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My PFS - Technical news - 24/05/16

Personal Finance Society news update from 11 May to 24 May 2016 on taxation, retirement planning and investments.

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Taxation and Trusts

Investment planning

Pensions

TAXATION AND TRUSTS

Foreign companies forced to disclose beneficial owners of UK property
(AF1, RO3)

Recently the Prime Minister, David Cameron, hosted the Anti-Corruption Summit at which he announced that any foreign company that wishes to buy UK property or bid for central government contracts here will have to join a new public register of beneficial ownership information before they can do so.

This will be the first register of its kind anywhere in the world and, crucially, will also include companies who already own property in the UK, not just those wishing to buy.

The new register for foreign companies will mean corrupt individuals and countries will no longer be able to move, launder and hide illicit funds through London's property market, and will not benefit from our public funds.

This announcement speaks for itself. In recent years the government is, and has been, committed to fighting against tax avoidance and, as can be seen, the fight continues….

Dividend/bonus/pension revisited
(AF1, AF2, AF3, JO3, JO5, RO3, RO4, RO8, AF3, FA2)

This article takes a look at the factors in the dividend/salary/pension contribution decision in 2016/17.

The arrival of 2016/17 marked:

  • The start of the new dividend tax regime, specifically targeting shareholder directors who used high dividends in place of salary/bonus payments; and
  • A cut in the standard lifetime allowance and the introduction of annual allowance tapering for high earners.

Both these changes have an impact on the salary v dividend v pension contribution decision. In this article we look at some of the basic considerations in making the selection.

Generally, a salary of £8,060 will make sense before any other payment is considered. The figure is chosen to match the primary earnings threshold and means that there is no employee or employer NIC involved, but the employee gains an NIC contribution record. 

At this level, the salary will also fall fully within the individual's personal allowance assuming there is not more than £2,940 of other earned/pension income and that the personal allowance is not subject to £100,000+ tapering. Salary is an allowable expense so provides a corporation tax saving.

A further consideration is the employment allowance, which effectively negates the first £3,000 of employer's NIC, but not (for 2016/17 onwards) for companies where the director is the sole employee. This is an obvious incentive for a director of a one-person company (eg consultancy) to employ their spouse/civil partner, typically paying up to their available personal allowance. If the spouse/civil partner is already a taxpayer, then it will usually not be worth paying them beyond £8,060 to avoid any NIC cost. There will be tax on these earnings, but at the margin this will generally be less than the alternative of a dividend payment to the director.

If there is any unused employment allowance after covering employer's NIC payments for other employees, then it can be used to increase the director's salary, but not beyond the remaining unused personal allowance. However, the net benefit beyond £8,060 is reduced because 12% employee NICs will bite.

Once both employer and employee NICs bite, dividends become a more attractive option, where payment is possible. This looks at the marginal situation above the (employer's) secondary threshold of £8,112:

 

Salary

£

Dividend

£

Gross profit

1,000.00

1,000.00

Corporation tax @ 20%

N/A

(200.00)

Dividend payable

N/A

800.00

Employer' NIC @ 13.8%

(121.27)

N/A

Salary

878.73

N/A

Employee' s NIC @ 12.0%

(105.45)

N/A

Pre-tax amount

773.28

800.00

As the rate of tax on earnings in this band will never be less than that on dividends, the dividend wins.

If we look at the situation above the upper earnings limit/higher rate threshold, the advantage of dividends remains, but is reduced (as the Chancellor intended):

 

Salary

£

Dividend

£

Gross profit

1,000.00

1,000.00

Corporation tax @ 20%

N/A

(200.00)

Dividend payable

N/A

800.00

Employer' NIC @ 13.8%

(121.27)

N/A

Salary

878.73

N/A

Employee's  NIC @ 2.0%

(17.57)

N/A

Pre-tax amount

861.16

800.00

Net to 40%/32.5% taxpayer

509.67

540.00

Net to 45%/38.1% taxpayer

465.73

495.20

However, remember that to reach this stage, at least £4,193 of employee NICs will have been paid.

