Relief Capping

I want to examine one of the proposals in George Osborne’s recent budget which has attracted a lot of press comment – however the press discussion has ignored rather more significant aspects of the proposal.  This entry is now amended to reflect the Chancellor’s announcement on 31 May 2012.

I’m talking about the suggestion that a cap should be introduced on all forms of tax relief which do not have a separate limit.  It has been suggested that some very wealthy taxpayers are using these reliefs unfairly to minimise their taxation liability – George Osborne claimed to have been shown evidence by HMRC concerning the aggressive use of upcapped reliefs to minimise liability –

He told The Telegraph:

“I was shocked to see that some of the very wealthiest people in the country have organised their tax affairs, and to be fair it’s within the tax laws, so that they were regularly paying virtually no income tax. And I don’t think that’s right. I’m talking about people right at the top. I’m talking about people with incomes of many millions of pounds a year. The general principle is that people should pay income tax and that includes people with the highest incomes. I’m not allowed to be shown the names of the individuals but I’ve sat with the most senior people at the Inland Revenue, the people who run some of the high net worth units there. They have given me examples, anonymised examples, and so we are taking action.”

Ironically in 2007 HMRC published a report on Gift Aid which suggested that wealthy people were not sufficiently aware of Gift Aid in particular – their report states – “If Tax reliefs on charitable donations are to be used more widely by wealthy people, levels of awareness must be improved…” seems they have been improved considerably.

The Press have focussed on the impact on charitable giving but it may be important to remember that gift aid as a system has not always been an unlimited relief – in 1999 Gordon Brown announced a number of initiatives to increase charitable donation in a package entitled “Getting Britain Giving” which included removing a number of gift aid and payroll-giving restrictions.

It is true that many very wealthy people have used their own charitable trusts to shelter income which has richly endowed many charities ranging from the Sackler galleries at the Royal Academy to local church halls.  Osborne has also stated that he is “specifically looking at making sure we are still encouraging philanthropy and charitable giving.”

Interestingly this capping will not affect the ability of the charity to reclaim tax under the Gift Aid system, only the excess liability relief that the taxpayer will be entitled to.

But the impact of this proposed measure may be more significant in two other areas – loss relief and relief for interest as a charge against income.

It seems that this will not affect the carry forward of losses against future profits nor carry back against trading income in earlier years.  However relief for trading losses against other income will now be capped at £50,000 or, if greater, 25% of a taxpayer’s income.  And that will apply to all of the reliefs which may be subject to capping.

Now it may be true that some very wealthy individuals have been buying avoidance schemes to artificially generate losses to offset income – and this year’s budget contains specific anti-avoidance provisions to counter the use of some of these schemes.  But if HMRC are concerned about the very wealthy why set the limit for this capping at such a low level?  Let’s think about a practical situation.

Alan set up a trading company eight years ago and subscribed for £120,000 worth of shares at this time.  Because of adverse trading conditions the company has failed and had to be liquidated with no money to return to shareholders.  Alan has taken employment with a company at an annual salary of £140,000 and in that sense he is lucky.  Alan can claim that the loss that he suffers on the disposal of the shares can be converted into an income loss and offset against other income that he may have – but he will now be affected by capping.  No more than £50,000 can be offset against income (as 25% of £140,000 is less) and as there are no other sources against which the loss can be offset the balance will be lost.  Is this the sort of situation that that George Osborne had in mind?

Aiden has two separate trades which he pursues, one as a farmer which generates income of £140,000, the other as an active Lloyds Underwriter.  As a result of several natural disasters his underwriting syndicate suffers losses of which his share for the year is £80,000.  This will be capped at £50,000.  If he claims against the previous year he may be allowed to offset against the trading profit of the previous year but not other income, however for this to be permitted reform will be needed to the scheme for offsetting losses as well, at present this relief is against total income from all sources without distinction.

