of 18% applies to everyone regardless of their income level. A basic rate taxpayer selling a property held since before 17 th March 1998 would currently pay Capital Gains Tax at an effective rate of just 12%. After 6 th April 2008, this increases by a factor of a half, to 18%.

In fact, any basic rate taxpayer selling property which they have owned for five years or more may be worse off under the new flat rate regime.

Example

Alistair is a property investor with a modest portfolio of properties. His portfolio produces a small rental loss each year and he lives off a salary of £10,000 from a part-time job which he augments by re-mortgaging the properties in his portfolio.

Alistair now wishes to sell a buy-to-let property which he bought in October 1998. He expects to realise a gain of £60,000 after taking account of selling expenses, etc, and is unsure whether the sale will take place before or after 6 th April 2008.

Alistair’s tax position on a sale before or after the new flat rate comes into force may be compared as follows:


Before
After
Gain on sale of property
60,000
60,000
Less: Taper relief @ 35% (9 years)
21,000
-
 
-
-
Annual exemption
39,000
60,000
 
9,200
9,200
 
-
-
Taxable gain
29,800
50,800
 
-
-
Capital Gains Tax @ 20%/18%
£5,960
£9,144

As we can see, in this example the investor will be more than £3,000 worse off if the sale takes place under the new flat rate regime.

On the other hand, of course, if Alistair were a higher rate taxpayer, currently paying Capital Gains Tax at 40%, he would be nearly £3,000 better off under the new regime. There are winners and losers here and you need to know which one you are!

Other potential losers

Many higher rate taxpayers currently save Capital Gains Tax on property disposals by making a pre-sale transfer of a part interest in the property to their basic rate taxpayer spouse or civil partner. This planning will be much less effective under the new regime.

Many properties currently have a partial entitlement to business asset taper relief, such as a mixed use building with a shop on the ground floor and flats above. The change to a flat rate will increase the effective rate of tax on the business part of the property.

Properties purchased before April 1998 currently attract indexation relief. For older properties held since March 1982, indexation relief amounts to 104.7% of the property’s value at that time. Indexation relief will also be abolished with effect from 6 th April 2008 meaning that the gain on some older properties will be significantly increased.

Planning for the new regime

The new flat rate regime will produce winners and losers and anyone contemplating a sale in the near future would be well advised to give some consideration to whether they want their sale to go through before or after 6 th April 2008. As a final word on this subject, remember that the date of sale for Capital Gains Tax purposes is the date on which there is an unconditional sales contract; this may be some time before completion in many cases.

Other news in brief

The change to the Capital Gains Tax regime is by far the biggest news for property investors. A few other points are, however, also worthy of a brief mention:

More information on this subject is contained in the guide How to Avoid Property Tax




Non-Resident and Offshore Tax Planning

By Lee Hadnum LLB ACA CTA

In many respects this is the ultimate form of tax planning. By becoming non-resident or moving your assets offshore it is possible to cut your tax bill to zero. However, there are also many traps to avoid and pitfalls to negotiate.

This tax guide is designed to help the following groups of people:

What Information is Contained in the Guide

 


Can You Be a Tax Exile?

By Lee Hadnum LLB ACA CTA

We've all read in novels and the popular press of the rich and famous avoiding UK taxes by basing themselves overseas and flitting in and out of the country to conduct business dealings. In the past, becoming a tax exile in this way was reserved for the very wealthy who had the access to the expertise, as well as the cash resources, to allow them to gain residency in low-tax jurisdictions and to fund this kind of lifestyle.

Now, though, with the ease of international travel and the rise in wealth of the middle classes, there are more openings to allow anyone to consider taking advantage of these opportunities to become a tax exile.

Why become a tax exile?

Well the answer to this is pretty obvious...to avoid taxes! Although the UK does have some generous tax reliefs, especially for businesses or assets that are used by a business, there are still a significant number of people who could be subject to high rates of tax.

Who becomes a tax exile?

Anyone can become a tax exile, but here are some of the typical people who move overseas to avoid UK taxes:

One of the biggest groups of people who can be hit by higher tax rates are property investors. The high price rises over the past couple of years have left many with huge paper gains, but also significant levels of debt. If properties have been remortgaged to obtain funds to invest in more property purchases it could easily be the case that there may not be enough cash left after the sale to satisfy any UK tax bill.

