Private clients newsletterSummer 2015

Finally, on behalf of the whole of the Private Clients team, thank you for your continued support and enjoy the rest of the summer.

2 pem.co.uk

This newsletter is devoted mainly to analysis of the post-election Budget, which made some surprising announcements, and some of the key repercussions it holds for all of us.

Firstly, page 3 considers the implications of the changes to the taxation of dividends. The changes announced will have significant impact which has not been widely publicised.

Page 5 considers capital gains tax from the perspective of family partnerships and companies. What is the “ER Trap” and how might it be avoided?

Page 6 looks in detail at the much heralded announcement on increasing Inheritance Tax exemptions to £1 million for a married couple. Is this really good news for those who wish to leave their family home to their descendants?

Page 8 considers whether the Chancellor’s property proposals will change our appetite for property investment. This is particularly relevant to those who are already operating in or considering entering the buy-to-let market.

Finally on page 10 the impact of the Budget for “non-doms” is addressed considering the issues brought to the fore for those who make a home in the UK but have substantial business interests and income derived from overseas.

This edition of our newsletter has a new look and feel. PEM has rebranded and now has a new visual identity; we like it and hope you do as well.

This newsletter is written for you, and I welcome any feedback you have on how it might be improved in the future.

The Budget specialThe Conservative victory in May’s General Election paved the way for the first Tory Budget in 18 years. A triumphant George Osborne presented the Budget he really wanted rather than one watered down by the influence of his former coalition partners.

David Cameron has ruled out a third term as prime minister if re-elected, so this was a chance for the Chancellor to show his credentials as potential heir.

Contents

Dividend raid on owner managers 3-4

No clarity on “ER Trap” 5

Family homes and IHT 6-7

A game changer 8-9Non-Doms take a hit 10

Sanchia Norris - Partner, Private Clients

Sanchia

3Dividend raid on owner managers

Dividend raid on owner managers

The Chancellor has announced a radical overhaul of the way that dividends are taxed on individuals.

Currently all UK dividends are paid with a notional 10% tax credit, this means that non tax payers and those paying at the basic rate have no further tax liability on dividends they receive.

From 6 April 2016 the tax credit will be scrapped. In future all dividends received will be treated as the ‘gross’ amount. All taxpayers will have a tax-free dividend allowance of £5,000 a year but beyond this, the rate of tax payable on dividends will be driven by the investor’s other income. Essentially, beyond the £5,000 tax-free dividend allowance, the personal tax liability for taxpayers increases by 7.5%.

Current rules

Net dividend Additional tax due

Dividend after tax

Effective tax rate

Non tax payer £1,000 £0 £1,000 0%

Basic rate tax payer £1,000 £0 £1,000 0%

Higher rate tax payer £1,000 £250 £750 25%

Additional rate tax payer £1,000 £306 £694 30.6%

From 6 April 2016 (tax due after utilising £5,000 dividend allowances)

Net dividend Additional tax due

Dividend after tax

Effective tax rate

Non tax payer £1,000 £0 £1,000 0%

Basic rate tax payer £1,000 £75 £925 7.5%

Higher rate tax payer £1,000 £325 £675 32.5%

Additional rate tax payer £1,000 £381 £619 38.1%

The Budget had a sting in the tail for many business owners who operate as limited companies and currently benefit from the preferential tax treatment of dividend income.

4 Dividend raid on owner managers

The graph illustrates how tax efficiencies remain similar throughout but the company becomes less beneficial as profits increase, quite the opposite when compared to the ‘old’ rules.

It is important to note that there are still significant benefits in operating through a company as this enables business income “peaks and troughs” to be smoothed for the individual, in addition to the increased commercial security. The fact remains however that the tax benefits have been greatly reduced.

Points to consider1. Utilise the £5,000 tax-free allowance. The £5,000 dividend allowance applies each year

and is completely free of tax – where possible this should form part of any remuneration package.

