Budget 2008 report 12 March 2008

Budget 2008 report 12 March 2008

1 Budget report Initial analysis from AEGON Scottish Equitable This communication is directed at professional financial advisers. It should not be distributed to, or relied upon by, private customers. Today s budget report from Chancellor Alistair Darling covered many of the issues that have been in the spotlight since the prebudget report, including Capital Gains Tax, Income Shifting, Pre-22 March 2006 Trusts and Residence and Domicile. On the pensions side, minor amendments have been made to some of the pre- budget report proposals, and some additional trivial commutation rules have been announced. Contents page 1. Income tax allowances and earnings limits 2 and thresholds 2. Capital Gains Tax 3 3. Income Shifting 4 4. Income Tax Rates 4 5. Pre 22 March 2006 Trusts 5 6. Residence and Domicile 6 7. Pension schemes - anti-avoidance, including inheriting tax-relieved savings 7 8. IHT and pension schemes 8 9. Trivial commutation 9 10. Benefit Crystallisation Event 3 (BCE 3) 9

2 1. Income tax allowances and earnings limits and thresholds Rate for 2008/09 Rate for 2007/08 Personal allowance (under age 65) 5,435 5,225 Personal allowance (65 74) 9,030 7,550 Personal allowance (75 and over) 9,180 7,690 Blind person s allowance 1,800 1,730 Married couple s allowance (aged less than 75 and born before 6 April 1935) Note: tax relief is given at rate of 10% Married couple s allowance (age 75 and over) Note: tax relief is given at rate of 10% Married couple s allowance minimum amount Note: tax relief is given at rate of 10% 6,535 6,285 6,625 6,365 2,540 2,440 Income limit for age-related allowances 21,800 20,900 Weekly lower earnings limit (LEL) 90 87 Weekly upper earnings limit (UEL) 770 670 Weekly primary threshold 105 100 Weekly secondary threshold 105 100 Corporation tax reduces from 30% to 28% with effect from 1 April 2008.

3 2. Capital Gains Tax (CGT) The Chancellor has confirmed that there will be an 18% flat rate of CGT applying to amounts over the annual exempt amount ( 9,600 for 2008/09) on disposals after 6 April 2008. The annual exempt amount for trustees will be 4,800 in 2008/09. In addition, from 6 April 2008, to complement these CGT changes, an entrepreneurs relief is being introduced which will be available when an individual sells their business. This means that the first 1,000,000 will be charged to tax at 10% and gains in excess of the 1,000,000 limit will be charged to CGT at 18%. The Treasury has announced that it doesn t see the need for a change to the taxation of insurance bonds as a result of the CGT changes. As a result, a policyholder is still subject to income tax at their marginal rate of tax on the event of a chargeable event gain. Analysis Even though the 18% flat rate of CGT, which would apply to collectives, looks more attractive than a potential income tax charge at 40% on a chargeable event gain with a bond, there are other factors to consider. There would also be an annual income tax charge to consider on the dividend/interest distributions from collectives even if this is accumulated which would be 32.5%/40% in the case of a higher rate taxpayer. Investment bonds offer the policyholder tax deferral in that clients can access money through the 5% tax deferred allowance, without incurring an annual income tax charge. Bonds are self-assessment friendly, as withdrawals within the 5% tax deferred allowance don t need to go on the tax return. Only chargeable event gains need to be put on the tax return. Withdrawals within the 5% tax deferred allowance don t affect a client s entitlement to age allowance. Investment bond holdings may be deemed excepted assets for means testing. IHT planning bonds are ideal assets for trustees to hold due to the administrative simplicity they offer. If trustees hold collectives, then they will have to consider the completion of annual tax returns and the associated professional costs.

4 3. Income Shifting These measures are intended to prevent individuals from arranging their tax affairs in such a way as to gain a tax advantage from income shifting, for example in the form of company dividends or partnership profits within small businesses. The Government feels that a further period of consultation is required and intends to introduce legislation via the Finance Bill 2009 rather than with effect from 6 April 2008. Analysis This extension to the consultation period and the potential impact of these measures should be viewed as the start of the advice process. Advice could focus on pension arrangements such as funding stakeholder pensions. As investment bonds are non-income producing assets, these proposals should not effect assignments of bonds, for example between spouses or from a parent to an adult child. 4. Income Tax Rates From the 6 April 2008, the basic rate of income tax will be reduced from 22p to 20p. The 10% starting rate will be removed for non-savings income, for example salary, rental income and pension income. However, there will be a 10% starting rate of 2,320 in 2008/09 for savings income such as dividend income, interest and offshore bonds. If an individual s non-savings income exceeds the limit for savings, then the 10% starting rate will not be available to offset against savings income. Analysis Where a non-taxpayer s only taxable income is a chargeable event gain on an offshore investment bond, they will still have the availability of the 10% starting rate for the next tranche of the gain following deduction of their personal allowance.

