TAXATION AND TRUSTS 

How the taxation of property income could be simplified - OTS recommendations

(AF1, RO3) 

The Office for Tax Simplification (OTS) is an independent adviser to Government on tax simplification; it does not implement changes - these are a matter for Government and for Parliament.

Back in March, the OTS published a call for evidence which invited detailed comments on the technical and practical operation of the tax system in relation to property income.

The report now published by the OTS considers the UK taxation of income from residential property, primarily in relation to individuals. Nearly one in ten income tax payers have income from property, underlining its importance within the UK economy and tax system. Across the spectrum of sophistication and scale of activities, the 2.9 million property businesses reported by individuals to HMRC for income tax must face the rules for taxation of income from property.

Key findings:

• Although the furnished holiday lettings regime can provide some tax benefits, it is not widely used and adds a complex layer to the tax rules which apply to property income. The Government should consider whether there is continuing benefit to the UK in having a separate tax regime for furnished holiday lettings.

• The report recognises that removing the furnished holiday lettings regime could put pressure on the boundary between whether a taxpayer has a property business or a trade, and recommends the Government consider whether it would be appropriate to introduce a statutory ‘bright line’ test to define when a property business should be handled under the trading rules.

• Should the Government wish to retain the furnished holiday lettings regime, the report recommends that the Government consider removing the benefits for properties in the EEA and removing the benefits where there is private use (other than a minimal level).

• The report reflects the weight of feedback on the long-standing tax complexity for landlords of whether costs are allowable straight away as repairs and replacements or should be disallowed for income tax as capital improvements, and recommends the Government consider a broader immediate income tax relief for the majority of property costs.

• Nearly half of landlords will be filing for Making Tax Digital for income tax in respect of jointly owned property. It is common practice for only one of the owners to keep records, and the report recommends that HMRC should establish a system to allow this practice to continue for Making Tax Digital. The report also notes the importance of HMRC accepting multiple agents to help with the new tax filings and recommends that HMRC should not go ahead with Making Tax Digital until these issues have been resolved.

Taxation of income from residential property

This report also covers the general regime for property and the confusion and challenge raised by large numbers of respondents about matters such as the allocation of income between joint owners, and in relation to rules which cause significant distortions or complexity such as the circumstances for diversified agricultural businesses.

The report looks in detail at how Making Tax Digital for income tax will affect landlords, and questions whether the initial and medium-term threshold for entry into the new system should be increased above £10,000.

The report also looks at non-resident landlords and encourages HMRC to make it easier for them to register for and report their income online for UK tax purposes. It also recommends that the Government should consider removing the obligation on individual residential tenants in some situations to withhold tax from their rental payments to non-resident landlords.

The Government announced on 23 September as part of The Growth Plan 2022 fiscal event that the OTS will be closed. As the OTS is a statutory body, this closure will take effect when the next Finance Bill receives Royal Assent. 

Government rejects requests for cohabitation law reform in England and Wales

(AF1, JO2, RO3)

The UK Government has announced it has no plans to reform the laws relating to financial remedy and succession for cohabiting couples in England and Wales.

What is financial remedy?

A financial remedy is a process to ensure financial provisions for parties to a marriage or civil partnership on the breakdown of a marriage. There is a specialist part of the Family Court that specialises in resolving financial issues for families, the purpose, of which, is to make sure that all parties are treated fairly.

The issue

There are now approximately 3.6 million couples who are living together as cohabitants in the UK. This is about one in five couples. This has led some organisations, including STEP, to call for reforms to the law that would provide unmarried cohabitants and their children with more financial recourse if the relationship ends. There are already some such provisions in Scottish law.

The cross-party House of Commons Women and Equalities Committee produced a report in August 2022 recommending reforms. This included, in certain cases, to give cohabiting persons in England and Wales some intestacy and family provision claims on their former partners' financial assets. This would give them similar rules to those granted by marriage or civil partnership, unless they opt out. The committee also asked the Government to publish clear guidelines on how pension schemes should treat surviving cohabitants when claiming a survivor's pension.