The abolition of the 10% tax credit gives dividends another advantage over salary/bonus in that gross income is 'kept down' as the table shows:

Gross income and gross profit cost to produce £1,000 net of tax and employee NIC income

Tax rate + NIC

Salary/Dividend (above allowance)

Salary

Dividend

Income

£

Profit Cost

£

Income

£

Profit Cost

£

20%+12%/7.5%

1,470.59

1,673.42

1,081.08

1,351.35

40%+2%/32.5%

1,724.14

1,962.07

1,481.48

1,851.85

45%+2%/38.1%

1,886.79

2,147.17

1,615.51

2,019.39

The smaller gross equivalent achieved by paying dividends is of increased importance when the (unindexed) thresholds for child benefit tax, phasing out of personal allowance, tapered annual allowance, etc are considered. Also significant is that the gross profits cost of the dividend route is less than the salary alternative for each tax rate.

As a general rule, dividend payments are directly proportionate to shareholdings, which means the dividend or salary choice can become impossible to make when there is a mix of shareholdings and total remuneration targets.

Dividend payments rather than salary may have adverse effects where tests are generally salary-related, eg mortgage borrowing capacity. However, the issue of lost S2P no longer arises in the world of the single-tier state pension.

When considering the alternative of a pension contribution, the first question now is whether it is possible, in the light of the tapered annual allowance, reduced lifetime allowance and any transitional protections in place. If none of these are a constraint, then the pension contribution is a completely tax-free exercise at the point of employer payment of the contribution.

The simplest way to consider the end value is to ignore any investment return and assume an uncrystallised funds pension lump sum (UFPLS) is drawn, ie 75% of the contribution attracts (retirement) marginal rate tax and the other 25% is tax free. Thus, for example, a higher rate taxpayer receives a net £700 (.75 x £1,000 x .6 + .25 x £1,000) per £1,000 of contribution. The corresponding figures for basic and additional rates are £850 and £662.50.

Comparing numbers at this stage starts to get complicated because of the dividend allowance and assumptions about how any dividend drawn would be invested (remember there is a £20,000 ISA limit from 2017/18). For a basic rate taxpayer, there is only limited advantage (via the 25% tax-free element) until the dividend allowance is exhausted. Higher and additional rate taxpayers will see more benefit, particularly if their marginal rate falls in retirement.

There is no real substitute for number crunching, once the principles are understood.

The Personal Savings Allowance
(AF4, RO2, CF2, FA7)

The personal savings allowance covers all life policy chargeable event gains, including those for onshore bonds which are deemed taxed at the (non-reclaimable) basic rate. However, priority rules come to the rescue.

The personal savings allowance covers savings income. Although mostly thought of in terms of interest, savings income also includes chargeable event gains on life policies. The focus here has been on offshore investment bonds and some press coverage has highlighted this. However, the legislation covering life assurance policyholder taxation (Chapter 9 ITTOIA 2005) makes little differentiation between onshore and offshore bonds, other than adding in a basic rate tax charge for certain offshore life contracts under section 531.

This raises an interesting question. If an individual has UK interest and a chargeable event gain on a UK life policy, which is covered first by the personal savings allowance? Clearly, the preference would be for the interest to take priority as the savings rate tax deemed paid on a UK life policy gain is not recoverable.

The answer is to be found in section 465A ITTOIA 2005, which states that if the taxable amount received is treated as having irrecoverable savings rate income tax paid (section 530), then the amount is treated as "the highest part of the individual's total income". As a consequence, interest will take priority for the personal savings allowance. This proviso does not apply for offshore gains, as there is no deemed tax paid.

The legislation works in the most favourable way, but it remains a fact that some investors will pay tax on interest via a life policy which they could otherwise avoid by choosing a different tax wrapper.

INVESTMENT PLANNING

The April inflation numbers
(AF4, CF2, FA7, RO2)

Annual inflation on the CPI measure was down 0.2% in April, with the rate falling to +0.3% over the year, the same as February's, and the first drop since September 2015. Market expectations had been that the April inflation numbers would be unchanged from March.

The CPI showed prices up 0.1% over the month, whereas between March and April 2015 they rose 0.2% (rounding explains the missing 0.1%). The CPI/RPI gap narrowed by 0.1% this month to 1.0%, with the RPI down 0.3% on an annual basis to 1.3%. Over the month, the RPI rose by 0.1%, the same as the CPI.

