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Tax credit cuts for higher rate taxpayers

If you have missed the media storm surrounding changes to the tax credit system, you may be in for a shock.

If you are a higher rate taxpayer (earning more than £50,000) and you currently claim child tax credits, you can expect to receive notification from HMRC very soon that your benefits will be cut or removed. You will be expected to repay any overpaid benefits via the tax system.

You will also be asked to complete a tax return, so that HMRC can work out precisely how much you need to pay back.

If this is the first time you have had to complete a tax return, you may find the experience a little unnerving. If you have multiple income sources (for example a rental property), the completion of your return will increase in complexity and you may feel it appropriate to consult an accountant or tax adviser.

An area that you should be thinking about now, especially if your household income is divided unequally between a breadwinner and a home maker is ways to reduce the principal household income. You could consider:
  • ensuring that income generating assets are held by the partner with the lowest income. This could include rental property, investments or cash deposits.
  • the partner with the highest income making additional pension contributions.
  • the partner with highest income sacrificing salary for other rewards such as holiday entitlement or employer funded pension contributions.
These points can also give rise to tax savings and it may be the case that you have already considered these for tax reasons. Remember that tax exempt assets, such as ISA's, still create income for benefit assessment purposes even though they are exempt from income tax. If you have accumulated substantial funds in ISA's, these will need to be considered as well.

Particular care should be taken by non-married couples when considering the transfer of assets since this could give rise to capital gains tax. This does not apply to transfers between married couples. 

It is very easy to fall foul of the rules and leave yourself in a worse position by make changes. Before doing so, it is always important to consult an accountant or tax adviser to ensure that whatever action you plan to take is appropriate and worthwhile.

The end to easy company closure?

From 1 March 2012, it will no longer be so straightforward to close a company and have the proceeds treated as a capital gain.

Before 1 March, using a special concession called ESC C16, a company could apply to HMRC for permission to treat distributions made on an informal winding up as capital. This would enable such distributions to be subjected to capital gains tax in the hands of the shareholders. Without this permission, the distribution of its reserves would be treated as dividends and taxed as income.

This distinction is important because many business owners are able to claim Entrepreneurs’ Relief. Using ESC C16, the applicable tax rate would reduce to 10% on distributions up to £5m, compared a tax rate if up to 50%, if ESC C16 is not used.

Historically, this has been an important part of tax planning over the life of an owner managed business. It has been common for business owners to set their annual remuneration at a level which minimises higher rate tax, leaving surplus profits to accumulate in the company, with the intention of withdrawing the accumulated reserves at an effective tax rate of 10% on company closure. The rules in ESC C16 also meant that the business owner could essentially manage the winding up of the business and could minimise external involvement.

This strategy is now no longer possible. However, some opportunities for sensible planning still remain.

The new rules will allow directors to treat distributions up to £25,000 as a capital gain. Whilst this will not be of use to many entrepreneurs, it will help the very smallest companies.

If a liquidator is appointed, then the distributions made by the liquidator to the shareholders will still be subject to capital gains tax in the hands of the shareholders with no upper limit. This situation has not changed. On the face of it, this suggests that in future it will be more beneficial to company shareholders to have a formal members’ voluntary liquidation, rather than to try and close the company informally, even though this would incur professional fees to do so.

A further possibility is to extract assets by arranging a company purchase of own shares. This route is likely to be more problematic, not least because HMRC clearance is invariably required for such transactions.

In summary, the withdrawal of ESC C16 will significantly affect the way in which business owner close their companies and is likely to increase the popularity of voluntary liquidation. However, options still remain and, as always, advisers will look for opportunities to maximise net returns to their clients and to protect their clients’ interests.