The outcome

Most of these proposed reforms were rejected by the Government, who stated that existing work on the law of marriage and divorce must be concluded before they would consider changing the law in respect of the rights of cohabitants. In addition, it stated that it has no plans to extend the inheritance tax treatment to cohabiting partners.

The Government added that it intends to take a cautious approach in this area and would want to consult before making any reforms. It also stated that individuals are free to set their affairs in order to ensure provision is made for cohabiting partners and, where this is not done, a claim can be made on intestacy to make provisions for families where they have been living in the same household in the two years prior to death.

Comment

It is disappointing that the reforms have been rejected, especially when there is such a high level of co-habiting partners. STEP have stated “we believe it is important that cohabitants have rights under the intestacy rules. The existing lack of legal protections can leave bereaved cohabitants financially vulnerable during very difficult circumstances.” They also said they will continue to persue reform and ask the Government to revisit this important issue.

Basis period reform - more guidance published

(AF2, JO3)

This major overhaul of business taxation will impact many self-employed businesses – including solicitors, accountants, doctors and dentists trading as partnerships. Working out relevant earnings for pension contributions is likely to become trickier for these clients in particular.

HMRC has published further guidance on the forthcoming changes to the rules used to work out taxable profits for income tax self-assessment.

From April 2024 onwards, sole traders and partners will be taxed on profits generated in that tax year, that is, from April to March. This will be the case regardless of a business’s accounting date.

Only taxpayers with an accounting date other than 31 March or 5 April are affected by this reform. The way profits are assessed for those who use an accounting date between 31 March and 5 April will not change.

The year beginning in April 2023 is a ‘transitional year’ in which all affected businesses will move to the new way of calculating taxable profits for the tax year. They will need to declare the total profits from the end of the last accounting date in 2022/23 up to 5 April 2024. This means that profits generated over a longer period will be taxable in the transition year.

As an example, if your client’s accounting date is 31 December, they must declare profits from 1 January 2023 up to 5 April 2024 in their tax return for the financial year 2023/24, i.e. covering 15 months rather than 12 months.

This return is due on or before 31 January 2025.

The changes will mean the amount of tax that owe in the 2023/24 tax year may change for anyone using an accounting date between 6 April and 30 March. However, this abolition of basis periods means that any double taxation (overlap profits) from the early months of trading will be available to be used (overlap relief). So, the individual will be assessed on both the tax for profits for:

• the 12 month accounting period they have previously been using; and
• the rest of the 2023/24 tax year — minus any overlap relief that may be due.

By default, the additional ‘transition’ profits from the rest of the 2023/24 tax year can be spread over five years – or over a shorter period if preferred.

Further instructions on how to claim this ‘overlap relief’, and further guidance on the new rules in general, will be published soon.

How profits for the 2023/24 tax year will be assessed

Profits for businesses with accounting periods ending between 6 April 2023 and 30 March 2024 will be divided and assessed over the five tax years starting on 6 April 2023. If there is any overlap relief available, that will be set-off against those profits first.

Any increased profits from the 2023/24 tax year will be treated in a special way to minimise the impact on benefits and allowances.

Overlap relief

If the individual used an accounting date between 6 April and 30 March when they started their business, they may have paid tax twice on some of their profits and be entitled to overlap relief.

Usually, businesses can only use overlap relief to get this tax back when they stop trading or when they change their accounting date. However, HMRC will allow any business that uses any accounting period and that has unused overlap relief to use it in the 6 April 2023 to 5 April 2024 transition year.

HMRC says that it will publish guidance on how to check how much overlap relief may be due in the future. In the meantime, it has provided the following example of where overlap relief is used against profits:

Example

1. Niki’s accounting period is from 1 October to 30 September.
2. Niki’s assessable profit is £42,000 from 1 October 2022 to 30 September 2023.
3. Niki’s assessable profit is £21,000 from 1 October 2023 to 5 April 2024.
4. Niki has £5,000 of unused overlap relief that she uses to reduce her assessable profit for 1 October 2023 to 5 April 2024 to £16,000 (£21,000 minus £5,000).
5. The £16,000 profit is divided equally and assessed over the next five tax years at £3,200 a year (£16,000 divided by five).
6. In the 2023/24 tax year Niki’s total assessable profits will be £45,200 (£42,000 plus £3,200).

