Ways in Which Couples can Seek to Reduce Taxation Liabilities on Investments and Savings - Essay Example

? Ways in which couples can seek to reduce taxation liabilities on investments and savings Introduction The need for financial security and independence are a predominant concern for most citizens globally. In its very definition the ability to earn and willfully spend one’s income is at the core of maturity as defined by social norms. This is also the case for governments and institutions. So the question is therefore how such a financial stability can be achieved? The most obvious answer to this is by investing. Investing refers to the deliberate and calculated directing of funds into revenue generating activities. Almost invariably not all individuals are born into financial security. As a result they must therefore find ways to channel their finances such that they can grow significantly unto the future. Usually investments are made directly out of savings; savings out of personal income. The economic model for this relationship is given as i 0 f (s); s  f (y). This therefore means that investments are a consequence of foregone present consumption of personal income. This may perhaps be the elusive point to most young people eyeing for immediate financial prosperity without the sacrifice of and discipline regarding present consumption. After the establishing the origin of investments, a need arises to examine what the deciding and influencing factors for investments are. Economists present a direct relationship between investments and the interest rates for the underlined security i.e. i  f (r). Both households and institutions will make their investment decisions based on the expected rate of returns as expressed in relation to the prevailing interest rates in the market. Another influencing factor in investment determination (both the amount and area of investment) is the risk level associated with the investment. The Capital Asset Pricing Model postulates that the expected returns for any asset or investment is a function of the investor’s risk tolerance level as expressed through the variation in the realized from expected returns within the market. This means that the investments have a risk-reward mechanism where the investor’s tolerance to market uncertainties will primarily determine how much returns they shall get from chosen investments. Thirdly, the tax treatment on investment is also a crucial determinant for investment ventures. Investors would like to know what percentage of their earnings from investment would be paid out as tax. The tax treatment on investments made by singles, married couples and partners in civil unions is different. For this reason, this essay examines ways in which the tax obligation on investments made by married couples or those in civil partnerships in the United Kingdom can be reduced. Discussion Different types of investments have different tax treatments (www.pru.co.uk). This therefore means that the impact of any taxation as well as any tax relief will depend on the particular circumstances for the individual of which are subject to future change without notice. These considerations become more complex in civil partnerships where a disparity in the amounts earned or assets owned becomes a challenge in making financial decisions based on emotive feelings. According to British Laws on taxation, all couples (whether or not they are married or in civil partnerships or are cohabiting) are taxed separately as individuals. Every tax paying individual in Britain is entitled to the first part of their income free of tax. This is referred to as a personal allowance. All incomes in excess of this amount are therefore subject to the applicant tax rules. The personal allowance depends on the age of the individual and the total level of income over the taxable period. In this regard, there are three levels of personal allowance as shown in the table below relating to the current budget period 2012/2013: Personal income Basic personal allowance (?) Adjusted net income limit (?) Age 64 and below 8,105 100,000 Age 65-74 10,500 25,400 Age 75+ 10,660 25,400 The age related personal allowance for a person aged 70 for example with an adjusted net income of  30,000 would be calculated by reducing the statutory personal allowance by half the amount in excess of the income limit as follows: ? 30,000 - ? 25,400 = ? 4,400 ? 10,500 -  = ? 8,300 The adjusted net income is the total income less specific deductibles and reliefs such as donations to charity loses on trade and contributions towards some pension schemes. However, it is important to observe that where the income is large enough, the personal allowance is adjusted downwards until it is nil. The ? 