You need to understand the basic tax and benefits rules to ensure you receive all the allowances, reliefs and benefits you are entitled to.

In this chapter, five things that really matter:

• ˜ Attacking your income tax bill
• ˜ Reducing National Insurance contributions
• ˜ Benefiting from social security
• ˜ Minimising capital gains tax
• ˜ Avoiding inheritance tax

For employees, income tax (IT) is deducted from pay by the pay-as-you-earn (PAYE) system, which spreads the impact evenly over the year. The self-employed do not have this convenience.

Some people look upon National Insurance contributions (NICs) as contributions to a fund rather like pensions. This is wrong. There is no fund and there are no rights to future benefits. Consequently you should recognise NICs as in effect another tax on income.

Capital gains tax (CGT) is payable on the sale not only of stocks and shares but also of anything other than household goods and personal effects up to the value of £6,000 and private motor vehicles. Subject to certain exceptions, you do not pay CGT on any gain you make when you sell your home. Nor, on the other hand, can you set off any loss against gains made elsewhere.

Inheritance tax (IHT) is normally payable on death but can be partly payable earlier. It is also sometimes called a voluntary tax, because there are so many ways of avoiding it, but they are not straightforward.*

Is this you?

• I am getting married next month – will we get the married couple’s allowance?
• How do I get these new tax credits?
• I am becoming self employed – how will my National Insurance contributions be paid?
• How do I work out the taxable gain when I sell some shares?
• If my husband and I leave

everything to each other, will we avoid inheritance tax?

Attacking your income tax bill

Allowances

Apart from the personal allowance (in 2001 £4,535), there is a married couple’s allowance for certain pensioners and a blind person’s allowance.

Reliefs

Reliefs from income tax arise in respect of certain payments that you make and are deducted from income in arriving at taxable income. They include:

• ˜ Interest on loans – mortgage interest relief has been abolished but you can claim tax relief on certain other loans, such as to buy or improve the property you rent.
• ˜ Pension scheme contributions.
• ˜ Expenses at work – if you are employed and you have to pay for:
  • things you use at work, such as tools or working clothes
  • travelling expenses or use of your car on company business (but not from home to work)
  • subscriptions to professional bodies.
• ˜ Renting a room – if you rent out furnished accommodation in your only or main home and receive less than (2001) £4,250 a year gross income, i.e. before deducting expenses, it is tax free.
• ˜ Maintenance payments – pensioners entitled to the married couple’s allowance get relief on maintenance payments, subject to the same limits.
• ˜ Charitable payments – every payment to a charity now qualifies for recovery by the charity of the tax deducted. If you are a higher rate taxpayer, you receive a tax rebate for the balance.

Taxable income

After deducting your allowances and reliefs, what is left is taxable income. This is subject to tax at increasing rates for successive bands, at the time of going to press:

Lower rate band 10%	Up to £1,880
Basic rate band 22%	£1,881 to £29,400
Higher rate band 40%	Over £29,400*

Tax credits

These have replaced certain National Insurance benefits. They are paid through the PAYE system. They have to be applied for on forms available from Benefits Agency offices, job centres, post offices and tax enquiry centres, as well as Citizens’ Advice Bureaux. Tax credits include:

• ˜ Working families’ tax credit – available to couples (or single parents) with one or more children living with them. One parent must be working for at least 16 hours a week and savings cannot be more than £8,000.
• ˜ Disabled person’s tax credit – the disabled person must be working for at least 16 hours a week and savings cannot be more than £16,000.
• ˜ Children’s tax credit – despite the name,

• this is an allowance rather than a credit. Families with at least one child will get 10% relief on £5,200, subject to a reduction if the claimant pays higher-rate tax.

Investment income

Income from the following investments is free of tax:

• ˜ National Savings Certificates and children’s bonus bonds
• ˜ TESSAs (till maturity)
• ˜ PEPs
• ˜ ISAs
• ˜ Friendly Society savings schemes.

Dividends on shares are treated as having been taxed at source at 10% (this is sometimes called the dividend tax credit). It cannot be avoided and cannot be recovered by a non-taxpayer. Higher-rate taxpayers must pay a further 32.5%.

Tax-free benefits in kind

Find out if any are provided by your employer. Can you persuade your employer to provide some, bearing in mind that they are also free of National Insurance contributions for the employer.

The following are tax free:

• ˜ Company contributions to occupational or (within limits) personal pensions.
• ˜ Loans – an employer can make a loan to an employee of up to £5,000 at no interest or at a low rate of interest. Above that amount, a set rate of interest (in 2001 7.75%) is used to calculate the taxable benefit.
• ˜ Relocation costs – if your employer moves you to another area, you can receive reimbursement of relocation costs totalling up to £8,000 tax free. Beyond that it becomes a taxable benefit.
• ˜ Golden handshakes – statutory redundancy pay is tax free and if you receive additional compensation, up to £30,000 may be tax free. There are complicated rules.
• ˜ Mobile phones.