How the basis period rules work now

For self-employed individuals, the general rule is that income tax is charged on the profits of the accounting year ending in the tax year. Accounts do not have to be made up for the tax year itself, because businesses are free to choose their annual accounting year end date. Although it’s possible to have a period of account that runs for less, or more, than 12 months and to change the year end date if required, it is common for it to run for 12 months, e.g. 1 April to 31 March, or 1 January to 31 December. Apart from special rules for the opening years and when the accounting date is changed, once the amount of profit is known, it’s assessed for tax in the tax year in which the accounting period ends. 

So, for example, profits for an accounting period that runs from 1 April 2021 to 31 March 2022 are taxed as income in the tax year 2021/22. And profits for an accounting period that runs from 1 May 2021 to 30 April 2022 will be taxed as income in the tax year 2022/23.

Choosing an accounting date early in the tax year (e.g. 30 April) gives more time for planning the funding of tax payments. It also means that tax is being paid each year on profits that were largely earned in the previous year, giving an obvious cash flow advantage if profits are rising.

Whilst choosing an accounting date late in the tax year (e.g. 31 March or 5 April) can cause difficulties in the funding of tax payments if profits are rising, many self-employed people nevertheless find it simpler to have an accounting year end that is in line with the tax year (HMRC effectively treats 31 March and 5 April as the same), particularly if their profits are relatively small and they aren’t using an accountant or tax adviser.

Large self-employed business, such as accountancy or solicitor partnerships, however, often choose a 30 April accounting year end.

And this can be particularly useful if considering personal pension contributions, as the amount of taxable profit is the relevant UK earnings figure to support pension contributions for the tax year. So, to calculate the maximum pension contributions to be paid in the 2022/23 tax year, the trader, or their adviser, would need to know the amount of taxable profit for the 2022/23 tax year.

The relevant UK earnings figure to support pension contributions paid in the 2022/23 tax year (i.e. between 6 April 2022 and 5 April 2023) are based on taxable profits for the period 1 May 2021 to 30 April 2022, allowing a reasonably long period of time to accurately work out relevant UK earnings and tapered annual allowance thresholds ahead of making any pension contributions for the 2022/23 tax year.

Conversely, for those who have chosen a 31 March year end, it is virtually impossible to accurately calculate relevant UK earnings, or total income for the purposes of checking if the individual will exceed the tapered annual allowance limits, before making a pension contribution for the tax year. Profits for an accounting period that runs from 1 April 2022 to 31

March 2023 are taxed as income in the tax year 2022/23. So, it is necessary to make an estimate of taxable profits received in the 2022/23 tax year. This probably, therefore, leads to a number of these individuals erring on the side of caution and not maximising the pensions tax relief potentially available to them each tax year.

The future

The changes will mainly affect businesses that do not draw up annual accounts to 31 March or 5 April, and those that are in the early years of trade.

This proposal will move everyone to a tax year basis with effect from the 2024/25 tax year, so that a business’s profit or loss for a tax year will be the profit or loss arising in the tax year itself, regardless of its accounting date.

Businesses that don’t have an accounting period end which matches the tax year (31 March or 5 April) will be required to time-apportion their profits into the appropriate tax years.

For businesses with an accounting period that ends early in the tax year, e.g. on 30 April, this will impact on working out income figures for pension contributions purposes.

For example, the relevant UK earnings figure to support pension contributions paid in the 2024/25 tax year (i.e. between 6 April 2024 and 5 April 2025) will have to be based on one month (1/12th) of the taxable profits for the accounting period 1 May 2023 to 30 April 2024, plus 11 months (11/12ths) of the taxable profits for the accounting period 1 May 2024 to 30 April 2025, making it virtually impossible to accurately work out relevant UK earnings, or whether the clients are likely to be impacted by the tapered annual allowance thresholds, ahead of making any pension contributions for the 2024/25 tax year.

This will, probably, therefore, lead to a number of these individuals erring on the side of caution and not maximising the pensions tax relief potentially available to them each tax year.

(Working out figures in the 2023/24 transitional year will likely be even trickier.)