5 5. Pre 22 March 2006 Trusts Under Schedule 20 Finance Act 2006, trustees had from 22 March 2006 to 5 April 2008 to change the beneficiaries on a pre-22 March 2006 interest in possession trust without the trust becoming subject to the discretionary trust IHT regime. This period has been extended to 5 October 2008. Confirmation has emerged that there will be no immediate charge to IHT where an interest in possession is removed and replaced by another interest in possession for the same beneficiary, so long as this replacement interest in possession is also a transitional serial interest or a disabled person s interest. Analysis There is an extended six-month window for trustees who set up trusts with us prior to 22 March 2006, to change the beneficiaries without incurring an immediate IHT charge. However care will still have to be taken that the gift with reservation of benefit provisions are not invoked. This is a complex area and the trustees should be seeking professional advice before changing the beneficiaries. This may be an opportunity for advisers to work with their professional connections.

6 6. Residence and Domicile From 6 April 2008, there will be a change to the way that days are counted for residence test purposes. Any day where the individual is actually in the UK at midnight will be counted (there is an exemption for days spent in transit, unless the individual is attending a business meeting whilst being in transit). Where an individual has foreign income and gains totalling more than 2,000 in the year, they will lose their entitlement to the income tax personal allowance, age allowance and the capital gains tax annual exemption from 6 April 2008, where they opt for the remittance basis of tax in that particular year. An individual will be subject to an annual 30,000 charge, where they have been resident in the UK for more than 7 out of the past 10 years and want to use the remittance basis. The 30,000 charge should be creditable against foreign tax. The rules will not be substantially revisited for the rest of this Parliament or next. Analysis As offshore bonds are not subject to the remittance basis but instead are taxed when a chargeable event gain arises, these changes may open up new opportunities for nondomiciliaries to use offshore life bonds as tax deferral tools as an alternative to opting to pay the annual levy. Offshore bonds may become more attractive, as 5% withdrawals won t trigger chargeable event gains and the levy won t be payable as bonds are not subject to the remittance basis.

7 7. Pension schemes anti-avoidance, including inherited tax-relieved savings As we explained in our pre- budget report analysis, the Finance Bill 2008 will contain provisions so that an unauthorised member payment will be deemed to have been made where the pension rights of a scheme member who was connected to the deceased member are increased directly as a result of the death of the deceased member. So, for example, where a member is drawing a scheme pension directly from scheme funds, if on their death any remaining scheme pension fund were added to their son s fund under the scheme, that payment would be unauthorised. Inheritance tax (IHT) charges will also apply, where appropriate. There was to be an exemption for schemes with 20 or more members, where the rights of all members were increased at the same rate. The Budget contains a modification to this exemption, so that the unauthorised member payment and IHT charges will not apply where there are at least 20 scheme members who have their rights increased at the same rate because another member has died. The new rules will apply where the member dies on or after 6 April 2008. The provisions extend across scheme pensions, lifetime annuities, dependants scheme pensions and dependants annuities.

8 8. IHT and pension schemes IHT to apply where an unauthorised lump sum payment is made when a scheme member in receipt of annuity or scheme pension dies aged 75 or over An IHT liability will arise where an unauthorised lump sum payment is made when a scheme member who is in receipt of an annuity or scheme pension dies aged 75 or over. This IHT liability already applies where an unauthorised lump sum payment is made from remaining alternatively secured pension funds. Any unused nil-rate band can be set against this IHT charge. Provisions will be introduced to ensure that where more than one such IHT charge arises, any remaining nil-rate band will only be able to be used once against the IHT charges. A similar change is being made for IHT charges arising on alternatively secured pension funds. These provisions will apply to deaths of members occurring on or after 6 April 2008. Inheritance tax on overseas pension schemes As announced in the pre- budget report, IHT protection will be given to UK tax-relieved savings in overseas pension schemes. This protection will also be given to all funds in overseas pension schemes that are tax-recognised and regulated in their country of establishment, or if there is no system for tax recognition or regulation, where the funds must be used to provide a pension income for life. These provisions will apply from 6 April 2006.

9 9. Trivial commutation The Budget announces some changes to the trivial commutation rules. Although we will have to wait for draft regulations for the detail, it appears that, on top of the existing provision that allows commutation where the value of all pension funds is not more than 1% of the standard lifetime allowance, it will also be possible to fully commute: (a) small stranded pots, which would include, for example, small funds arising after someone had taken other benefits under a trivial commutation exercise and which would not be able to be commuted under the current rules b) savings in occupational pension schemes where the total value falls below 2,000 (this provision does not apply to personal pension schemes) The news on stranded pots is welcome, but it is disappointing that the additional 2,000 trivial commutation limit has only been made available to occupational pension schemes. A-day was about creating one tax regime for all types of registered pension scheme, and this measure unfortunately creates an unwelcome division. 10. Benefit Crystallisation Event 3 (BCE 3) This relates to a test that is carried out against the lifetime allowance when increases above a certain level are made to scheme pensions. Its aim is to prevent schemes from setting an artificially low scheme pension at outset (and so reducing the amount that is tested against the member s lifetime allowance) and then providing for very large increases in the following years. BCE 3 is very complex and proposed easements were published in the pre- budget report. Following consultation in December 2007, three small changes to the prebudget report amendments have been announced in the Budget: pension increases of 250 a year or less will be exempt from the BCE 3 test (to be backdated to 6 April 2008) once a pension increase has been awarded, it can be rounded up to the next whole number without the need for a further test (to be backdated to 6 April 2006) in calculating limits for BCE 3 exemptions, schemes will be able to use the RPI for any month within the 12-month period before the increase in pension (effective from 6 April 2008)