Spouses

There are various ways that a married couple can minimise their joint tax liabilities, by making full use of both personal allowances and lower tax rates.

If one is self-employed, could the other receive pay from the business, perhaps by performing clerical tasks? Could the business be in joint ownership so that the profits are shared?

Where one spouse is employed and the other is not, the only way of transferring income is by putting savings in the name of the one who is unemployed, so that they receive the income.

Money can be freely transferred. Shares or units can be transferred between spouses (but not between unmarried couples) without payment, although the transfer must be unconditional. All that is required is the preparation of a standard share transfer form (obtainable from any law stationer). It must be stamped, but only at 50p.*

The married couple’s allowance (now only available to pensioners) is normally received by the husband, but can be transferred to the wife. However, since the allowance is limited to 10%, this action would save tax only if the wife does but the husband does not pay income tax.

Children

Children are liable for income tax and are entitled to the personal allowance and the lower rates. Parents can only transfer to a child capital which earns no more than £100 a year. If income from transferred capital exceeds that amount, it is treated as income of the parent and is taxed accordingly.

Since the limit only applies to parents, there is nothing to prevent grandparents (or anyone else) from transferring capital to a child, although the inheritance tax rules apply.

Loss-making business

If you have an expensive hobby you might be able to turn it into a loss-making business. Then losses can be set against other taxable income, thus reducing tax liability.

Professional advice is advisable. You need to be trading so that there is some way, or potential way, of earning income.

Annual planning

It is worth reviewing your situation before the end of each tax year (i.e. before 5 April).

Check whether there have been any changes in your personal position which can affect your tax liability. Are there any allowances or reliefs you can claim which you have previously overlooked?*

Reducing National Insurance contributions

National Insurance contributions (NICs) are paid on earnings, not unearned income. Consequently any replacement of earnings by unearned income reduces your NICs.

In the case of benefits-in-kind for employees, tax-free benefits are generally free of NICs. Taxable benefits are not.

The main limitation on fringe benefits is that they must be convertible neither into cash nor reimbursements. For example, a season ticket paid for by the employer is free of NICs, but if the ticket is bought by the employee who is then reimbursed, then NICs are payable.

Petrol for private use must by paid for by company voucher or company credit card. Alcoholic liquor is specifically made subject to NICs.

Examples of fringe benefits free of NICs are:

• ˜ board and lodging
• ˜ clothing
• ˜ gifts of tangible items (not money) in respect of long-service awards, birthday or retirement presents
• ˜ luncheon vouchers
• ˜ club membership fees
• ˜ fees to professional bodies (if membership is a condition of employment)
• ˜ medical insurance
• ˜ school fees.*

Benefiting from social security

The main benefits are:

• ˜ Child benefit – payable for each child under 16 or, if in full-time education, 19. There are no limits or deductions; every child is eligible.
• ˜ Income support – payable if you work for less than 16 hours a week. There are income and savings limits.
• ˜ Council tax benefit – for those who receive income support.
• ˜ Housing benefit – for those who pay rent and receive income support.

Other benefits include incapacity benefit, attendance allowance, industrial death or injury, maternity and widows benefit.

In addition, those in receipt of other benefits may qualify for help with NHS costs, such as prescriptions, dental and optical costs.*

Minimising capital gains tax

Capital losses are set off against capital gains in the same tax year and after that there is an annual exemption, currently £7,500. As a result, few people pay capital gains tax (CGT).

If the net result of a year’s transactions (before the annual exemption) is a loss, it can be carried forward to succeeding years. The annual exemption cannot be carried forward, but can be applied to the net gains for a year before any loss brought forward which, if not then used, can be carried forward again.

The following investments are exempt:

• ˜ gilt-edged stock
• ˜ company debentures and loan stocks
• ˜ ISAs and PEPs
• ˜ permanent interest-bearing shares of building societies (PIBs)
• ˜ enterprise investment schemes and venture capital trusts (EIS and VCTs).

Indexation and taper relief

For purchases before April 1998 the cost can be indexed, that is adjusted by the cumulative rate of inflation (RPI) between purchase and April 1998. However, indexation cannot be taken beyond break-even, i.e. it cannot be used to create a loss.*

From April 1998, indexation was replaced by taper relief which is based on length of ownership. It only applies to shares held for at least three complete years, although an extra year is added to the total for shares owned on 17 March 1998.

The percentage of the gain chargeable reduces to 95% after the third complete year and by a further 5% for each successive year, to a minimum of 60% after ten complete years.

For example, if you bought shares in August 1996 and sold them in June 2001, the taxable gain would be calculated as follows:

• ˜ the original cost would be increased to 5 April 1998 in accordance with the CGT indexation allowance for the period, to give the indexed cost

• ˜ the excess of the selling value over the indexed cost gives the taxable gain before taper relief
• ˜ although the shares have only been held for two full years since April 1998, as the shares were held on 17 March 1998 an extra year is added, making a total of three years, so taper relief reduces the chargeable gain to 95%.

