Mike Tombs's Blog

This blog provides information about tax, accounting and other issues affecting small owner-managed businesses in the UK. It is intended as a general source of information but you should not assume that everything applies to your specific circumstances. We are always happy to discuss providing tailor-made solutions to suit your individul needs. Visit www.tlaservices.co.uk to sign up for our free monthly Tax Tips and News newsletter.

Monthly Archives: June 2017

IHT: main residence nil-rate band

From April 2017, each individual spouse or civil partner will be offered a residence nil rate band (RNRB), which is designed to help pass on a home to ‘direct descendants’, including children or grandchildren, tax-free after their death. The rules governing the inheritance tax (IHT) nil rate band are complex and it is always recommended that prior professional advice is considered.

Phasing in of RNRB

The RNRB is being phased in over a four-year period as follows:

  • £100,000 in 2017-2018
  • £125,000 in 2018-2019
  • £150,000 in 2019-2020
  • £175,000 in 2020-2021

Broadly, the new RNRB will be added to the existing £325,000 IHT threshold, meaning the total tax-free allowance for a surviving spouse or civil partner will be up to £850,000 in 2017-18, and up to £1 million in 2020-21.

For the purposes of the new nil-rate band, ‘direct descendants’ include the spouse or civil partner, children, step children, adopted children, foster children, and any lineal descendants.

The property in question must be a ‘qualifying residence’. This means it must be a property where a person held an interest and had occupied the property as their residence at some point. HMRC may require evidence of this, so it is essential to maintain proper records to help substantiate a claim. Where a person has more than one property, an election can be made so that the exemption is offset. For the purpose of the exemption, there is no requirement for the property to be the main residence at death.

Tapering

The new allowance will be tapered away from those leaving an estate of more than £2 million, so that those leaving more than £2.35m will not benefit from it.

For estates (broadly, assets less liabilities) exceeding £2 million, the RNRB (£100,000 for 2017-18) is reduced by £1 for every £2 over the £2 million threshold. The effect of tapering is an extremely important planning point, particularly where the whole of an estate is being left to a surviving spouse or civil partner – whilst no IHT will be charged on first death, the amount of RNRB that may subsequently be transferred to the surviving person may be affected by the taper.

If there is no qualifying residence or the residence is left to someone who is not a direct descendant, upon the first death of one spouse or civil partner, the RNRB will not be available. However, the surviving spouse or civil partner may be able to benefit from the unused RNRB when they subsequently die. On the death of the surviving spouse or civil partner, they will be entitled to two times the RNRB. Note that for this to happen, a claim would need to be made within two years of the death of the second spouse or civil partner.

There is an additional benefit to this exemption which will naturally affect a number of people whom in their old age may wish to, or require to, either downsize or dispose of their residence (move in with family or into a care home). Provided that the sale of the property occurred on or after 8 July 2015, the RNRB will not be lost. Instead, the exemption can be maintained and used against either the remaining value of their smaller residence or equivalent value of assets (provided it has been left to a direct descendant).

In the event that the property was given away, the RNRB can be available, provided the gift was made on or after 8 July 2015, and assets of a similar value have been left to a direct descendant.

The calculations for the RNRB where a residence has been downsized, sold, or gifted are extremely complex and careful planning is required to ensure the exemption is not lost. It is extremely important that proper records of sales and/or purchases of residential property are maintained.

Advertisements

Reform of landlords’ taxation?

The government’s plans to allow landlords to use the cash basis for tax purposes were confirmed in the 2017 Spring Budget, but although the proposed legislation was included in Finance Bill 2017, it did not appear in the much reduced Finance Act 2017, which received Royal Assent on 27 April 2017. It is likely that the proposals have been temporarily shelved, pending the outcome of the General Election, and are expected to reappear in a second Finance Bill later this year. If the provisions are subsequently enacted, they are expected to apply retrospectively from 6 April 2017, i.e. for the current tax year.

Up to and including 2016-17, profits of a property business must be calculated in accordance with generally accepted accounting practice (GAAP), commonly referred to as the accruals basis. Although this remains the case for certain landlords (including companies, LLPs, corporate firms, and trustees of trusts), if the Finance Bill 2017 provisions are enacted, the position for 2017-18 onwards will be more complicated. The general rule is that the cash basis must be used. However, this is subject to some exceptions and there will be scope for the individual to elect to continue using the accruals basis if they so wish. The new property allowance will remove some landlords from income tax, whilst for others, it will provide a deduction from profits of £1,000.