Of course, the introduction of Making Tax Digital (MTD), from their next accounting period starting on or after 6 April 2024, for self-employed businesses and landlords with annual business or property income above £10,000, will help somewhat in future tax years. Businesses will need to use software to keep digital records and send quarterly and end of year updates to HMRC, so your clients should at least have an up to date estimate of their profit levels to help with estimating relevant earnings, etc.
 

INVESTMENT PLANNING 

October inflation numbers

(AF4, FA7, LP2, RO2)

The UK CPI inflation rate for October 2022 was 11.1%, up from 10.1% in September

The CPI annual rate for October jumped by 1.0% to 11.1%. That was 0.4% above market expectations, according to Reuters and a 41-year high according to back-calculations by the Office for National Statistics (ONS). A year ago, the October CPI reading was 4.2%. October 2022’s monthly CPI rise of 2.0%, four times the September level, compares with a 1.1% increase in October 2021.                     

The CPI/RPI gap widened to 3.1%, with the RPI annual rate up 1.6% at 14.2%. That is also the highest level for more than 40 years. Over the month, the RPI index was up 2.5%.

The ONS’s favoured CPIH index rose by 0.8% to an annual 9.6%. Remember, Tuesday’s news coverage of the 2.6% shrinkage of real wages reported by the ONS used CPIH data for July-September, not the higher CPI.

The ONS notes that the increase in CPIH inflation was mainly due to the following factors:

Upward drivers

Housing water, electricity, gas and other fuels (including owner occupied housing costs) This category’s overall costs increased by 3.4% on the month in 2022, compared with an increase of 1.2% in October 2021. The net result was a 2.4% increase in the annual rate to 11.7% in October 2022. The increase came primarily from the arrival of the new utility price cap, which the ONS decided should be allowed for in its inflation calculations. Over the month, gas prices rose by 36.9% while electricity was up 16.9%.

Food and non-alcoholic beverages There was an overall increase of 1.6% between September and October 2022, against a 0.9% rise last year. This took the division's annual inflation rate to 16.4% in October 2022, up from 14.5% in September. This category’s annual rate of inflation has risen for the last 15 consecutive months, from negative 0.6% in July 2021.

Downward drivers

Transport Prices were unchanged overall between September and October 2022, compared with an increase of 1.5% in the same period last year. Annual inflation in this category is now 9.3%, well down from its June 2022 peak of 15.2%.

Seven of the twelve broad CPI divisions saw annual inflation increase, while four (Furniture, Household Equipment and Maintenance; Transport; Recreation & Culture and Education) fell. Housing, water, electricity, gas and other fuels was predictably the category with the highest annual inflation rate at 26.6% (6.4% up from last month). Next highest was food and non-alcoholic beverages at 16.2%. Only two minor divisions (Communication and Education), accounting in total for just 5.8% of the CPI basket, posted an annual inflation rate not above 5%.

Core CPI inflation (CPI excluding energy, food, alcohol and tobacco) was flat at 6.5%, a reminder of the components driving the headline increase. Goods inflation in the UK rose 1.6% to 14.8%, while services inflation added 0.2% to 6.3%.

Producer Price Inflation was 14.8% on an annual basis, down from 16.3% in September on the output (factory gate) measure. Input price inflation was 19.2%, down from 20.8% in September. Inputs of metals, crude oil and chemicals all provided downward contributions to the change in the annual rate of input inflation; these were offset slightly by positive contributions from fuel and food. Similarly, petroleum products provided the largest downward contribution to the change in the annual rate of output inflation. On a monthly basis, input prices increased by 0.6% and output prices increased by 0.3% in October 2022.

Comment

The October CPI figure of 11.1% will put more pressure on the Chancellor to adhere to the pension triple lock and uprate other benefits in line with inflation rather than earnings. At the same time, the 2.5% one month jump in the RPI will cost the Treasury about £14bn in debt servicing costs.

The impact of the Energy Price Guarantee may not appear especially visible in the latest inflation numbers, but, as the ONS says, ‘the increases would have been notably higher without the EPG’s introduction.’ It estimates that without the EPG, CPI inflation would have been 13.8%. That highlights another problem for Mr Hunt – how he replaces the EPG from next April. A targeted approach is unlikely to be treated by the ONS as reducing energy costs. 