More favourable taper relief applies to business assets and since 6 April 2000 it also applies to all shares owned in your employing company and to all shares in unquoted and AIM quoted companies.

The percentage of the gain chargeable in this case reduces to 87.5% after the first complete year, to 75% after two years and 50% after three, to a minimum of 25% after four years.

Where shares qualify as business assets only from 6 April 2000, the gain for shares owned on that date has to be apportioned between the two periods.

The complications of indexation and taper relief can of course be ignored if your total gains for a year do not exceed the annual exemption, currently £7,500.

Re-investment relief

Chargeable gains on disposals can be deferred indefinitely if the amounts realised are re-invested in new share issues from qualifying companies under the Enterprise Investment Scheme.*

Annual planning

This is mainly a matter of ensuring you make use of your annual tax-free allowance.

You should keep a running record of your sales during each financial year (starting 6 April), with a note of the gain or loss, after adjusting for indexation and taper relief.

Check on the cumulative position at the beginning of March. If you have a substantial amount of your annual allowance still available, then take a look at the unrealised gains in your portfolio.

Bed and breakfasting

Before 17 March 1998, any unused annual

allowance could be applied to unrealised gains before the end of the tax year by selling the shares one day and buying them back the next. This has been stopped by introducing a 30-day interval between selling and buying back, otherwise the two transactions will be ignored for capital gains tax purposes.

It is, of course, possible to take the risk of being out of the market for 30 days. Other alternatives are:

• ˜ If you have not used all your current year’s ISA allowance or have uninvested amounts in a PEP, then you can ‘bed and ISA’ or ‘bed and PEP’, that is buy back into an ISA or PEP.
• ˜ If you are married you can sell and your spouse buy back (or vice versa).
• ˜ You can buy a similar share (e.g. BP for Shell) or your best choice of new investment.

With all these alternatives the sale and buy-back can be done simultaneously, so there is no risk of adverse price movement overnight.

The disadvantage is that costs of both selling and buying (including stamp duty) are incurred, although some stockbrokers will forgo some or all of their commission on the second transaction. Also, you lose the difference between the buying and selling prices.*

Avoiding inheritance tax

Making gifts during your lifetime

Inheritance tax (IHT) may be payable on gifts you make before your death but, if you can afford it, there are a number of gifts you can make free of IHT. Of particular importance is the £3,000 annual exemption (higher amounts on marriage) and the unlimited number of gifts of £250 to any one person.

Gifts to individuals or certain trusts that are not otherwise exempt are potentially exempt transfers (PETs). Tax is avoided if you live for seven years after making the gift, but if not it may be payable on your death.

Gifts to companies or discretionary trusts are called immediately chargeable transfers

(ICTs) and half the IHT rate of 40% is payable immediately. The balance may become payable if you die within seven years but if no tax is due then you cannot recover what has been paid.

Tax payable on death

Amounts left to your spouse are free of IHT and most couples leave everything to each other, but this may not be the best solution.

The first £242,000 of taxable estate (the exempt amount or threshold) is free of tax. It sounds a lot but with house values now so high, tax may be payable. Beyond the threshold, the tax rate is 40%.

PETs and ICTs made within seven years of your death are counted in order of payment and so are set against the threshold first. There is taper relief from the fourth year but it only applies to amounts which exceed the threshold.

Tax must be paid before grant of probate (official permission for executors to act) but assets cannot be sold before getting probate, so it may be necessary for the executor(s) to borrow.

If the estate includes property, it is possible to defer payment of the proportion of IHT payable that is equal to the proportion of the property value to the whole estate.

Certain investments that include life cover, such as with-profits bonds, although subject to IHT, can be written into trust so that they pass directly to your heirs and can then be realised to meet at least some of the tax bill.

Planning for IHT

The importance of making a will cannot be over-stressed. Otherwise, intestacy rules apply, which may not suit you.*

If a married couple’s joint estate may exceed the threshold, they need to find a way of using the exempt amount on the first death. The problem usually is that the survivor cannot manage without the assets, particularly the house.

There are ways in which this problem can be overcome but they need to be watertight, so the use of a solicitor experienced in IHT

planning is essential. Usually a trust is set up to come into operation on the first death and receive assets up to the exempt amount. It is possible for the surviving spouse to be a beneficiary.

If all the beneficiaries agree, a will can be changed within two years of the death – this is called a deed of variation.

If you know that IHT will be payable, make some provision for it, such as life assurance. For a married couple, a joint life second death policy can be taken out, written into trust for the beneficiaries so that it escapes the IHT net.

Summary points

• * Check your income tax position shortly before the year end to make sure you have all the allowances and reliefs you are entitled to.
• * Are your fringe benefits subject to National Insurance contributions because they are convertible into cash? If so, can you do anything about it?
• * Are you aware of the social security benefits you may qualify for? If not, get hold of leaflets from your local office.
• * Capital gains tax liability should also be looked at before the year end to see whether you can sensibly use your exempt amount.
• * If you have a potential inheritance tax liability, think about taking steps to reduce it, or at least provide for it.