Private client briefing for September 2012

Income tax relief capping

In July 2012 HM Treasury and HMRC published the consultation document on the capping of currently uncapped income tax reliefs. (The condoc is available at www.lexisurl.com/VpoKF; comments are sought by 5 October 2012.)

Charitable donations have been excluded from the scope of the proposed cap, following intensive lobbying by the charitable sector, but the proposals are otherwise unchanged, including the intended commencement date of 6 April 2013.

The affected reliefs are those listed in ITA 2007 s 24, which are offset against general income (at step 2 of the income tax calculation):

• trade loss relief against general income;
• early trade loss relief;
• post-cessation trade relief;
• property loss relief against general income;
• post-cessation property relief;
• employment loss relief;
• former employees deduction for liabilities;
• share loss relief;
• losses on deeply discounted securities; and
• qualifying loan interest.

The cap will therefore not apply to expenses and allowances, including capital allowances, which are deducted when calculating particular categories of income. However, if such expenses or allowances create or increase a loss that can be set against general income, that loss would be capped.

The cap will be the greater of £50,000 or 25% of an individual's income, and there will be a separate cap for each year. Where a relief, such as a trading loss, can be offset in the current year and/or the previous year, the amount offset will be calculated by reference to the cap in the year of offset. It will still be possible to carry forward unused amounts.

The cap will be retrospective to the extent that it will apply for years before 2013/14 to which losses are carried back.

Why it matters: Although in the foreword to the consultation document the government refers to ‘wealthy individuals’, ‘those on the highest incomes’, and ‘those who wish to exploit these reliefs for tax avoidance purposes’, this measure would potentially affect anyone with an income of just £50,000 or more, and in respect of reliefs which have nothing to do with tax avoidance, such as relief for genuine trading losses.

The impact assessment estimates that ‘over 90% of the static yield is attributable to individuals with incomes over £150,000’ – there would therefore appear to be a very good case for applying a de minimis income limit of at least £150,000, in order both to exempt those with a much lower income than is mainly being targeted, and to reduce the time and costs for taxpayers and HMRC alike in administering something which HMRC acknowledges would account for less than 10% of the expected yield.

With the proposed cap due to come into effect from 6 April 2013, individuals may need to consider ways of realising losses in the current year in order to obtain full tax relief, including bringing forward the end of a loss-making accounting period. Alternatively, if it is known that a loss will be realised after 2013/14, it may be possible to defer income until that tax year so that the 25% cap is higher.

IHT: periodic charges on trusts

In July 2012 HMRC issued a consultation document inviting comments on the options for simplifying the calculation of IHT periodic and exit charges on trusts that hold or dispose of relevant property. (The condoc is available at www.lexisurl.com/WCLiJ; comments are sought by 5 October 2012.)

Broadly, these charges arise every ten years and when property is withdrawn from a trust. The calculations concerned can be complex and burdensome.

The government recognises that for some smaller trusts the burdens and professional costs involved in gathering the necessary information to undertake these tax calculations and make a return to HMRC can often be disproportionately large, compared to the tax at stake. Similarly, for HMRC, it is sometimes not cost-effective to deal with such returns and computations.

However, HMRC wishes to retain a system that charges IHT on assets held within trusts, and does not wish to jeopardise tax revenues. HMRC has not put forward any proposals, and has simply asked for suggestions as to how the regime could be simplified, without any significant loss of revenue.

After consultation, HMRC will publish a summary of the responses to the consultation. Legislation, if needed, is likely to be introduced in Finance Bill 2014.

Why it matters: A simplification of this complex area would obviously benefit both taxpayers and HMRC.

Attribution of gains to members of closely controlled non-resident companies

At the end of July 2012 HMRC published a consultation document on the attribution of gains of non-resident close companies to their UK-resident participators, and transfers of assets abroad (see www.lexisurl.com/vDwR6; comments are sought by 22 October 2012).

The consultation is a response to infraction notices issued to the UK by the European Commission in February 2011. The EC considers that the current UK rules are disproportionate and incompatible with the treaty freedoms of the single market. The opportunity has also been taken to undertake a more general review of the provisions.

Currently the provisions aim to:

• prevent UK-resident or ordinarily resident individuals keeping assets outside the scope of capital gains tax by holding them through a closely controlled company resident abroad (TCGA 1992 s 13); and
• prevent UK ordinarily resident individuals avoiding income tax through a transfer of assets, so that income becomes that of an offshore person while the UK ordinarily resident individual continues to be able to enjoy the income, or to receive entitlement to capital or other benefits as a result of the transfer (ITA 2007 Part 13 Chapter 2).

