Personal Tax

Comment

Income tax rates stay put for a further year and the fears surrounding the prospect of national insurance increases have proved unfounded.

Allowances

The 2006/07 personal allowances were announced in last December’s Pre-Budget Report. The personal allowance for the under 65s is increased in line with inflation to £5,035. Personal allowances for those aged 65 and over are increased in line with earnings.

Tax Credits

The childcare element of Working Tax Credit is currently limited to 70% of eligible childcare costs up to a maximum of £175 per week for one child or £300 per week for two or more children. From 6 April 2006 the percentage increases to 80%.

The government has announced a commitment to increase the child element of the Child Tax Credit at least in line with average earnings until the end of this parliament.

The problems caused by overpayments of Working Tax Credit and Child Tax Credit are well known. In many cases this is because claimants’ income has risen compared to the income in the base year on which their tax credits award was initially calculated. On current rules, the first £2,500 of any increase in income is disregarded in recalculating the award. From 2006/07, this will increase to £25,000.

Comment

The change means that claimants’ 2006/07 tax credits awards will not be recalculated simply because their income has gone up, unless their 2006/07 income is at least £25,000 more than their 2005/06 income. Clearly this will only apply in a very small percentage of cases.

Child Trust Fund (CTF)

Children born since 1 September 2002 receive at least £250 to invest in a tax free savings account. Children from lower income families receive £500. The Chancellor announced that at age seven children will receive a further payment of £250 or £500 for children from lower income families. The government will consult on making further payments to secondary school age children.

Children become entitled to the fund at age 18. Children, parents, family and friends are together able to contribute up to £1,200 a year to the account and there is no tax to pay on any interest or gains made on this money.

Comment

The further payment will be welcomed. Unfortunately this tax free account which is useful for tax free savings is not available to children born before 1 September 2002.

Pensions

The new taxation of pensions regime finally takes effect from 6 April 2006, referred to as ‘A’ day. There will be a single set of tax rules for all registered pension schemes.

Pensions - investments

From ‘A’ day the government will remove the tax advantages for investing in residential property or certain other assets such as fine wines, classic cars and art and antiques from pension schemes which are ‘self-directed’. This will include Self Invested Personal Pension Schemes (SIPPs) and Small Self Administered Schemes. The effect will be to remove all tax advantages from holding prohibited assets directly or indirectly in such schemes. The broad result will be that it is at least no more advantageous to hold such assets in a pension scheme than it is to hold them personally.

The legislation will also apply to indirect investment in these assets. An example of this would be residential property owned by a company in which a SIPP held 100% of the shares. But not all indirect investment will be subject to these rules. Self directed pension schemes which invest in certain commercial vehicles that hold residential properties may be allowed. An example would be the proposed UK Real Estate Investment Trusts.

Pensions and the tax free lump sum

The new pensions regime allows a tax free lump sum of 25% of the fund up to the lifetime allowance to be withdrawn when a person is eligible to take pension benefits.

However the government is introducing an anti-avoidance provision to prevent a device known as ‘recycling’. The device works by taking a tax free lump sum from a scheme which is reinvested back into another scheme giving further tax relief on the amount invested. This in turn allows a further tax free lump sum to be paid out. The new rules will remove tax advantages in relation to lump sums which are artificially recycled in this way.

The legislation is not intended to affect cases where a person withdraws a tax free lump sum as part of the normal course of taking pension benefits.

Pensions - Alternatively Secured Pension (ASP)

The government has announced the inheritance tax (IHT) provisions which will apply to pension funds invested as an ASP. An IHT charge will apply to ‘left over’ ASP funds on the death of the scheme member.

Comment

The pensions tax rules require an individual to secure an income before they reach the age of 75. Most people will have an annuity or scheme pension, but ASP has been provided as an alternative. ASPs were designed for those who have a principled religious objection to annuitisation. The government is therefore trying to restrict the use of ASPs to their original limited purpose.

Unclaimed assets

The government proposes that unclaimed assets in the banking system should be reinvested in society while they remain unclaimed. Where the owners can be traced they can be reunited with their assets.

Unclaimed assets include accounts where there has been no customer activity for a period of 15 years. The money will be reinvested in the community, particularly in deprived communities, with a focus on youth services and financial education.

Venture Capital Trusts (VCTs)

In 2004 the government announced a temporary doubling of the rate of income tax relief for investments in VCTs to 40%. This will be reduced to 30% for shares issued on or after 6 April 2006.

Individuals currently must hold VCT shares for a period of three years to qualify for income tax relief. This period will rise to five years for shares issued on or after 6 April 2006.

The limit in the maximum size of companies able to raise money under VCTs is reduced to £7 million before investment and £8 million afterwards.

Comment

It had been anticipated that the VCT relief would be reduced to the previous level of 20% and so the 30% rate is to be welcomed.

Enterprise Investment Scheme (EIS)

Individuals who invest in qualifying EIS shares are entitled to income tax relief of up to 20% on their investment. For shares issued on or after 6 April 2006:

• the annual investment limit for income tax relief is doubled to £400,000
• the limit on the amount of shares subscribed for in the first six months of the tax year, which can be treated as if they had been issued in the previous tax year, will be doubled to £50,000
• the maximum size of companies able to raise money under EIS is reduced to £7 million before investment and £8 million afterwards.