By moving overseas before disposal, they would be looking to ensure that any disposal of the properties would be free of UK capital gains tax. If they also establish residence in a capital gains tax-free country, they could avoid overseas tax as well.

They can avoid UK income tax on dividends and capital gains tax on share disposals by becoming a tax exile

The nature of the internet means that they can conduct their business from anywhere. Many websites are run from one-room operations and have limited staff or running costs. Depending on the services actually provided, they can structure their activities as being conducted from overseas to ensure that they avoid UK tax and filing requirements.

Inheritance tax is a big issue for many. Losing UK domicile allows them to potentially avoid UK inheritance tax on their overseas estate.

How to avoid the main UK taxes

Income tax

This is determined to a large extent by your residence status. Therefore if you are UK resident you'll be charged UK income tax on your worldwide income. If you're non-UK resident, you'll only be charged UK income tax on your UK income. However, in practice there are a number of exemptions for non-UK residents.

In particular, if you're non-UK resident (and ordinary resident -- see below) you should be able claim an exemption for UK source interest and dividends on the basis that no tax is deducted at source.

So a non-resident shareholder can avoid UK income tax on dividends. Any overseas income will be excluded from UK tax but other UK income, such as UK trading income and rental income, will still be taxed in the UK, even if you're non-resident.

Capital gains tax

This is one of the key tax exemptions. Individuals who are non-UK resident are exempt from UK capital gains tax on UK and overseas disposals provided they're not used for the purposes of a UK trade. So unless you use the UK assets for the purpose of a UK trade you should be able to claim the capital gains tax exemption.

Note that a caveat here is that if you've owned the asset before you leave the UK you will usually have to remain overseas for five full tax years to avoid the capital gains tax charge.

This is the main attraction for many tax exiles, and UK property investors, for example, could take advantage of these rules to avoid paying any tax on the disposal of UK properties.

Inheritance tax

Your liability to inheritance tax has nothing to do with your residence status. Instead this is almost solely concerned with your domicile status. If you lose UK residence, you'll be able to take advantage of the income tax and capital gains tax exemptions as above, but your worldwide estate will still be subject to UK inheritance tax.

If you lost your UK domicile you'd only be subject to inheritance tax on your UK estate, although you'd find that most UK domiciliaries would have a UK estate that was below their UK nil rate band (as they'd hold assets overseas) to ensure there was no inheritance tax charge.

So if you wanted to become a total tax exile you'd need to lose both your UK residence and domicile status. If you weren't too concerned with inheritance tax, at least not for the time being, you'd be mostly focused on losing your UK residence status.

Losing UK residence status

There is a much-publicised rule from the Revenue that states you can lose UK residence if you are in the UK for less than 90 days per tax year (on average over a period of up to four tax years). However it's crucial that when considering this you don't see it as just a case of counting UK visits. Other people have done this and have come a cropper.

The Revenue are concerned with people leaving the UK, claiming non-residence but still having significant UK ties. So if you want to establish non-UK residence you should look at:

When going overseas you should always try to ensure that your absence is for at least three years. When combined with the above this would then also assist in ensuring your are non-UK ordinarily resident (which is important, particularly in terms of the capital gains tax exemption).

Whichever option you go for or whatever tax you wish to avoid, actually cutting UK ties, selling UK assets and minimising visits are crucial. Ensure you take detailed advice on any plan to become non-resident for tax purposes.


More information on this subject is contained in the guide Non Resident and Offshore Tax Planning

 



The World's Best Tax Havens

By Lee Hadnum LLB ACA CTA

This book provides a fascinating insight into the glamorous world of tax havens.

This is the only book of its kind and, as with all Taxcafe guides, The World's Best Tax Havens is written in clear English with plenty of examples and tax planning tips. You'll find out all about:



Working Abroad - Minimise UK Income Tax

By Lee Hadnum LLB ACA CTA

Many people are now offered the opportunity to go and work overseas. One of the key considerations should be achieving the tax advantages that can go with working overseas.

What are the tax advantages?

The main tax advantage is that if you can be classed as non-UK resident and non-UK ordinarily resident, you will be exempt from UK income tax on your overseas salary income. If you're working in a nil or low-tax environment such as Dubai, this means you can receive your salary totally tax free.

