The UK’s tax system could be simple if its sole purpose was to raise revenue.
However, it also needs to be fair, efficient, and enforceable, while successive governments have increasingly used the tax system to drive behaviour and influence social policy.
Complexity impacts the poorest in society more than those who can afford and are willing to take advice.
Additionally, the lay person is unlikely to know, let alone understand, many of the hundreds of reliefs, exemptions and allowances to their advantage, while at the other extreme, in most instances, HMRC take the view that ignorance of the law is no defence.
In this article, Quilter’s head of technical sales, David Denton, seeks to debunk some examples.
The illogical
Arriving in the UK, one might reasonably expect becoming tax resident would relate to the day of physical arrival.
But according to the 2013 Statutory Residence Test, the relevant day could be the 6 of April gone, the 6 of April to come, or following the day of arrival, splitting the tax year in two.
Once that is established, one might also expect that any profits on investments up until that point would not be taxable when investments are realised, following arrival in the UK.
However, in most instances, capital gains will in fact be chargeable back until when that asset was purchased, so that any gains enjoyed but not crystallised while non-UK tax resident would become taxable.
This will be the situation for shares, mutual funds and property (with its own set of additionally complicated rules).
But life assurance or redemption bonds fare significantly better.
An individual who once owned them as a non-UK tax resident upon final encashment or other chargeable event can have a proportion of the gain removed from UK taxation.
The proportion removed is the number of days that asset was owned as a non-UK tax resident as a proportion of the total period of ownership.
This is known as ‘time apportionment relief’ and is a fundamental reason why advance planning for future UK tax residents often involves the use of vehicles that benefit from this feature.
Further, any top up to a life assurance or redemption bond will benefit from the same time apportionment going back to the inception of that investment which can have a disproportionately positive effect.
Impenetrable
The long-standing nil rate band is one of the most valuable features of UK inheritance tax legislation and in simple terms means that the first £325,000 ($459,724, €376,730) of one’s estate is free of inheritance tax upon one’s death.
However, an innovation of former chancellor George Osborne, the residence nil rate band (RNRB), adds significant complexity.
This represents an incremental allowance of up to £175,000 per person, subject to a qualifying residential interest (QRI) which is broadly ownership of a residential property that has at some point during the deceased period of ownership been occupied as their residence.
However, there are several instances where this will disapply.
For example, a QRI needs to be ‘closely inherited’, ie left to someone who is a direct descendant.
This might not be desirable, or even possible.
Also, the RNRB is reduced by £1 for every £2 by which the deceased’s net estate exceeds £2m, known as tapering. For this purpose, the estate is everything which the deceased owned after their debts, but before deducting certain exemptions and reliefs including business relief, so that many business owners can’t benefit from the RNRB.
As far as married couples and civil partners are concerned, the total value on the second death (where there are reciprocal wills) could mean that both the RNRB and transferrable RNRB are both tapered away.
This will seem a poor outcome if both partners owning half the estate each are below the £2m threshold each.
Planning well in advance can ensure that value upon the first death doesn’t swell the survivor’s estate so the relief is not lost. This can be achieved by lifetime gifts, establishing investments under trust, or simply not transferring some of the estate to the spouse upon the first death, with dramatic effect.
Irrelevant
Although irrelevant for all but a few, heritage property saves huge amounts where it applies, and is often how estates are passed on to the next generation without being broken up.
In essence, some buildings, land and works of art can be exempt from inheritance tax and capital gains tax where strict qualifying conditions are met.
They must be of outstanding historical, architectural interest, or natural beauty with spectacular views. Or land with scientific, historic or artistic interest, including special areas for the conservation of wildlife, plants and trees.
To qualify, the new owner must undertake to look after the item, property, or land, making the property in question available for the general public to view, and keeping it in the UK where moveable.
Conclusion
As Max Baucus, a former chair of the US Senate Finance Committee pronounced – ‘tax complexity itself is a kind of tax’ and is one of the best reasons of all to take timely financial advice.
This article was written by David Denton, head of technical sales at Quilter.
