Tax Planning for Post the Apocalypse
In this special feature, Alan Pink looks at the ways the government may try to fill in the current black hole in their finances, and how UK taxpayers can position themselves to avoid bearing the main brunt.
As a tax adviser, but part-time journalist, I have my own theories as to how this whole coronavirus “scare” has come about. Looked at objectively, this is one of thousands of nasty diseases which can make you feel very uncomfortable or even kill you, and even now, if you look at the actual numbers, it hard to see why this one disease is so singled out from all the others, for example, malaria, pneumonia, and even flu. Baulked of their apocalyptic visions of half a million or more people dying in this country, the doom merchants are forced back on to the highly speculative theory that there may be a “second wave”, which the more “optimistic” amongst them say will be far worse than the first one. (On 23 April Professor Neil Ferguson was reported as saying that such a second wave, worst than the first, was “virtually certain” to happen. We’re still waiting for this phenomenon properly to arise in any single country in the world.)
If you are Covid-19 sceptic, who do you blame for the fact that most of the world seems to have been scared witless by this threat? The scientists? Personally I don’t think so, because, as some sceptics point out, there’s been a highly selective choice of scientists to believe: exclusively, in practice, those who are prophesying dire consequences. Those who disagree with their more pessimistic colleagues are effectively ignored.
The politicians? No, I very much get the feeling that they are reacting to the situation presented to them, rather than originating what some see as a kind of mass hysteria.
No, for me, the fourth estate should step forward as the real author of this “pandemic of fear”. And you only need a fairly basic lesson in How Journalism Works to understand why this has come about. Journalists are interested principally not in what happens as such, but in the fact that something should happen. Those newspapers and journals start off with what seems like acres of white paper that are going to need to be filled somehow, and the threat of a future epidemic is, to put it bluntly, an absolute godsend to the profession of which I form a small and insignificant part. And have you noticed how most “news” is not so much about what has happened, as about what is going to happen? So a professor somewhere makes a guess, puts that guess into his calculator, and this is grist to the journalists’ mill.
What all this is getting round to saying is that, however valid the basis for the worldwide scare about Covid-19 is, we definitely have a real event on our hands now: created by the government’s response. One estimate has it that the black hole which has appeared in government finances has been getting bigger at a rate of £2.5 billion a day during “lockdown”. For those who aren’t comfortable with numbers, especially big numbers like this, let me assure you: that is an unbelievable amount of money. In one day, the government has lost more than it gets from inheritance tax in a whole year. You might say that this article I am writing now is just another example of baseless speculation dressed up as responsible journalism. But the hard fact of the matter is that the huge additional government borrowing (we were told by the Bank of England, in fact, that the government very nearly ran out of money the other week) is going to have to be repaid somehow, and the only way the government can do this is by getting in a lot more tax than it has been doing in recent times.
So sensible business people and investors will allow for a “virtually certain” spike in taxation, and there are lots of ways that they can do this. I like to think, then, that I have a much greater moral justification than most for writing yet another Covid-19 article, which is that I’m not looking to sell newspapers by scaring my readers, but am looking to present a positive way of taking action to make their prospects a lot better.
So what are the best “tips” for future tax rises, and what can we do about them, if anything?
If I was in government, I would be looking at the grand gesture: increases in the rates of the government’s three main earners, which are income tax, national insurance and VAT. But I can’t help feeling that the government are now in the position of the desperate householder searching in every nook and cranny, including behind the sofa cushions, to find a few pence wherever they can. So let’s look at all of the main sources of revenue for HM Government, and do a bit of – hopefully educated – guesswork about what might change, and how we can prepare ourselves for such a change.
Income Tax
Easily the most straightforward way of bumping up tax revenues would be to increase the basic rate of income tax from the current 20% to 21, 22, or even 25 percent. Paradoxically, perhaps, increasing the top rates is not so likely to have a good effect on government revenues. Some left leaning politicians seem to talk as though the main point of having high income tax rates is not to fund the government, but to punish the well off. But for whatever reason, the effect of putting up top rates beyond about 42% (which seems to be the ideal top rate) seems to be to reduce government revenues, not increase them.