2. Consider accelerating dividend payments (and therefore tax liabilities) to the 2015/16 tax year to save on future tax liabilities.

3. Tax should never be the sole motivator when deciding whether to operate through a company. However, it is still possible to decide when funds are paid out by way of dividend, enabling profits to be reinvested in the business or paid flexibly to reflect fluctuations in personal liabilities.

£0

£20,000

£40,000

£60,000

£80,000

£100,000

£120,000

£140,000

£160,000

£20K £50K £100K £150K £200K £250K

Annual profit

Net

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DIVIDEND SOLE TRADER

Mind the gapPrior to the changes, operating through a company has typically resulted in a significant tax saving compared with a sole trader or partnership.

The increased dividend tax ‘closes the gap’ on this saving to the point where there is no advantage at all. The graph below details the ‘net cash position’ of operating as a sole trader or as a company under the new rules – assuming all net profits are drawn as dividends with a £11,000 director salary (one director/shareholder).

5No clarity on “ER Trap” for family businesses

No clarity on “ER Trap” for family businessesEarlier in 2015, changes to the Finance Act threatened to make life difficult for members of family partnerships and companies wishing to claim Entrepreneurs’ Relief (ER) on the sale of business assets owned individually. Unfortunately the recent Budget remained silent on this and clarification was not provided.

ER is available where the asset disposed is “associated” with the individual’s withdrawal from participation in the business. There is no requirement to reduce the number of hours worked, but it is necessary to dispose of an equity stake in the business for relief to be due - this can include a gift to a family member.

There has previously been no minimum requirement as to the size of this withdrawal and some people have taken advantage of these rules to benefit from ER on personal assets while not making a meaningful withdrawal. To address this the rules have been changed.

From 18 March 2015, ER will not be granted unless the assets are disposed in connection with a disposal of at least a 5% share in the partnership assets, or a 5% shareholding in the company.

Consider the case of a company director who owns at least 5% of the shares of a company and also owns the trading premises. If he sells the building at the same time as he sells the shares, this counts as an “associated disposal” and will be eligible for ER, and the gain will be taxed at 10% rather than 28%

However, there is a hidden trap within the new rules that denies ER on the associated disposal where “partnership purchase arrangements” or “share purchase arrangements” exist at the time of sale. This catches arrangements under which the vendor (or any person connected with the vendor) is entitled to acquire a future stake (or additional stake) in the business.

Within a family partnership for example, it is likely that most of the members will be connected with each other. A well drafted partnership agreement will contain provisions under which, following the death or retirement of a partner, the remaining partners, will acquire the interest of the deceased or retiring partner. The clauses should be included in all partnership agreements to prevent the automatic dissolution of the partnership on the death of the partner thus enabling the business to continue intact. Refusing ER along these lines seems harsh.

For companies, it is common for the Articles of Association to require that a shareholder, or his personal representatives, offers his shares to other shareholders before selling them to a third party. Again, the existence of such arrangements would appear to fall foul of the new rules.

It was hoped that HMRC would clarify the position in the summer Budget, but no such announcement was made. Accordingly, a great deal of uncertainty exists for members of a family business contemplating an associated disposal.

It is important for anyone in this position to seek professional advice without delay as it may be possible to restructure to secure ER and an 18% tax saving.

You didn’t need to be a fortune teller to see this one coming. The Chancellor has kept his promise to tackle the ever-increasing number of estates being caught within the Inheritance Tax (IHT) net.

In the past IHT has been viewed as a tax that hits only the wealthy. In recent years however, the surge in UK house prices has meant that an increasing number of families face IHT liabilities.

A simple way to deal with the problem would have been to raise the nil-rate band which was frozen at £325,000 in 2009/10. This option clearly did not appeal to the Chancellor as he has in fact extended the freeze on the band to 2020/21; three years more than originally planned.