PENSIONS

Pension Schemes Newsletter 144
(AF8, FA2, JO5, RO4)

Pension Schemes Newsletter 144 covers the following:

 

• requesting a refund from Pension Schemes Services 
• pension flexibility statistics 
• registration statistics 
• pension scheme migration 
• Accounting for Tax (AFT) returns 
• Managing Pension Schemes service — how you can help us 
• Digitisation of relief at source (RAS) 

Areas of interest 

Pensions flexibility statistics 

HMRC have provided the latest information on the number of tax repayment claim forms process for pension flexibility payments.

 From 1 July 2022 to 30 September 2022 HMRC processed: 

• P55 = 6,759 forms
• P53Z = 2,119 forms
• P50Z = 1,078 forms 

Total value repaid: £33,088,782 

Registration statistics 

HMRC received a total of 717 applications to register new pension schemes between 6 April 2022 and 30 September 2022.  This is a 9% decrease over the same period in 2021. 

Of these, 65% have been approved, 14% refused and the decisions are pending on the remaining. 

Digitalisation of relief at source 

HRMC are focussing on delivering a digital relief at source service by April 2025.  The aim is for all claims to be based on individual data to allow HMRC to accurately calculate the tax relief for members.

They state the potential benefits include: 

• streamlined reporting
• quicker payments with most claims being made in days rather than weeks
• removal of the need for some declarations as HMRC will establish the eligibility and amount of relief available for each individual
• a new approach to handling overpayments of pensions tax relief.

HRMC state they are working closely with stakeholders from the pensions industry as they  design and implement the new processes. 

TPR publishes DB trust-based pension schemes research
(AF8, AF7, FA2, RO4, JO5)

The Pensions Regulator (TPR) has published a report summarising the findings from its annual survey of trust-based occupational DB pension schemes. In relation to DB funding, key findings include the following: 

• Long term objective – 88% of trustees and 87% of employers reported that their scheme had a long-term objective (LTO) – with 55% intending to buy out and 40% intending to reach a position of low dependency on the employer. 69% of trustees and 56% of employers hoped to reach their LTO within ten years, with 26% and 20% respectively aiming to do so within five years.
• Journey plan – 70% of schemes had a journey plan, 91% of which were aligned with the scheme’s technical provisions and 95% to investment de-risking.
• Covenant – 51% of trustees considered covenant risk ‘to a great extent’ when setting the recovery plan, 47% when setting the investment strategy and 43% when setting the technical provisions. 49% of schemes had contingent support in place.
• Investment – 51% of schemes had an endgame investment strategy, and 45% had de-risking funding triggers.
• Recovery plan – 71% of schemes had a recovery plan in place. When structuring the plan, 90% of trustees considered the affordability of the employer’s contributions, 87% the maturity of the scheme, 66% the likelihood of employer insolvency and 50% the value, terms and enforceability of any contingent security.
• Risk management – 95% of trustees felt that the information received from the employer was sufficient for good risk management and 97% were confident they could document and articulate their approach to risk management, with appropriate evidence. 

On other matters there was a worrying lack of engagement with pensions dashboards, with large schemes showing only slightly more engagement than medium schemes.  However, as the field work for the survey was undertaken between November 2021 and February 2022, hopefully some 9-12 months on there is much more engagement. 

FCA: Pensions Dashboards rules for pension providers – feedback on CP22/3 and our final rules and guidance

(AF8, FA2, RO4, JO5) 

The FCA has issued PS22/12 which has confirmed that: 

• Complete connection to the digital architecture operated by the Pensions Dashboard Programme;
• Most pension firms will need to have data ready for pensions dashboards from 31 August 2023.
• However, those pension providers with fewer than 5,000 pension pots in ‘accumulation’ can apply to have until 31 October 2024 to comply with the regulations.
• Be ready to receive requests to find pensions and search records for data matches; and
• Be ready to return pensions information to the consumer’s chosen pensions dashboard. 