The drop in the CPI annual rate was due to three main "downward contributions", offset by  two less significant "upward contributions", according to the ONS:

Downward

Transport:
Prices overall fell by 0.1% between March and April this year compared with a rise of 1.1% between the same two months a year ago. By far the largest downward effect came from air transport, with prices falling by 14.2% compared with a rise of 4.5% between the same two months last year. This was due to the timing of Easter which, via higher fares, was the main contributor to the previous month's 0.2% CPI jump. There was also a smaller downward effect from purchase of vehicles, particularly second-hand cars, for which prices fell between March and April 2016, compared with a rise between the same two months last year. However, prices for both petrol and diesel rose by more than they did a year ago.

Clothing and footwear:
Overall prices fell by 0.4% between March and April this year compared with a rise of 0.9% between the same two months a year ago. Much of the downward contribution came from women's outerwear.

Housing, water, electricity, gas and other fuels:
Overall prices fell by 0.2% between March and April 2016 compared with a rise of 0.4% between the same two months a year ago. The downward effect came mainly from social housing rent. This is likely to be due to changes that were announced in last Summer's Budget, in which social housing rent was set to decrease by 1% for the next 4 years, starting in April 2016.

Upward

Food and non-alcoholic beverages:
Overall prices were unchanged between March and April this year compared with a fall of 0.4% between the same two months a year ago. Deflation in this CPI component is now -2.5% on an annual basis.

Recreation and culture:
Overall prices rose by 0.8% compared with a rise of 0.2% between the same two months a year ago. The upward contribution came mainly from computer games, with prices rising between March and April 2016 compared with a fall last year, and from admission to cultural events, for which prices increased by more than they did a year ago.

Core CPI inflation (CPI excluding energy, food, alcohol and tobacco) fell 0.3% to an annual 1.2%. As for last month, there are three out of twelve index components in negative annual territory. Goods inflation continues to be solidly negative (unchanged at -1.6%), while services inflation is distinctly positive (but 0.4% down from March to +2.4%).

The fall in core inflation will be a relief to the Bank of England as it awaits the Brexit vote in just under a month's time. A leave vote could push up inflation by hitting the value of sterling, which all other things being equal would prompt a rise in interest rates. On the other hand, the likely short-term hit to an already slowing UK economy would point to a rate cut.

PENSIONS

Automatic enrolment report by work and pensions committee
(AF3, RO4, RO8, JO5, FA2, CF4)

The Work and Pensions Committee have published a report into the overall success of automatic enrolment (AE) but raise some important questions with regards to the master trusts and the possible detrimental effect that the Lifetime ISA could have on pension savings.                                                                                                         

The Work & Pensions Committee inquiry into AE was instigated with the principal objective of establishing whether small businesses were being adequately supported in introducing AE. Evidence, the Committee found, pointed to two significant concerns: the regulation of multi-employer occupational pension schemes known as master trusts, and impact of the proposed introduction of a new savings product, the Lifetime ISA.

The Committee states that AE has so far been a tremendous success. An additional 6.1 million people are enrolled in a workplace pension and saving for their retirement, with many more to follow. Employer compliance rates are high and employee opt-out rates are low. It is therefore essential that the continued success is not undermined.

Master Trusts

The Committee found that gaps in pension regulation have allowed potentially unstable master trusts onto the market. Should one of these trusts collapse, there is a very real danger that ordinary scheme members would lose their retirement savings. The Pensions Minister on speaking to the Committee stated that she wants a Pensions Bill for stronger regulation of master trusts.

Concerns about master trust regulation begin when a master trust is set up. "Rigorous standards" and capital and solvency requirements enforced by the FCA act as barriers to entry for contract-based pension providers. By contrast, Lesley Titcomb, Chief Executive of TPR, told us that she was not able to issue equivalent regulatory authorisation for trust-based schemes "we just learn about a master trust being set up through the Revenue telling us, so there are no checks at the gateway".

The TPR also acknowledged that some of the smaller master trusts "may not be run by competent people". Inadequate regulation increases the prospect of "substandard governance and investment strategies", which could make poor investment returns for scheme members. A proliferation of poorly-governed master trusts would also limit their ability to become large in scale, undermining their ability to provide cost-effective retirement saving.