100,000 limit similarly applies to all households irrespective of the age. The personal allowance applies to all tax paying citizens irregardless of their marital status. Consequently the tax benefit for those in recognized unions by the law will be to the extent of their earnings. Recent policies by the coalition government have been geared towards helping to crack down on tax avoidance by the ultra-rich members of the British society. However, whilst this is a morally sound proposal, there have been cries that politicians are tentatively blurring the line as between tax evasion and tax avoidance (Simon). Although the two concepts are geared towards a similar end, they are distinct and different in their nature and occurrence. Firstly, tax evasion is unequivocally a criminal offence. Ironically, it is also a practice that has been most prevalent amongst the rich members of the society. On the other hand, tax avoidance is a legitimate mechanism of following rules on taxation but carefully planning ones financial investments such that the incidence of tax on their overall returns is significantly lesser than would otherwise be under general asset investing. Generally, this takes the form of adopting saving plans that are tax-efficient such as premium bonds and ISAs or efficient utilizing of tax reliefs. The general rule of tax being charged against individual earnings and assets can be easily and carefully minimized, if not wholly avoided, by married couples and partners in a civil union through a careful arrangement of investments and savings. However, the widely held view is that this is only possible where one spouse pays a lower tax rate than the other. Therefore, a switching of income generating assets-like common stocks, bank accounts and investment funds- as well as jointly owned property into the name of the spouse with the lower tax rate. Consequently, tax obligations on dividends, interest on savings and rental income will be less than should be. This mechanism also by-passes the general rule of income from jointly owned assets being taxed at 50/50. The transfer of property must be genuinely done and it is final; the spouse cannot claim back the asset once transferred. Married couples are also able to make gains on jointly owned assets. For unmarried individuals, the aforementioned transfer of property will most likely trigger the taxation clause on capital gains (CGT). Therefore on such assets, it might be beneficial to jointly own them. The tax obligation arising from the capital gains clause depends highly on three fundamental aspects: the amount of revenue generated annually, time when the asset(s) are most likely to be realized and the size of the possible capital gain. The basic rate taxpayers pay a capital gains tax of 18% as opposed to the standard or normal rate of 28%. Cohabiting couples do not qualify for marriage couple’s allowance. They therefore pay capital gains tax as well as an additional transfer tax for any conveyance of asset from one spouse to another. Similarly, where one marriage spouse inherits the wealth of a deceased partner whether as stipulated in the will or in its absence (since the surviving spouse has automatic right to the assets of the deceased), the inheriting spouse does not pay the inheritance tax as prescribed under the inheritance tax (IHT) bill. Any unmarried person who receives an inheritance that is over the ‘nil rate band’ currently set at an upper limit of ? 325,000 is subject to an IHT tax rate of 40%. The mount received under the Marriage Couple’s Allowance is determined by the amount of the claimant’s income. In effect, a spouse’s individual tax liability is deductible by up to 10 % of the amount claimable under the Married Couples Allowance. Therefore by jointly owning property, married couples can avoid the high IHT tax rate under the transfer or inheritance of property clause. For example where a couple has assets amounting to ? 600,000 and where the distribution of the assets is in the ratio of 2:1. When there is a transfer of property through inheritance or conveyance, the couple will incur a tax of 40% directly. However they can avoid this tax incidence through two major ways. Firstly, by equalizing the assets; this means that the partners agree to own the total assets on a ratio of 1:1. This means that each spouse will have under their name assets amounting to ? 300,000. Any transfer or inheritance by either spouse would attract a zero tax since it is within the ‘nil rate band’ of ? 325,000. If for example the first ratio of 2:1 prevails then one of the spouse in possession of assets valued at ? 400,000 would incur a tax burden upon transfer equal to ? 160,000. Secondly, when buying second property, the married couples can put it under their joint names. There are two ways of owning properties jointly; either as joint tenants or tenants in common. As tenants in common, the couple can decide to own property in any proportion they desire other than by the 50/50 rule. Another advantage is that the couple can decide to bequeath their properties to anyone through their will thereby avoiding the direct inheritance clause by the surviving spouse. As joint tenants, the surviving partner inherits the property of the deceased directly. However the IHT bill still applies. It is also important for married couples to pay caution against rushing to transfer properties that they have owned separately for years under joint names since they will attract a capital gains tax as under the CGT bill. Under the Marriage Couple’s Allowance, the maximum allowance under the current taxation period 2012/2013 equates to minimum amount of ? 2,960 and a maximum of ? 7,705. Therefore, the tax reduction benefit will range from ? 296 to ? 770.5. For instance for a 70 year old married man, he will be able to claim Marriage Couples Allowance in the same manner as personal allowance is computed. Assuming he has an income before allowances amounting to ? 