This brings the prospect of Pension Dashboards coming a step closer with them expected to be available from the summer of 2024. Once up-and-running, dashboards will allow millions of savers to view their retirement pots online. The Government’s hope is that dashboards will help reconnect people with over £26 billion of ‘lost’ pension pots (see Pensions related surveys and research to 4 November 2022) and, over time, boost retirement engagement. 

DWP: Ten years of Automatic Enrolment in Workplace Pensions
(AF8, FA2, RO4, J05)

The Department for Work and Pensions has published a report entitled: “Ten years of Automatic Enrolment in Workplace Pensions: statistics and analysis” along with a spreadsheet entitled: “Ten years of Automatic Enrolment statistics”. The report examines the role that its auto-enrolment policy has played in improving people’s quality of life, by addressing poverty through increasing financial resilience. 

Auto-enrolment started in October 2012 and since then, the report finds that participation has increased among private sector eligible employees in every industry and occupation between 2012 and 2021, including those with historically low rates of employees saving into a workplace pension.  This has been replicated in every region of Great Britain, and in the most common private sector eligible employee jobs within each region. 

The total annual workplace pension contribution of all private sector eligible employees has increased in real terms from £41.5 billion in 2012 to £62.3 billion in 2021.  These increases have been replicated across all industries and all occupations, except for the Energy and Water sector. 

The report also shows the latest data from master trust providers.  This shows, over the period from January 2020 to August 2022, an increase in active members of the 11 largest master trusts, with contributions 32% higher in August 2022 than in January 2020.  For such trusts the proportion of new members that decided to opt out of auto-enrolment has oscillated over this period and stood at 10.4% in August 2022 compared to 7.6% in January 2020, whilst the proportion of those actively saving who stopped saving stood around the 3% mark throughout this period. 

FCA: Defined benefit pension redress calculations
(AF8, AF7, FA2, JO5, RO4)

In a Press Release, the FCA has warned companies that they must comply with its DB redress calculation rules, having recently received information about a small number of companies not including all fees and charges in their DB pension advice redress calculations, in line with current guidance. The FCA said: “We are looking into these matters and where we identify firms not calculating redress correctly, we will take action using the full range of our powers which may include appointing an independent professional to check calculations and help consumers get the right redress.” They have also updated their guidance.

In a Statement updated on 9 November 2022, the FCA has confirmed that it will review its current redress calculation guidance FG17/9. If they decide to make further changes to the guidance following this review, they will consult on these.

The FCA then go on to state their expectations on firms to take into account the impact on consumer’s tax position and/or benefits entitlement. They state:

Where redress is paid in the form of a lump sum, it should be adjusted to take account of the consumer’s individual tax position and wider circumstances.

For tax, firms should:

• check if the consumer is a non-taxpayer.
• check if any payment would change the consumer’s marginal tax rate.
• adjust the redress payment accordingly so that the consumer is not disadvantaged by the payment.

For wider circumstances, firms should:

• check if the consumer receives means tested benefits.
• check if any payment would change the consumer’s eligibility for means tested benefits
• adjust the redress payment accordingly so that the consumer is not disadvantaged by the payment.

This could clearly have a significant impact on the cost of any redress payments.

One in four over 40s have no pension

(AF8, FA2, JO5, RO4) 

Analysis of the DWP’s Planning and Preparing for Later Life survey found that while most people had started saving for retirement, 24% of 40-75 year olds did not have a private pension, and 16% had not yet started saving. 

Only 23% had an idea of the amount they would need to save for retirement, with the majority unsure. 

People on lower incomes were less likely to have started saving for retirement. Around 32% of those with incomes of less than £10,500 had not yet started saving compared to just 1% of those with incomes of £44,000 or more. 

People with higher incomes were more likely to expect to retire before the current State Pension Age (SPA), which is 65. For example, 54% of those with gross earnings of £44,000 a year or more expected to retire before the current Spa compared with only 36% of those earning below £10,500. 

Similarly, people with savings over £100,000 were more likely to expect to retire before the SPA (15%) than those with no savings or those with savings under £15,000 (34%). 

The survey provided evidence on how far individuals can make well-informed decisions about how and when to retire and whether they will be in a position to enjoy financial security when they do. 

Many respondents reported being unable to afford to make contributions to their pension, with 53% currently without one.