But by putting a few points on the basic rate, you pretty much have a “captive audience”.
What, then, if anything, can we do in advance to mitigate the effect of such a possible future increase in the basic rate?
Part of the answer to this depends on what they do to corporation tax rates – of which more shortly. Currently the rate of corporation tax is 19%, and was proposed to be reduced to 17% this year. This proposal was reversed by Boris Johnson, however, as one of the first things he did as premier. So at present, there is only a 1% difference between the basic rate of income tax and the rate of corporation tax. For anyone who has a form of income (usually business income) which can be passed, effectively, either through a company or be received direct, the company therefore saves very little tax (although it can save a lot of national insurance). However, if corporation tax rates were to stay the same, or even go down, but income tax rates were to increase, the differential could become much more marked. Setting up a company, if you haven’t got one, could result in a not completely trivial annual saving depending on your circumstances. Of course, if the company’s income is then all paid out to you anyway, there’s no saving, as is a notorious feature of tax planning using limited companies. But this isn’t by any means always the case: for example, it’s sometimes possible to draw money out of companies in capital form rather than as income. Also, a company can be a convenient mechanism for spreading income amongst various members of your family or household, thus using their personal allowances.
As a general rule, setting up your business and investment affairs in such a way as to provide flexibility in this way could be enormously useful if the government starts tightening the screw on everyone.
Almost inevitably (to anyone who reads a lot of my writings) this could enhance the benefits currently enjoyed by those running family investment Limited Liability partnerships (LLP’s).
National Insurance
Interestingly, NI is both one of the government’s major sources of revenue, and one of the most easily avoided taxes in the whole list.
Frankly, if I was the government, I would look to move towards repairing the hole in my finances by applying NI to unearned income as well as to earned income: which would really put the cat among the pigeons. But this seemingly obvious move, redressing the current anomaly whereby earned income is effectively taxed much higher than unearned income, seems to be something which governments have historically been reluctant to do. Probably more likely is an increase in the rates of national insurance, especially those relating to employees, and especially the employer’s contribution. The harsh reality of the matter is that, whilst it is businesses which have been hit hardest by the draconian measures taken against this virus, it is also businesses which will be required to pay for it. The idea, of course, has been scouted of actually reducing national insurance, particularly the employer’s contribution, which is a payroll tax in all but name. But to bring in serious new amounts of money, there’s no doubt that putting a percentage point or two on employee’s and employer’s NI would be an easy way to do it.
How do we avoid suffering from this extra imposition?
Well, depending on what other changes happen at the same time, you could look at using one of the current methods of NI avoidance. The simplest is to pass your income through a limited company, if you can. If you work for a “small” employer (a highly relative term) you may well be able to set up as a company rather than simply being on their payroll. On a certain band of income, even under current rates this wipes out 25.8% NI liabilities as if by magic. Alternatives, if you are in control of the income, are to take dividends out of the business rather than remuneration, or even income in other forms, such as interest (on a director’s loan account) or rent (on property occupied by the business). But the area I do see a lot of concentration on is what is commonly referred to nowadays as “off payroll working”. That, as I say, means working for whoever you work for not as an employee but as a one (or more) man (or woman) service company. Whilst things will get much more difficult in this area from April 2021 if your employer is medium sized, large, or in the public sector, a large proportion of people actually work still for small employers. So consider eliminating your NI bill overnight by some such arrangement, if you’re in the fortunate position of being able to.
VAT
I would definitely be looking at putting this up if I was Rishi Sunak. Of course, increasing VAT is a directly inflationary thing to do, because prices will go up penny for penny. But inflation is the last of the government’s problems at the moment.