The Chief Executive of the Pensions and Lifetime Savings Association (PLSA) Joanne Segars, warned that the financial burden of winding up a failed undercapitalised master trust may fall on individual member pension pots. The Pensions Minister shared this concern and has called for a Pensions Bill to introduce stronger regulation of master trusts.

Employer Liability for AE

The DWP have stated unambiguously that employers are not liable for their choice of AE pension scheme. Legal experts, however, have given evidence to the enquiry on the basis that there could be grounds for legal action if employers cannot demonstrate due diligence. The committee.  We recommend DWP use their response to this report to make a clear and comprehensive statement about an employer's potential liability. DWP should also confirm where liability will fall if a scheme performs badly or fails. This would provide reassurance to small and micro-employers choosing a scheme.

AE support for employers

The committee found that the decision not to develop the HMRC Basic PAYE Tools (BPT) to support AE was a mistake. The BPT are trusted by small and micro employers, many of whom will not be able or willing to use commercially available software. TPR has acknowledged that small and micro employers need automated support to cope with AE. Its solution has been to build an entirely separate Basic Assessment Tool that has limited functionality and cannot send information to pension providers. This risks undermining AE. The committee therefore recommends that DWP work with HMRC to expand Basic PAYE Tools to support small businesses in meeting their automatic enrolment obligations.

Impact of the LISA

For some employees, notably higher earners, saving for retirement in a Lifetime ISA may complement pension saving. Those with a limited disposable income, however, will need to weigh competing priorities and many will be faced with the option to either save in a LISA or remain in their workplace pension. Whatever the attractions of the LISA, the Committee stated that it must not be presented as a direct alternative to AE. Savings under AE carry an employer contribution, which will not be available in the LISA. Opting out of AE to save for retirement in a LISA may leave people worse off. The Committee found that Government messages on this issue have been mixed. While the DWP has been very clear that the LISA is not a pension product, the Treasury has proffered an alternative view. The Committee recommends the Government develop a communications campaign that highlights the differences between the LISA and workplace pensions and should make it clear that the LISA is not a pension and that, for employees who have been automatically enrolled, any decision to opt-out is likely to result in a worse outcome for their retirement. The Government should also conduct urgent research on any effect of the LISA on pension saving through AE. The findings of this research should be reported in time for the 2016 Autumn Statement and the evidence will be reviewed by the Committee before the introduction of the LISA.

Building on AE

The Committee recommends that as part of its 2017 review of AE, the Government considers:

  • removing the lower qualifying earnings band for contributions and lowering the earnings trigger threshold in order to bring more low paid people, including many more women, into AE;
  • mechanisms for automatically enrolling self-employed workers, including how the income tax self-assessment system might be used;
  • approaches to increasing contributions beyond the statutory minimum of 8% of qualifying earnings, including mandatory increases in employee and employer contribution rates and means of encouraging greater voluntary contributions;
  • steps necessary to create a single, comprehensive pensions dashboard by 2019 and the degree of Government intervention necessary to deliver on its pledge.

New online pension tracing service launched
(AF3, RO4, RO8, JO5, FA2, CF4)

A new DWP website has been launched by the Pension Tracing Service to help people find their lost pension savings.

There is currently an estimated £400 million in unclaimed pension savings. This is money people have previously saved for their retirement, and the new website will better help people to locate their hard-earned savings.

Our wider pension reforms are creating a dynamic market where people have greater freedom and flexibility over their savings, and we expect our reforms will increase demand for the Pension Tracing Service.

Minister for Pensions, Baroness Ros Altmann said:

"People have had on average 11 jobs during their working life which can mean they have as many work place pensions to keep track of.

The new DWP online Pension Tracing Service helps reunite people with their lost pensions, giving details of providers to help people track them down.

I'd encourage anyone who thinks they may be missing out on any savings to use the free online service."

The new service is simple to use and provides trace results immediately. Individuals enter their former employers' details into the online database and are provided with contact details for pension schemes they may have paid into.

The Pension Tracing Service is a free service that enables people to search a database of more than 320,000 pension scheme administrators.

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