HMRC has therefore proposed the following main changes:

• a new exemption from the attribution of gains rules where the non-resident company is a genuine business establishment pursuing real economic activity overseas or, alternatively, where there is no tax avoidance motive;
• a new exemption from the transfers of assets abroad rules for arm's-length transactions that are carried out for the purposes of genuinely commercial activities that take place overseas; and
• a new exemption from the transfers of assets abroad rules where companies that are incorporated overseas are UK-resident by virtue of their management and control.

HMRC is also willing to consider increasing the current TCGA 1992 s 13 de minimis participation limit of 10%, and making amendments to the transfers of assets abroad rules in relation to the identification of relevant income, double charging and double taxation relief.

The changes would be included in Finance Bill 2013, with a retrospective effective for 2012/13, which would be optional in the case of the changes to the TCGA 1992 s 13 rules.

Why it matters: Any move to take non-abusive arrangements outside the scope of the legislation is welcome, but it remains to be seen whether the EC will regard the proposed relaxations as sufficient.

Consultation on vulnerable beneficiary trusts

The government is planning to change the definition of ‘vulnerable persons’ for tax and trust purposes. (The consultation document is available at www.lexisurl.com/XbuDI; comments are sought by 8 November 2012.)

Trusts are recognised by the Treasury as an important means of making provision for vulnerable people in need of assistance. Part of this recognition comes in the form of tax advantages for assets held in such trusts and the income from them.

There are three tax advantages:

• The trustees are able to pay income tax at the rate applicable to the beneficiary, instead of at the usual inflated rate for trusts.
• The trustees are able to utilise the beneficiary’s annual CGT exemption and any personal losses.
• The inheritance tax ‘relevant property’ regime does not apply to property held on trust for a disabled person, which is treated as the beneficiary’s own property on death.

The Treasury has restricted the relevant definition of ‘vulnerable person’ to orphaned minors and those with a severe mental or physical disability. The latter is in many cases linked to the Department for Work and Pensions’ (DWP) assessment of the person's disability – specifically, whether it entitles them to the highest or middle rate care component of disability living allowance (DLA).

However, DLA will shortly be abolished by the Welfare Reform Act 2012 and replaced with the personal independence payment (PIP), initially for people aged 16 to 64. This creates issues with the current definition for vulnerable beneficiary. Without an amendment by HMRC to the current definition, some trusts that would have qualified will no longer do so, or the trustees may have to collect ‘more subjective, and possibly upsetting, evidence about the beneficiary’s incapacity’.

Where the person concerned has a physical disability, the proposed new definition will be based on the DWP’s ‘daily living component’ test for PIP entitlement, which examines the person’s ability to perform various tasks.

HMRC believes that withdrawal of the DLA test may lead to many new applications for vulnerable beneficiary trusts, based on mental incapacity. Currently, such a trust will qualify for tax relief if the person has a mental disorder within the meaning of the Mental Health Act 1983 making them incapable of managing their affairs. The consultation document proposes to limit the scope of this test to examine the person’s ability to manage or administer only their property and everyday financial affairs, not their wider affairs; and then only where the incapacity is permanent.

Why it matters: Although the new rules will not be retrospective for inheritance tax purposes, existing trusts will not be entitled to the special income tax and capital gains tax treatment if they cease to qualify as a vulnerable beneficiary trust.

Lifting the lid on tax avoidance schemes

HMRC has also published a consultation document entitled Lifting the lid on tax avoidance schemes (see www.lexisurl.com/CBkhK; comments are sought by 15 October 2012). HMRC wishes to:

• improve the provision of information about tax avoidance, to ensure that where tax avoidance schemes are identified, the public knows about the risks of using them;
• extend the information disclosed to HMRC under the disclosure of tax avoidance schemes (DOTAS) regime;
• extend the information reported to HMRC about users and other parties involved in a disclosable avoidance scheme;
• raise the threshold of ‘reasonable excuse’ for a promoter who fails to notify a disclosable scheme;
• impose additional reporting obligations on a promoter who incurs a penalty for failure to disclose a scheme;
• impose a personal responsibility on an individual, to sit alongside the firm’s obligations, to comply with a promoter’s DOTAS obligations; and
• revise and extend the DOTAS hallmarks, including: amending the confidentiality hallmarks to ensure that more schemes (such as schemes designed to circumvent the disguised remuneration rules and in-house schemes) are notified to HMRC; tightening the tests for the losses hallmark; and introducing new hallmarks in relation to employment income via intermediaries, financial products and offshore schemes.

Why it matters: The proposals would see a significant tightening of the DOTAS rules, requiring the disclosure of more information by promoters or their clients. It is vital that the changes target those promoters who are selling artificial schemes, to ensure that tax agents providing normal tax planning advice are not affected.