32,000. The man has exceeded his income limit by ? 6,600. The HMRC will take away half of this excess equal to ? 3,300 from his allowances as follows: 1. The HMRC reduces higher age-related personal allowance of ? 10,500 by ? 2,395 to the basic minimum personal allowance of ? 8,105. An excess of ? 905 still remains (from ? 3,300 - ? 2,395) 2. The excess ? 905 is deducted from the maximum Marriage Couple’s Allowance entitlement of ? 7,705 reducing it to ? 6,800 3. The husband can claim Marriage Couple’s Allowance at the rate of 10% on the resulting entitlement which equates to ? 680 For cohabiting couples who are also unmarried, a surviving partner will lose the property of a deceased spouse to the relatives of the deceased unless there is an existing with clear stipulations to the effect of conveying it to the surviving partner. They will also be required to pay capital gains tax or inheritance tax for the same properties. Married couples can decide to maximize the Marriage Couple’s Allowance benefit by either sharing the minimum ? 2,960 as between them or transferring it to one of the partners before the start of the taxation period by filling form number 18. It is important to note that the Marriage Couples Allowance benefit applies to couples who were born before 6th April, 1935 or who were married on or before 5th December, 2005 and at least one of the spouses was born before 6th April, 1935. However, a point of caution needs to be exercised by couples when calculating their capital gain tax benefit since it is added onto the annual income for that tax period. The effect of this is to raise the net total income and may to this end elevate them to the 28% bracket for capital gains tax in addition to lowering their personal allowances (as computed above). It is therefore advisable for couples realizing lumpy securities to own the property jointly therein taking full advantage of the two CGT allowances since essentially either of two partners will in fact pay CGT at a higher rate. The Civil Partnership Act was enacted in 2005 to the effect of realizing rights for same-sex civil partners in the United Kingdom. Previously, same-sex spouses were forced to endure severe tax obligations since the tax law failed to recognize same-sex relationships. For instance, where one partner inherited property following the demise of the partner, the surviving partner would be forced to sell the property in order to inheritance tax as prescribed under the inheritance tax (IHT) bill. The effect of this law was to confer the tax privileges and treatments as under marriages to couples of the opposite sex. For instance Jane and Lucy are in a same-sex civil union. Jane who previously was a shopping assistant has agreed to quit her job and become a stay-at-home mom so as to take care of the couple’s new adopted 2 year old daughter. In so doing Jane has become a non-tax paying civilian. Lucy is a higher rate tax-payer and feels there is a high taxable amount on her earnings. She can transfer some of her income generating assets (such as common shares and bonds) to Jane so as to make use of her personal income allowances as well as her lower tax rate. This is also beneficial as the couple avoids corporate gains tax obligations as under the CGT bill due to the property transfer. Although the Civil Partnership Act provides tax treatment to partners similar to that of married spouses, it falls short of providing full equality in this respect. Another demerit is that if there was a previously existing will before the registration of this union, upon registration, the will and its stipulations become null and void making the partner the primary inheritor of the spouse’s assets in case of death of one of the partners. The law provides selective application to this rule in the sense that Civil Partners are only equal with regard to public sector pension schemes. Private sector pension schemes are not recognized under the Act and the benefits are guaranteed retrospectively to civil partners up to 1988 only. Married couples and civil partners can invest in individual saving accounts (ISAs). ISAs are increasingly becoming a popular and simple form of investments and significantly attractive since the returns do not attract personal income tax or capital gains i.e. dividends are paid net of a 10% tax credit (www.pru.co.uk). This partly was in its deliberate engineering by the government. Individual savings accounts were introduced by the government in 1999 to replace Personal Equity Plans (PEPs) and Tax Exempt Special Savings Accounts (TESSAs) as a tax-efficient way of enticing households to invest in medium to long term securities. There are two forms of ISAs: cash ISAs and Shares and stock ISAs. The current annual investment is ? 11,280 and individual investors can acquire a tax deduction amounting to ? 