April 13, 2012 6:56 pm

Wealthy face cap on income tax relief

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Recent government scrutiny of tax avoidance strategies has highlighted the ability of the UK’s wealthiest individuals to reduce or eliminate their income tax bills.

But the announcement in last month’s Budget that a cap will be imposed on unlimited income tax relief from next April – subject to – consultation, means that taxpayers and their advisers will need to rethink financial arrangements over the next 12 months.

Accountants confirmed this week that company structures, gifted assets and charitable donations are all regularly employed by higher and top-rate taxpayers to minimise their income tax.

HM Revenue & Customs had earlier demonstrated that existing tax reliefs can take some high earners out of tax altogether. It gave the example of an individual with an income of £10m who could claim business loss relief of £5m, make charitable donations of £4m, and offset qualifying loan interest of £1 million – to end up with an income tax bill of zero.

Under the chancellor’s Budget proposals, however, anyone seeking to offset business losses (also known as sideways losses), interest on certain loans or charitable donations against tax will be limited to maximum relief of either £50,000 or 25 per cent of their income, whichever is greater.

As a result, donors, partners in unprofitable business ventures, and those who borrow money to make investments in certain partnerships, or purchase shares in their company or finance company loans will all face higher tax bills from next year.

Kevin Custis, of the tax and trusts division of wealth manager Rathbones, said clients should look upon this year as an opportunity not to be wasted.

“If you have control over your own income, you may wish to increase it now in order to utilise reliefs that will be capped next year,” he explained.

Capping reliefs is partly intended to stamp out schemes that are knowingly structured so that individuals can offset bogus commercial losses or donations.

But Katharine Arthur, tax partner at accountants MHA MacIntyre Hudson, argued that many of the problems could have been solved with better policing of existing anti-avoidance rules. She pointed out that business losses incurred by inactive partners are already capped – and expressed concern that the new cap could have an adverse effect on genuine businesses and charities.

Richard Mannion, tax director at advisers Smith & Williamson, said he expected to see a rush of charitable donations in the next 12 months.

“I think this will all take some time to settle down,” he said. “There are a lot of things happening at the same time. We have the caps on relief, and the introduction of the General Anti-Avoidance Rule legislation to differentiate between tax planning and tax avoidance, coming in at the same time.”

Jeremy Croysdill, head of wealth structuring at private bank Kleinwort Benson, reminded investors that the tax reliefs with an existing cap – such as those for investments into pensions, enterprise investment schemes, and venture capital trusts – won’t be affected by the changes.

But he also expected his clients to start making arrangements that will take account of the future changes.

“We are entering into period of consolidation,” he said. “We have a year’s grace and I expect to see clients – especially those who pay tax at the 50 per cent rate – to maximise charitable donations this year before income tax relief is capped and the tax rate is cut.”

While the government has insisted that it wants to preserve the tenets of responsible tax planning, accountants and wealth managers warned that the current spotlight being shone on to the financial arrangements of high profile politicians risks making tax planning more risky and complex.

Many cited the scrutiny of London mayoral candidate Ken Livingstone, who funnels his earnings through a company to pay corporation tax rather than income tax,

“We’re seeing morality brought into arguments on tax, which is difficult for something that based on law,” said Mannion. “The rules are complicated enough without adding moral or reputational issues in as well.”

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