Instead he has taken a more direct approach, introducing an additional main residence nil-rate band of £175,000. This gives each individual a £500,000 exemption or £1 million for a deceased couple. This additional rate band is aimed specifically at the family home. It is not unreasonable to want to leave your home to your children, but property prices have risen

to the point where even a fairly modest home, especially in Cambridge, would take the value of an estate above the combined nil rate band of £650,000.

The Budget headlines are stating that estates of £1m will now be exempt, but let’s take a look at how this will actually work:

• The additional main residence nil-rate band announced of £175,000 will be phased in over four years, with £100,000 for 2017/18 rising by £25,000 each year until 2020/21 after which it will be index linked.

• The relief will be limited to either the lower of the value of the property or the phased in nil rate band (£100,000 - £175,000)

• The property must be left to a direct descendent (child, grandchild, step-child, foster child or adopted child).

• A claim can be made to transfer any unused proportion of the main residence nil-rate band to the surviving spouse in the same way as the existing nil-rate band can be transferred.

Family homes and Inheritance Tax

6 Family homes and IHT

Points to considerWhat if I want to downsize?

In a country struggling to build enough houses to accommodate a growing population it would be madness to discourage parents whose children have left home from downsizing. A line has effectively been drawn at 8 July 2015. If you downsize following that date, or indeed cease to

own a residence at all by moving into a care home or with family, provided that equivalent assets are left to a direct descendent the additional nil-rate band would be available even though the property no longer exists. HMRC’s example is of an individual downsizing from a house worth £200,000 to a home worth £100,000. They could still benefit from the maximum allowance of £175,000 in 2020/21 by leaving the new home and assets worth £75,000 to a direct descendent.

What if I own more than one property?If you own and use more than one property as your own home, then your personal representatives will be able to nominate which property should qualify for the relief.

Can I elect a buy-to-let property?The simple answer is no! If a property has never been your residence it will not qualify.

What if I am already a widow or widower?The additional main residence nil-rate band will be

able to be transferred irrespective of when your spouse passed away.

Does this apply to everyone?In short, no. The Chancellor pledged to ensure these measures do not benefit the “very wealthy”. Tapering measures limit the benefit of the main residence nil-rate band for estates over £2m. The benefit will be withdrawn at a rate of £1 for every £2 over the limit so that from 2020/21 for estates over £2.35m no additional allowance will be given.

7Family homes and IHT

2015/16 2020/21Family home 320,000 320,000

Other assets 680,000 680,000

Total estate 1,000,000 1,000,000

Nil-rate band (325,000 x 2) (650,000) (650,000)

Additional main residence nil-rate band (£175,000 x 2 restricted to £320,000)

n/a (320,000)

Taxable estate £350,000 £30,000

IHT @ 40% £140,000 £12,000

Below are two examples of how the new rules work in practice. In the first case the family home is relatively modest but there are significant other assets. In the second example the family home is worth a substantial amount and forms the bulk of the estate.

Example oneSue and Pete’s family home is worth £320,000 and they have other assets to the tune of £700k. Their entire estate will be left to their three children; Jake, Ben and Karen. The table below shows the difference should the 2nd death occur under current rules or in 2020/21:

Example two

Sue and Pete’s family home is worth £900,000 and they have other assets to the tune of £100k. Their entire estate will be left to their three children; Jake, Ben and Karen. The table below shows the difference should the 2nd death occur under current rules or in 2020/21:

2015/16 2020/21Family home 900,000 900,000

Other assets 100,000 100,000

Total estate 1,000,000 1,000,000

Nil-rate band (325,000 x 2) (650,000) (650,000)

Additional main residence nil-rate band (£175,000 x 2) n/a (350,000)

Taxable estate £350,000 nil

IHT @ 40% £140,000 nil

8 A game changer for property investment?

A game changer for property investment?The Budget contained a number of changes affecting individuals who let residential properties or rooms in their own home.