5,640 in cash investment with one provider. Insurance is another avenue with which married couples and civil partners can reduce their tax obligation. Life insurance can be bought to cover the individual or both the spouses. Presently, joint insurance is available for “first death” insurance policies. This means that the policy covers the death of one of the couples after which the surviving partner is no longer covered by the policy. This rule however becomes extinguished where both the partners are covered by separate policies. It then follows that the dependents will benefit upon the “second death” a particular benefit with opting for separate life insurance policies is that such policies can be ‘written in trust” thereby avoiding inheritance tax. It is worth noting that not all life insurance are designed to purely provide family protection; they can also be taken against liabilities such as mortgages. Term insurance is the most popular form of life insurance providing cover for a set period of time. Where it is used to cover against a mortgage then it must be written in similar terms of the mortgage. Similarly, married couples and partners in a civil union can benefit from borrowing efficiently by adopting a buy-to-let investment. The interest charged on such a mortgage provides a tax relief claim for the borrower thereby reducing the amount payable under the mortgage. However, this needs to be done rationally through opening of a business bank account where all rental income will be deposited and expenses regarding the mortgage be paid out of. Furthermore, profits from the rental income can be used to reduce the mortgage liability. The married couples and civil partners can lower their tax obligation through charitable donations to UK based charities or Community Armature Sports Club on Gift Aid by claiming a basic tax rate of 20% on the amount of donations during the tax period. The parties would then notify the HMRC so as to receive the tax benefits on such donations. Those who are self-employed and operate their businesses from home can also receive allowances on claims on extra operational costs such as lighting, heating, property insurance and even interest on mortgage. Married couples and partners in civil unions who have children can further reduce their tax burden through a foregoing of part of their salaries for other non-taxable benefits such as childcare vouchers. Conclusion For married couples and registered Civil Partners, there are many avenues with which they can reduce the tax obligations on their incomes and investments. More specifically, the aforementioned mechanisms allow the achievement of this purpose without adopting complicated accounting and financing structures domestically. For high net-worth individuals who bear the burden of large tax incidences owing to their high revenue streams, such options seem very lucrative in addition to securing their financial requirements. Reference Simon, E., 2010. 10 ways to beat the taxman honestly. The Telegraph, 24 September. p.17. The article observed ways with which normal citizens that lack the ability to move their investments to offshore tax havens or employ high profile accountants to handle their tax concerns. It approaches this with a focus on tax avoidance rather than tax evasion thereby providing guidance for tax reduction within the confines of the relevant tax laws. The article is a clear indicator of how legislators in their attempt to curb tax evasion have invariably opened numerous loop-holes through which individuals and institutions alike can by-pass the tax man’s noose. It presents an ironic scenario where government bends its legislation in attempt to encourage households to save and in return meet tax requirements. This Is Money, 2012. How to profit from Isas and tax-free investing. [Online] Available at: HYPERLINK "http://www.thisismoney.co.uk/money/investing/article-1583946/How-profit-Isas-tax-free-investing.html" http://www.thisismoney.co.uk/money/investing/article-1583946/How-profit-Isas-tax-free-investing.html [Accessed 13 April 2012]. The website provides greater insight on how the gay and other same sex couples have been financially rescued through the enacting of the Civil Partnership Act in 2005. It provides a grim vision of how the apparent failure of tax laws to recognize same-sex unions had led to financial crippling of same-sex couples. The blatant discrimination over Marriage Couple’s Allowance and as under the inheritance bill provided little incentive for investment by the group. The enactment of this Act transforms the position of same-sex couples-at least financially-to a position of near equity with other heterosexual couples www.gayfinance.com, 2005. Civil Partnership Act - rights and obligations for same-sex "civil partners". [Online] Available at: HYPERLINK "http://www.gayfinance.info/civil-partnerships/civil-partnership.htm" http://www.gayfinance.info/civil-partnerships/civil-partnership.htm [Accessed 13 April 2012]. www.pru.co.uk, n.d. Investment and tax. [Online] Available at: HYPERLINK "http://www.pru.co.uk/investments/guide/taxation/" http://www.pru.co.uk/investments/guide/taxation/ [Accessed 13 April 2012]. Prudential investment is an investment firm that offers a variety of investment products in addition to providing financial advice to the British public over financial matters. Primarily, the firm is concerned with where to invest? How much to invest? Issues relating to said investments such as taxation, rate of returns, risk and legal implications. The website provides a variety of tax reduction advice for m married couples and same-sex civil partners, the limitations for the same regarding to tax treatments and alternative areas of investing. Read More