Now comes the difficulty. It’s all very easy to look at it from the government’s point of view and see the extra money coming in with no effort on their part. In theory, VAT is a tax on the consumer. In reality, like every other tax, it’s a tax on business. If you are selling someone a Mars Bar in a shop, the customer isn’t the slightest bit interested in how much of the price of that bar of chocolate you have to pay over to the government in VAT. He will pay what he thinks it is worth, and won’t buy if it is priced above that. So an increase in VAT may well not result in an increase in the price of the goods, and effectively therefore it will be a tax on the shopkeeper’s profits.
VAT is a very difficult tax to plan to reduce in any way, let’s be honest. But for certain types of business, the idea of “business splitting” is still a valid one. Despite HMRC’s weapons of registering a number of linked businesses as if they are one, or even claiming that the split into a number of businesses is a “sham”, this sort of planning, if properly done, can relieve comparatively large amounts of income from VAT liability for a small business. Let’s look at a straightforward example of business splitting, that works until such time – if ever – as HMRC comes along and decides to direct that the two businesses shall, in future, be registered as one:
Charlotte is an electrical contractor, whose work is mainly for other businesses, fitting out shops and doing electrical work in new property developments. But she also has a side-line doing small electrical work for private individuals. The main work is done through a company, Charlotte Electrics Limited, and VAT applies to this company’s turnover, because it’s well over the £86,000 threshold. This isn’t a problem, because all of her customers can reclaim their VAT as they are in business themselves. The private work, however, she does through the medium of an LLP in which she and her husband are the partners. The turnover of this business is below the threshold, and therefore it doesn’t need to register. So she is cheaper and more competitive, for such private customers, than a larger business would be. Charlotte is completely indifferent to the government’s increase in VAT rates from 20% up to a higher percentage. It literally makes no difference to her whatsoever.
Corporation Tax
Placing myself hypothetically in the chancellor’s “hot seat” again, what would I do, if I were him, about corporation tax? The answer is very firmly that I would reduce it!
Why? Because firstly corporation tax is a lesser contributor to the Exchequer than some of the other taxes we’ve mentioned; and, importantly, a low corporation tax rate has been proven to attract large overseas businesses to a jurisdiction: just look at the success story that was the Republic of Ireland, with its 12½% corporation tax rate. Corporation tax is a less important tax as a source of government revenue than some others, and getting inward investment by overseas businesses has immense potential advantages in terms not just of employment but also increasing the tax take in other areas, for example income tax and national insurance on employee wages, VAT on the money which the employees spend, and also such taxes as fuel duty when the incoming business sets up its fleet of vehicles in this country. As far as the UK government and the incoming business is concerned, it’s win: win.
As I say, that’s what I would do. But we have to face the fact that politicians don’t run the country, sometimes, as well as we could! What if the reaction were different, and the decision were made to increase corporation tax rates? They are, after all, currently at their lowest level in living memory (I can remember when the top rate of corporation tax was 52%).
I think the key here is to leave your structure as flexible as possible for future changes. If a company format for your business (if you have one) becomes tax inefficient because of increases in CT, you will really want to be in the position of being able to come back out of the company structure if that’s what the tax environment is telling you to do at the time.
So don’t tie up valuable and appreciating assets in a limited company, because taking these out on any future disincorporation could be very expensive in terms of capital gains taxation and even income taxation. Don’t put properties into limited companies if you have any choice in the matter, and certainly don’t set up an investment company. That would be my advice.
Capital Gains Tax
This is something of a “tiddler” in comparison with the bigger fish we’ve been talking about. But on the principle of searching down the back of the sofa, there could be increases. Frankly, though, it’s difficult to see what you can sensibly do, that arguably you shouldn’t have been doing already, to guard against such a future increase in the rate of CGT. Certainly, I personally would have no great appetite for “triggering” disposals of assets in anticipation. This would just give rise to tax which I wouldn’t have had to pay otherwise.
CGT planning by way of sharing asset ownership amongst a number of people in the household could obviously turn out to be a very good thing to do in the event of an increase in CGT rates: but it’s also true to say that this is a good thing to do in any event, as things are now.