Property allowance

The property allowance works as follows:

  • Full relief: if income from a property business for the tax year is equal to or less than £1,000, no income tax will payable in respect of that property business for that year. Individuals may elect to use the rules normally applying to calculate profits.
  • Partial relief: if income from a property business for the tax year exceeds £1,000, the individual may elect to deduct £1,000 from his income – rather than the expenditure actually incurred – in arriving at the profits of the property business.

A number of restrictions apply. The property allowance will not apply:

  • to income on which rent-a-room relief is given; or
  • where the ‘alternative method’ is not elected, but instead the actual allowable expenses are deducted.

Cash basis

The cash basis operates by reference to the tax year. This means that profits are calculated for the tax year by adding or subtracting:

  • all income received in connection with the property business in the tax year;
  • any income that is not taxable and for expenses which are not allowable.

Reform of capital expenditure rules

To date, the cash basis rules have prohibited a deduction for expenditure of a capital nature unless such expenditure would qualify for plant and machinery capital allowances under the ordinary tax rules. However, if the Finance Bill 2017 proposals are enacted this general disallowance of capital expenditure rule will be replaced from 2017/18 onwards with a more limited disallowance of capital expenditure incurred in relation to assets which are not used up in the business over a limited period.

So, if enacted, from 2017/18 onwards, relief will be prohibited only in relation to costs incurred in relation to the provision, alteration or disposal of:

  • any asset that is not a ‘depreciating asset’ (to be defined as having a useful life of up to 20 years);
  • any asset not acquired or created for use on a continuing basis in the trade;
  • a car (but of course business mileage-based relief is available);
  • land (as defined);
  • a non-qualifying intangible asset, (as per Financial Reporting Standard 105) including education or training; and
  • a financial asset.

Costs in relation to the acquisition or disposal of a business, or part of a business, will also be excluded.

On entering the cash basis, which many taxpayers will do for 2017-18, it will be necessary to adjust for:

  • amounts which, applying the cash basis, would have been brought into account for a period before the change and were not brought into account; and
  • amounts which, applying the cash basis, should be brought into account for a period after the change and were brought into account for a period before the change.

These adjustments are designed to ensure that no amounts are either left out of account or double counted. The adjustment income/expense is brought into account on the last day of the first period of account under the cash basis.

Similar rules apply where a taxpayer leaves the cash basis with the exception that adjustment income is automatically spread over six years unless an election is made to accelerate the charge.

Given the uncertainty of the current situation, clients are encouraged to ensure that all income and expenditure is recorded, particularly where clients are intending to make use of the property allowance. If the proposals are not enacted, or are delayed to a future tax year, the client will need to report their actual income and expenditure and so it is important that adequate records are kept.

CGT annual exemption: use it or lose it!

Capital gains tax (CGT) is normally paid when an item is either sold or given away. It is usually paid on profits made by selling various types of assets including properties (but generally not a main residence), stocks and shares, paintings, and other works of art, but it may also be payable in certain circumstances when a gift is made.

The most common method for minimising a liability to capital gains tax is to ensure that the annual exemption is fully utilised wherever possible. Whilst this is relatively straight-forward where only capital gains are in question, the computation can be slightly more complex where capital losses are also involved.

Where a loss arises on the sale of assets it can be offset against any other gains made in the same year or in the future. However, a strict order applies for setting-off losses.

Firstly, losses arising in the tax year are deducted from any other chargeable gains for the same year. All losses for the year must be deducted, even if this results in chargeable gains after losses below the level of the annual exempt amount. If the allowable losses arising in the tax year are greater than the total chargeable gains for the year, the excess losses can be carried forward to be deducted from chargeable gains in future years. In this situation, the annual exemption for the year in question may be lost.

If chargeable gains remain after deducting the allowable losses arising from the same year, unused allowable losses brought forward from an earlier year may then be deducted. It is only necessary to deduct sufficient allowable losses brought forward to reduce the chargeable gains after losses to the level of the annual exempt amount. Any remaining losses brought forward are carried forward again without limit, to be deducted from chargeable gains in future years.

Plan ahead

For 2017/18, most individuals will be entitled to an annual exemption of £11,300, which means that no CGT will be payable on gains up to that amount for that tax year. Since spouses and civil partners are each entitled to the exemption, for jointly held assets, there is scope for exempting £22,600 worth of gains in 2017/18.

The annual exemption is good only for the current tax year – it cannot be carried forward or taken back to an earlier year – so anyone planning to make a series of disposals, may want to consider the timing of sales between two or more tax years to use up as much and as many annual exemptions as possible.