From 6 April 2010, there will be a new higher rate of income tax in the UK, which will apply to individuals with income over £150,000. Dividend income will be taxed at 42.5% and other income at 50%. For those earning over £100,000, there will be a progressive erosion of tax allowances, which will increase the effective rate of tax for income above that threshold.
The position for trustees where income is accumulated is worse. Subject to a de minimis threshold of £1,000, these higher rates of income tax will apply to trusts whatever the level of their income and so trusts will be taxed more heavily than individuals.
If there are distributable reserves in a company, consider declaring dividends whilst rates of tax are at 32.5%; an effective rate of tax of 25%. If the company is held in trust then this may require a revocable income appointment in favour of one or more beneficiaries so that the dividend can be declared on their tax return, rather than accruing to the trustees.
Gifting or selling assets
Can and should income producing assets be transferred between family members so that some income is taxed at lower rates? There should be no tax implications on transfers between spouses or civil partners but there may be non-tax reasons why this would not be sensible. If capital gains tax is payable, it might be sensible to gift or sell whilst the rate of tax is 18% and asset values are still depressed.
Consider if pay or bonuses can be accelerated; this may be easier to achieve in the family managed business environment. This will accelerate the payment of tax and so could create cash flow issues and there could be problems if employment is terminated early.
Consider whether your investment policy should be adjusted to mitigate the impact of a 50% rate of income tax. Consider disposing of assets that are taxable to income tax, such as non-distributor or reporting status offshore funds, before 6 April. Going forward, one option would be to invest for capital growth. Alternatively, you could hold income-producing assets in an investment wrapper to defer charges to income tax; in the meantime you will benefit from the gross roll up of funds. If investments are held through a holding company, you will pay corporation tax rather than income tax but there may be an extra layer of fees and, in due course, a higher overall rate of tax to extract profits.
Trustees should consider:
- distributing retained income before rates of tax increase;
- appointing an income interest in favour of beneficiaries who will not be affected by the changes in rates of tax so that income is taxable at their lower rates – this can be on a revocable basis;
- reviewing their investment policy. Given the differential between 18% capital gains tax and 50% income tax where income is accumulated, trustees should consider the emphasis between capital growth and income under their investment mandate. Any decisions should be documented in their annual investment policy statement to protect against criticisms from beneficiaries;
- winding up the trust. Tax changes are only one factor but, if the trust has served its purpose, it might be sensible to wind up the trust before the rate of income tax increases.