Wealth of liability in a complex system

In the UK, the wealthy are liable for a number of taxes on investment gains. John Battersby outlines some of the liabilities in an increasingly complex taxation system. The Merrill Lynch/Cap Gemini Ernst & Young World Wealth Report 2001 notes that, even with equity market fluctuations, the number of high net worth individuals continues to rise both in the UK and elsewhere. That increase in wealth brings potentially significant tax liabilities for the individuals involved. With an increasingly complex UK tax system, the tax effects of apparently straightforward commercial or personal finance transactions can be capricious. Holdings of quoted shares Accountants frequently encounter individuals or families for whom private investment wealth is concentrated in one or two shareholdings in the quoted sector but where there is no longer any involvement in the relevant business. For long-term investment strategy, the client needs to diversify but the potential tax liability is unacceptable. Accountancy firms have developed a number of sophisticated arrangements to overcome this problem and allow the investor to achieve the desired investment diversification without incurring an immediate tax bill. Even when an individual is an employee and therefore likely to attract the beneficial capital gains tax (CGT) taper relief, there may be occasions when they cannot wait for the benefits of the new reliefs to kick in if they are to maximise their investment return. These diversification techniques can also be extremely effective at that time. Holders of share options Although the equity market has suffered several steep falls in the past 18 months, many individuals still hold unapproved share options which entitle them to acquire shares in their employer company at a favourable price. To acquire these shares, however, a significant income tax liability is incurred. In some cases, there may also be national insurance problems. The employees are therefore faced with the prospect of incurring a potentially significant tax liability to acquire the shares, without any cash from which to fund the liability other than perhaps through selling some of the shares. To address this issue, accountants have developed a number of techniques that effectively spread the option over a wider class of assets. There are also deferral opportunities, which can significantly reduce the immediate tax liability and spread it forward over a number of years. Holders of private company shares In many cases, holders of private company shares, particularly those in the trading sector, assume that the benefits of the government’s new CGT taper relief will apply to them in full and that from April 6 2002 their effective rate of capital gains tax will be 10 per cent. Unfortunately, this is an extremely complicated area with many pitfalls for the unwary. The table below shows the various rates of UK tax and the crucial importance of business asset status and years of ownership. The UK tax authorities took until summer 2001 to publish their view on some key elements of the original taper legislation introduced in 1998 and developed in later budgets. The result is that there are a number of uncertainties on the application of the provisions. As far as practical, the taxpayer should defer any disposals until after April 2002. Many vendors will have sold their shares for paper to seek to achieve this. But where benefit from the taper provisions is now in doubt, then it is appropriate to revisit the position. There are several ways to protect the 10 per cent taper relief rate and there may be opportunities, in some cases, to eliminate the capital gains tax liability altogether. Property investors The tax legislation grants no favours to the property investor. There is no opportunity to roll over gains on one investment property into acquisitions of further property. In many cases, property is owned within a company and when the individual tries to access the value they suffer a tax double whammy, first on the company’s realisation of the property and second on the extraction of the funds from the company. Despite recent changes in the law, there are still significant opportunities to use capital losses to minimise the gains on property. Growth in the use of limited liability partnerships to own property has been a practical response to the double tax liability. Planning for CGT and stamp duty on property transactions can make a significant impact on the funds available for property investment and, ultimately, on the returns available to the investor. Remuneration planning Many of the new high net worth individuals continue to draw significant income from their own businesses in their roles as employees. While the extension of national insurance liabilities to benefits in kind means that it is no longer fashionable to pay employees in platinum sponge or trust interests, there remain possibilities to reduce the impact of income tax to below the nominal 40 per cent rate. These can yield worthwhile benefits in the right circumstances and are best suited to significant levels of salary. Inheritance tax Once an individual has generated significant wealth, be it from investments or income, there is normally a desire to hand this on tax-efficiently to the next generation. It is often the case that those assets represent investments which are not favoured by the inheritance tax regime. There is persistent speculation that the burden of inheritance tax will be increased at some stage. The present system has created a number of opportunities that accountants can employ with their clients which enable these assets to be handed down without creating a tax liability. But the opportunity to implement tax-saving measures may be somewhat short-lived. So speed is of the essence. John Battersby is a partner in the national private client group of KPMG.