Restricting finance cost reliefFrom April 2020 onwards, individuals who receive rental income from letting UK or overseas residential properties will be restricted to 20% tax relief on finance costs. Examples of such costs include mortgage interest on purchase and loan interest on replacement fixtures and fittings.

To give landlords time to adjust to the new system, the restriction will be phased in over a four-year period from April 2017 onwards.

• Until April 2017 tax relief will still be at the highest marginal income tax rate – typically 40% or 45%.

• From 2017/18, 2018/19 and 2019/20, a mix of the old and new system will apply. This will result in tax relief for finance costs being given at an effective tax rate of 38.75%, 32.5% and 26.25% respectively.

• From April 2020 tax relief will be limited to 20%

It is worth considering that further restrictions may also be introduced to prevent a property business loss.

There may be a way round these restrictions for some existing property investors – and for those new to buy-to-let investments. The proposed restrictions on interest only apply to individuals but not to companies.

For long-term investors who have a significant property business it may be possible to incorporate the business taking advantage of generous capital gains tax reliefs.

For those acquiring new buy-to-let property a corporate structure should be considered. It can be harder to secure finance through this medium but tax savings can now be achieved long term. It is complicated and, if not implemented correctly, costly – especially for those who may be considering unlocking value in pension funds to fund the deposit, but for many will be worthwhile pursuing in the long run.

9A game changer for property investment?

Wear and tear allowance for furnished properties is being replacedCurrently, landlords of furnished residential properties can deduct 10% of rents as an expense of their property business to represent the wear and tear of fixtures and fittings.

From April 2016, the government intend to replace the 10% wear and tear allowance with a new relief that only allows landlords to deduct costs they actually incur when such items are replaced.

Qualifying furnished holiday lets will not be affected by either of the above new proposals

Good news for those renting out rooms in their homes!In Cambridge many homeowners let out rooms to earn extra money. To reflect increasing market rents the tax free Rent a Room allowance will be increased from £4,250 to £7,500 from 6 April 2016.

This change should reduce the administrative burden for those letting rooms in their home.

Protection for landlords from the property fraudsterProperty fraud is not new but is becoming increasingly common. A property can be sold, or mortgaged to raise money, and is therefore an attractive target.

Buy-to-let properties are particularly common targets for property fraudsters. Fraudsters have been taking on tenancies, then by way of occupation transferring that property into their own name with the Land Registry and subsequently securing a mortgage against it. Having converted the equity in the property into cash the fraudster then disappears, and leaves the true owner to deal with the consequences.

You can however protect your property from this type of fraud. A little-publicised fact is that it is possible to register a restriction on the property reflecting that it is not occupied by the owner, and prevents the property being transferred or mortgaged unless a conveyancer or solicitor certifies the application was made by the rightful owner.

In addition ensuring that the Land Registry have up-to date contact addresses including email addresses and signing up to receive a notification of any application to change the tile can help reduce fraud.

There is no charge for any of this at the Land Registry as it forms part of their anti-fraud measures. The applications can be made simply without the need for professional intervention.

None of the above methods offers water-tight protection against property fraud. Like all other crime, where a fraudster is exceptionally devious or relentless, there will always remain a threat. By taking the above sensible and regular precautionary action, the chances of property fraud and the opportunities available to the fraudster are greatly reduced.

10 Non-Doms take a hit

Non-Doms take a hitNon-doms were a hot topic in the recent election campaign. While changes were expected in this area the scale of the changes introduced in the Budget were surprising. The main measures will apply from April 2017.

Individuals who have been resident in the UK for more than 15 out of the past 20 tax years will be deemed domiciled for ALL tax purposes. This means no remittance basis will be available to them and they will pay UK taxes on their worldwide income and gains.

The remittance basis is the ability to only pay UK tax on offshore income and gains when bringing or “remitting” the overseas funds into the UK rather than when they arise. To benefit from this basis the non-dom has to pay an annual “charge”, which is scaled to the time they have been resident in the UK.

