Get ready for 5th April

Now that the festive season is fading from memory, it’s time to start thinking about 5th April and your year end tax planning.

After two Budgets in 2021, there should be no spring Budget this year, Covid-19 permitting. However, the Chancellor is expected to make a statement to parliament on 23 March alongside the publication of the latest economic forecasts from the Office for Budget Responsibility. Good Friday falls on 15 April, so Easter will not disrupt the planning timetable.

Arguably, tax planning for the 2021/22 year end matters more than in previous years because in 2022/23:

• The personal allowance and income tax bands (other than in Scotland) will be frozen, despite inflation expected by the Bank of England to be running at 6% by April 2022. 

• The increases to National Insurance contributions (‘NICs’) and dividend tax announced last September take effect.

The impact of these two is significant. For example, to maintain their buying power, someone in England with a salary of £50,000 a year in April 2021 will need a pay increase of 9.5% in April 2022 to counter the double hit from 6% inflation and higher NICs. 

The to-review list

Tax year end checklists change subtly each year, as tax rules change. For 2021/22 the main items are:

Pensions

5 April 2022 is the final date for taking advantage of any unused pension annual allowance (of up to £40,000) from 2018/19. The calculations involved can be complex, so it important to start this element of planning early.

Normally any pension contribution up to your available annual allowance will reduce your income tax bill, but the more value you already have in your pension, the more you need to check before adding to it. The same freeze until April 2026 that applies to the income tax personal allowance also fixes the standard lifetime allowance for the next four years. HMRC statistics show that the number of people exceeding their allowance and paying a tax penalty of up to 55% doubled between 2015/16 and 2019/20 (the latest stats available). A headroom check is therefore a wise precaution. 

ISAs 

With widespread income tax freezes and an increase of 1.25 percentage points in the tax rates on dividends, the value of the tax shelter provided by ISAs has grown. That probably explains why the Chancellor left the maximum contribution for 2022/23 at £20,000, the same level that has applied since 2017/18. 

All types of ISA offer four valuable tax benefits:

• Interest earned on cash or fixed interest securities is free of UK income tax.

• Dividends are also free of UK income tax.

• Capital gains are free of UK capital gains tax (CGT).

• ISA income and gains do not have to be reported on your tax return. 

For most basic rate taxpayers, the combination of the personal savings allowance, dividend allowance and CGT annual exemption means ISA tax benefits are largely academic. However, it is a different story if you pay income tax at more than basic rate or have exhausted any of your allowances.

As well as considering fresh ISA investment, you should review your existing ISAs. ‘Flavour-of-the-month’ ISA fund choices made years ago may now be tasteless. Similarly, old cash ISAs can offer negligible returns. For example, despite a recent rate rise, the National Savings & Investments Direct ISA pays just 0.35%. Even so, that is 35 times more than Halifax is paying on its instant access ISA accounts.

CGT

Towards the end of last year, a large question mark hanging over the future of CGT was removed. The Chancellor announced that he would not be implementing most of the reform proposals made in a CGT review he commissioned from the Office of Tax Simplification (OTS) in 2020. Ironically, the clarification has simplified year end planning. There is now no need to consider whether to incur a CGT bill today to avoid a potentially larger bill tomorrow. 

The year-end CGT exercise is, thus, the normal one of considering whether and how to use any remaining CGT annual exemption (£12,300, again frozen to 5 April 2026). 2021 was a good year for most world stock markets – even the FTSE 100 was up 14.3% – so you may well have gains that can be set against the exemption. In many instances, it will make sense to take maximum advantage of the exemption as it cannot be carried forward to next tax year; use it or lose it. 

Unfortunately, you cannot sell holdings one day and buy them back the next to crystallise capital gains, but there are other ways to achieve much the same result, such as using an ISA or a pension as the reinvestment route. 

Inheritance tax (IHT)

The uncertainty that CGT faced last year was mirrored by IHT. That too had been subject to a review by the OTS, commissioned in January 2018, which had seemingly got lost in the Chancellor’s in-tray. Thankfully, after nearly four years, the end of November saw a statement confirming that there would be only one administrative change to IHT, (first announced in March 2021), easing the paperwork burden for many executors. IHT year end planning is, thus, also business as usual, meaning that you should consider using the three main IHT annual exemptions:

1.    The Annual Exemption Each tax year you can give away £3,000 free of IHT. If you did not use all the exemption in 2020/21, you can carry forward the unused element to this year (and no further), but it can only be used after you have used the current tax year’s exemption. For example, if you made no gifts in 2020/21, and you gift £4,000 in 2021/22, you will be treated as having used your full 2021/22 exemption and £1,000 from the previous tax year. 

2.    The Small Gifts Exemption You can give up to £250 outright per tax year free of IHT to as many people as you wish, so long as they do not receive any part of the £3,000 exemption. 

3.    The Normal Expenditure Exemption The normal expenditure exemption is potentially the most valuable of the yearly IHT exemptions and one which the OTS wanted to replace. Under the exemption, any gift – regardless of size – escapes IHT provided that:

 a.    you make it regularly; 

b.    it is made from your income (including ISA income, but excluding investment bond and other capital withdrawals); and 

c.     the sum gifted does not reduce your standard of living. 

Venture capital trusts (VCTs) and enterprise investment schemes (EISs)

The lifetime and annual allowance constraints that apply to pensions have encouraged growing interest in VCTs and EISs as an alternative way to invest with tax relief. Subject to generous limits, both offer:

• income tax relief at 30% on fresh investment, regardless of your personal tax rate; and

• freedom from CGT on any profits. 

While these tax reliefs are attractive, VCTs and EISs are by no means a straightforward substitute for pensions. The focus for VCTs and EISs is on high risk investments in small, relatively young companies – a long way from the typical investment choices for pension arrangements.  

Business income planning

If you are a shareholder director in your company, it could be worth bringing forward the payment of any dividend or bonus into this tax year, rather than leaving it until after 5 April. Higher NICs and increased dividend tax will both arrive after that date, reducing your net income. The table below demonstrates the impact, based on £10,000 of gross profits being paid to a higher rate taxpayer with no remaining dividend allowance.

Remember too that your company’s corporation tax rate will rise from 1 April 2023 if profits exceed £50,000. At £250,000 or more the new rate will be 25% against the current 19%.