Other tax benefits of establishing non-UK residence status include:

Residence

There is no firm guideline laid down in the tax legislation as to when an individual is and is not UK resident and the courts have traditionally given residence its ordinary dictionary meaning.

Therefore, they take the view that to reside somewhere means to 'dwell permanently or for a considerable time’, and to live in or at a particular place.

In this respect, the courts/commissioners could look at a person’s ties to the UK, the regularity and length of visits to the UK, past and present habits of life and freedom of attachments abroad. As such, if you go to work overseas and have no real visits to the UK in the period since departure, you’d clearly be non-UK resident. If, on the other hand, you retained a UK property, came here for around 5-7 days per month and lived with close family, it is likely you would be UK resident.

In fact, though, this strict legal position is modified by Revenue practice/concessions, but it’s still worth bearing the strict legal position in mind because the Commissioners can and do ignore the Revenue practice if they choose to.

Revenue Practice

If you leave the UK to work full-time abroad under a contract of employment, you are treated as not resident and not ordinarily resident if you meet all the following conditions:

- total less than 183 days in any tax year, and
- average less than 91 days in a tax year. (The average is taken over the period of absence up to a maximum of four years. Any days spent in the UK because of exceptional circumstances beyond your control, for example the illness of yourself or a member of your immediate family, are not normally counted for this purpose.)

If you meet all these conditions, you are treated as not resident and not ordinarily resident in the UK from the day after you leave the UK to the day before you return to the UK at the end of your employment abroad. You are treated as coming to the UK permanently on the day you return from your employment abroad and as resident and ordinarily resident from that date.

If you meet ALL these conditions, you are entitled to claim non-UK resident and non-UK ordinary resident status from the day following departure from the UK for full-time work abroad as above. That status continues as long as you continue to meet all of these conditions.

As soon as you cease to meet these conditions in a tax year, you would then not be entitled to the concessionary treatment.

It's therefore essential that, in order to claim the benefit of the concession (essentially to expedite your non-residence application and to prevent the strict legal position being initially considered), you are:

If you're not, the Revenue will usually be quick to point out the concession does not apply.

Full time

This is not defined and there is no minimum number of hours specified. However, the Revenue regard a working week of 35-40 hours as full time and can accept lower hours if it’s reflected in local conditions. Several part-time jobs can also constitute full-time work.

If you own a company, there is nothing to prevent you from establishing non-UK residence by drafting a contract of employment with an overseas subsidiary. Provided you then meet the above conditions, the fact that you are a shareholder in the company would not prevent you establishing UK residence. Clearly you'd have to be an employee and be able to show that there was a genuine full-time employment.

When can the conditions be breached?

There are lots of circumstances where the conditions can be breached aside from the obvious breaches of exceeding the 90-day requirement or not ensuring the employment contract lasted for a complete tax year.

The Revenue have stated that '...If there is a break in full-time employment, or some other change in your circumstances during the period you are overseas, we would have to review the position to decide whether you still meet the conditions...' and '...If at the end of one employment you returned temporarily to the UK, planning to go abroad again after a very short stay in this country, we may review your residence status in the light of all the circumstances of your employment abroad and your return to the UK...'

You would also need to ensure that there were no UK duties other than 'incidental' UK duties. Incidental has been strictly construed for this purpose and, for example, a pilot whose flights required occasional stopovers in the UK was held to have more than incidental UK duties.

You would also need to ensure that your employment was full time. If, for example, you had a significant period away from the overseas office and spent this in the UK, it is likely the Revenue would argue that you were not in full-time employment. Therefore, there are cases where the Revenue have challenged individuals having 80 days spent in the UK in a tax year to visit aged relatives etc on the basis that they were not in full-time employment.

Whenever you’re considering an overseas employment, paying careful attention to the above details can ensure UK income tax is significantly reduced, or even avoided in full.

More information on this subject is contained in the guide Non Resident and Offshore Tax Planning




Using a Company to Save Tax

By Lee Hadnum LLB ACA CTA

By running your business through a limited company you stand to save tens of thousands of pounds in tax and national insurance every year.