The rules will apply to all non-doms irrespective of when they arrived in the UK so those who are currently paying a remittance basis charge and have been resident for 17 out of 20 years, will cease to pay this and revert to the arising basis.

For those individuals who have a domicile of origin (i.e. acquired on birth) outside the UK and are in the UK for only a limited time, the remittance basis remains available and there are still considerable advantages to be had with careful planning.

Perhaps of greater significance are the Inheritance Tax (IHT) changes. There are a number of people who will have been here for 15 years at 5 April 2017 and as a result their deemed domicile status will be accelerated.

From this date IHT will be due on all UK residential property owned by non-doms, whether that ownership is direct or indirect through any offshore structure, for example a trust or a company.

An opportunity to review global financial affairs, and plan for worldwide income and gains exists before April 2017 and when a stay in the UK approaches 15 years, as the remittance basis ceases to be available.

Private client receptionTuesday 15 SeptemberCheffins, Clifton House, Cambridge

We would be delighted if you could join us for an exclusive preview auction of fine art. This prestigious event will be held at Cheffins premises, Cambridge at 6pm. Champagne and canapés will be served through the evening which will provide an excellent opportunity for an “early-bird” look at what might be on offer when the auction opens.

11Events

Events

Goldmine in your garden?Thursday 15 OctoberImperial War Museum, Duxford

Land for new residential building is in short supply in and around Cambridge. As a result many developers and increasingly individuals are looking “outside the box” for small plots of land, many of which are carved from gardens attached to existing homes. The issues are complex; there are significant legal, planning and tax considerations. PEM have teamed up with leading Cambridge law firm Tees Law and land agents Carter Jonas to present a seminar advising on the pitfalls and possibilities. Find out if you or someone you know could benefit from this.

PEMSalisbury HouseStation RoadCambridge CB1 2LA

t. 01223 728222f. 01223 461424e. pem@pem.co.uk pem.co.uk

Sanchia NorrisPartner, Private Clients01223 728225 snorris@pem.co.uk

Fiona WalkerTax Adviser01223 728285 fwalker@pem.co.uk

Ollie PingleAssistant Manager01223 728251 opringle@pem.co.uk

Mary ShoesmithAssistant Director 01223 728260 mshoesmith@pem.co.uk

Charlie FordenTax Adviser01223 728353 cforden@pem.co.uk

Beata LeeTax Adviser01223 728358 blee@pem.co.uk

Michael DeanTax Adviser01223 728229 mdean@pem.co.uk

Daren PeacockDirector01223 728220 dpeacock@pem.co.uk

Ryan SteelAssistant Manager01223 728325 rsteel@pem.co.uk

Pat GreenwoodManager - Trusts01223 728255 pgreenwood@pem.co.uk

Nicola AndersonPartner, Private Clients01223 728261 nanderson@pem.co.uk

Jacqui DenneyAssistant Manager - Trusts01223 728268 jdenney@pem.co.uk

Victoria KingmanManager01223 728253 vkingman@pem.co.uk

Sarah TuckerDirector01223 728241 stucker@pem.co.uk

Sarah Martinez-MccuneTax Adviser01223 728329 smartinez-mccune@pem.co.uk

Anna MackenderAssistant Manager01223 728227 amackender@pem.co.uk

About usOur experienced private clients team offers expert advice and support for all areas of personal taxation to suit your specific needs. Please meet the private clients team who will be happy to talk to you about any issues you may have.

For further advice, information or to feed back please do not hesitate to contact Sanchia Norris on 01223 728225 or email snorris@pem.co.uk

For General Information Purposes onlyPlease note that this brochure is not intended to give specific technical advice and it should not be construed as doing so. It is designed merely to alert clients to some issues. It is not intended to give exhaustive coverage of the topics. Professional advice should always be sought before action is either taken or refrained from as a result of information contained herein.