Inheritance Tax
This has actually been talked of as an area where the government may seek to raise some more dosh, even though, as I have already mentioned, it’s a very minor contributor to the Exchequer in fact.
One possibility is that the rate of Business Property Relief might be reduced from the current very generous 100%. At present, if you leave an interest in a trading business (not quoted) to your children on your death, there will be no tax on this because the whole value will be relieved by BPR. However, the rate of BPR within living memory was 50%, and the government could, fairly easily, derive quite a bit more inheritance tax income from reverting to that original rate. So a person who dies and leaves his £10 million private company to his sons, would have an inheritance tax liability of £2 million (or more if the rate is put up). Currently, the government gets absolutely nothing.
Now this really is a case of a possible future tax increase which can be forestalled. One way to do it, to use our example of the chap with the £10 million private trading company, would be to put the shares on trust (if he doesn’t want to give them away absolutely) for his sons or indeed children and remote issue, as the lawyers put it. Under current rules this can be done without any tax, and the value of the business, subject to meeting the conditions, would be outside the donor’s estate for inheritance tax, should this become taxable in the future. The trust itself has an inheritance tax regime, by way of 10 year inheritance tax charges, but these are arguably no worse, and indeed can be much better, than the tax liability that would arise on the shares being left on death.
Also, a possible future increase in the rate of inheritance tax, or the reduction of reliefs, encourages the making of lifetime gifts now. For example, if you set up a regular set of gifts, perhaps by standing order, to the younger members of your family, this will start making a hole in your taxable estate and establish a pattern of giving which should mean that you can qualify for the “normal expenditure out of income” exemption from IHT.
Pensions
Those who plan ahead and put money into tax approved pension schemes are now quite familiar with the government’s repeated raids on pensions. Starting with Gordon Brown in 1997, these seem to have been consistently an Aunt Sally for governments to have a shot at. It is a multi-billion pound industry, and you can see the temptation for Rishi Sunak, or one of his near successors, to levy more tax.
What should one do about such a concern? My own reaction, and it is a very personal one, would be to think twice or three times before funding my pensions any more than they are at present. The thing about money in pension schemes is that it is to a large extent “trapped” where it is. You can’t take the money out until you retire, and then it is charged at potentially very high rates of income tax. Whilst in the scheme, there are severe restrictions on what you can do with the money. If we are going to add to this a harsher tax regime for pensions than they currently enjoy, then tax approved pensions begin to look ever less attractive as a home for your money. Alternative arrangements which aren’t tax approved (for example straightforward investment or property portfolios) become correspondingly more attractive.
Development Land Tax
What? You may ask. Development Land Tax as such (or DLT) did previously exist but was abolished over 30 years ago: much to the chagrin of an individual who had just completed an encyclopaedic tome on the subject of the tax! But it’s got to be a favourite for easily raking in more government cash at this time. As the economy restarts, and immigration continues to exacerbate our massive nationwide housing shortage, the chances are that developers will be given permission for more and more new housing developments, resulting in huge “windfall” type increases in the value of land that they hold. Incidentally, if I were not just a tax adviser but also one addicted to giving business “tips”, now would seem to be a very good time to acquire parcels of land near towns and villages which are currently not zoned for development. Things could easily change.
Getting back to my own subject, though, a development land tax of some kind could easily and relatively painlessly (in terms of lost votes) give rise to massive new tax revenue opportunities for the chancellor.
What to do about this threat, if you agree with me that it is a potential threat? Well, one possibility is that there would be transitional relief for such a new tax. When a person decides to carry out a property development, this can take a number of years to complete, and must be carefully budgeted at the outset to make sure that it works and is viable financially. It would be harsh, and even oppressive, to levy DLT on a development which has already been budgeted and commenced when the tax is introduced. So this might just be a spur to getting on with a development which you have in mind, in the hope of benefiting from such putative transitional relief. DLT may or may not be immediately on the horizon, but developments do take a long time to get properly started, so the early bird could easily benefit substantially here.
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