Why? To start with UK corporation tax rates are much lower than income tax rates. Secondly, company owners can pay themselves dividends, which are taxed much less heavily than other forms of income. Finally, setting up a company with your spouse allows you to split your income which almost always results in a lower tax bill.

This tax guide tells you everything you need to know about the tax benefits of incorporation. It is important reading for:



Why it's More Attractive to use a Company After the Pre Budget Report

By Lee Hadnum LLB ACA CTA

When considering the tax benefits of using a company (as opposed to trading in your own name) one of the key tax advantages is the ability to retain profits in the company, which are then only subject to corporation tax as opposed to income tax. Based on current rates and assuming the company is a small company with profits of less than £300,000 the difference is between someone paying corporation tax at 20% and income tax at 40%.

Retaining cash within the company can therefore represent a significant tax saving, but the ultimate problem is how to extract it. You could extract it annually as a dividend, but for many shareholders this would incur an additional 25% income tax charge.

A popular option is to retain cash in the company, which would be used to fund business investment or to provide the option of a large cash extraction in the future.

The current problem with retaining cash in the company is that on any disposal of the shares or on a liquidation, business asset taper relief status could be withdrawn. If you built up significant cash reserves in the business any disposal or transfer of shares in the company could be 'penalised' as the company may not qualify for full business asset taper relief on the shares.

This is because the taper relief provisions don't count a company as a trading company if it has substantial non-trading assets or income. ‘Substantial’ in this context is taken to mean at least 20% of net assets or income. The Revenue will consider any form of non-trading asset for this purpose, including property held in a company that is let (eg old business premises) as well as surplus cash not required for the purposes of the trade.

Therefore anyone looking to benefit from retaining profits within a company could, under the current taper relief provisions, suffer a tax penalty when they sell the shares.

Liquidating the company to extract cash

This was even more prominent when looking at liquidations. An extraction of cash from a company during the course of a winding up is generally treated as a capital distribution as opposed to an income distribution, and would therefore be subject to capital gains tax as opposed to income tax.

As such, if a large amount of cash was generated in a company, rather than extracting it annually and suffering an effective 25% income tax charge, one option would be to retain the cash in the company, liquidate it in the future and pay a capital distribution. If business asset taper relief applied, this would mean that you’d only be taxed at 10% on the extraction of the cash. This 15% tax saving on extraction can represent a significant sum.

The downside, though, is that, as above, the Revenue would consider whether the company truly was a trading company for the purposes of taper relief and could refuse business asset status for the shares (which could significantly increase the tax charge anywhere from 24% to 40%).

Where are we now?

The recent Pre-Budget report made an announcement that taper relief would be withdrawn for disposals after 6 April 2008. As from this date all capital gains will instead be subject to a flat CGT rate of 18%.

This means that there is no capital gains tax problem in retaining cash within a company. In the scenario above, the company could be liquidated and CGT would be payable on the extraction of cash as a capital distribution.

This, therefore, makes using a company potentially more attractive. Trading profits can be retained in the business, incurring a reduced rate of tax, and can then be extracted again at minimal tax cost in the future.

Downsides of using money box companies

There are a couple of points that you would need to watch out for:

However, provided a trade is actually carried out in the company and it is simply a case of not extracting all of the trading profits, it is very unlikely that the company would be classed as an investment company.

However, aside from these, the new CGT rate removes one of the obstacles to retaining large cash balances within companies.

It should also be remembered that, as well as extracting the cash as a distribution on winding up it could be extracted as a simple dividend either after you're non-UK resident or while UK resident but within your basic rate tax band. In either of these cases, dividends can be received free of income tax.

More information on this subject is contained in the guide Using a Company to Save Tax

 

Pay Less Tax with Taxcafe's Guides

How to Avoid Property Tax

Using a Property Company to Save Tax

How to Avoid Inheritance Tax

Tax Planning for Couples

Non-Resident & Offshore

World Best Tax
Havens

Salary versus Dividends

Using a Company to Save Tax

Taxcafe Tax Guides

All Taxcafe tax guides are written by professionals in jargon-free, easily digested English.  Click on the following link to view our entire range of tax guides:

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Disclaimer

Please note that this information is for general guidance only. Taxcafe UK Limited cannot be held responsible for any decisions made as a result of information contained herein. You are encouraged to seek legal and financial advice before making any investment decisions.