Lets look at another situation – interest relief.  Relief can be claimed for interest paid as a deduction in calculating income from certain sources, principally trading and property ownership.  These are, we are told, not affected.  Interest relief can also be given as a charge, a deduction from total income which will now be subject to capping; these reliefs apply to loans applied to a qualifying purpose, broadly relief for loans used to purchase an interest in a close company or a partnership, loans used to make loans to a close company or partnership and loans used to purchase plant and machinery for use by a company in it’s trade. Relief is also available for loans used by employees buying an interest in an employee controlled company, for investments in co-operatives by members and loans used by executors to pay inheritance tax arising on death.  These will all now be subject to capping

Brian has traded through his company for many years and recently it made a takeover bid for another trading company.  This was financed by a loan which Brian took from his bank, as it was not willing to lend to his company directly.  Brian lent the money on to his company and charges the company interest of the same amount that he pays to his bank.  Under the new proposals he runs the risk of not being able to claim full interest relief on the amount he pays to the bank even though he will still be taxable on the amount he receives from the company.  Was this the sort of situation envisaged by George Osborne?

Bill is a director of a large manufacturing company and has the opportunity, with five other directors and senior managers, to complete a management buyout.  He will mortgage his home and borrows £1,500,000 on which he will pay annual interest of £75,000.  He has agreed with the individuals involved to draw modest income for the first few years until the business is established. Unless Bill receives income of at least £300,000 pa he will be subject to capping.

Is this what George Osborne intended? – Personally I doubt that it was.

I think part of the problem is the very low level at which the restriction applies – HMRC and Osborne are complaining about the actions of multi-millionaires and yet setting a level of £50,000 is going to directly affect many taxpayers who are most certainly not millionaires and not using this device to avoid liability. There are also no exceptions envisaged for bone fide reliefs where avoidance or even mitigation of liability is the furthest thing from a taxpayer’s mind.  Loss-making multi-millionaires may have bought into artificial schemes to minimise the tax that they pay but many, many ordinary taxpayers will be adversely affected by these proposals.

Perhaps if the ceiling was set considerably higher at £500,000 it would attack the sort of abuse without significant adverse effects, and if there were exceptions permitted it would help but as it stands this is evidence of the revenue simply being unwilling to use existing measures to counteract avoidance.  It is easier for the revenue to impose this sort of limit than to have to police more specific anti-avoidance measures even though they continue to actively seek these powers as well.

This is exactly the same strategy that saw the ludicrously small £25,000 limit set on the statutory equivalent of ESC C16 that I discussed in my December podcast last year.

What can we do?  Like many suggestions in the budget which are intended to be applied in the future – this restriction is intended to be introduced in April 2013 – this will be subject to consultation later this year.  It is vitally important that we take part in the consultation process – and yet very few people do.

Here is a quote from the published results of a recent consultation – 83 representations were received from a range of interested parties including 11 individuals and 72 organisations, ranging from the professional bodies and larger firms of accountants to commercial companies and institutions affected by the measure.  11 individuals only!

If accountants and taxpayers simply sit back and do not take an active part in consultation which potentially affects them then they shouldn’t complain when these measures are subsequently introduced.

There are reliefs which know will not be affected, these include credits against liability – tax credits, double taxation relief and credits under the event gain regime and also where there is a financial limit established such as Pension Contributions and the various Venture Capital reliefs.  We are also told that it won’t apply to the Cultural Gift Scheme – this is the name now being given to the scheme introduced in the Finance Act 2012 for objects of pre-eminent interest being gifted to the nation – although the capping here is the total value from all taxpayers of objects accepted of £30million per annum – the Secretary of State for Culture, Olympics, Media and Sport will have overall accountability for ensuring that the annual limit is not exceeded.

There are also reliefs which might be affected where no clarification has yet been received – what about the payment or spreading of patent royalties for example, or the averaging provisions allowed for authors artists and farmers?

The guidance says that computational reliefs which determine how income from a particular source is measured are excluded which should mean that interest on the acquisition of buy-to-let properties will not be affected although this is often cited as an example of avoidance of this type.

In applying the cap we are told that income is measured without deduction of capped reliefs which can help to maximise the relief available but the revenue’s own example is not completely clear on this point.  In applying the limit relief such as gift aid relief which operates by extending the basic rate band will be converted into the equivalent of a relief that reduces income.

Suppose Charlie has total income of £250,000, claims qualifying interest relief of £40,000 and relief for a donation of shares to a charity valued at £25,000.  That gift of shares qualifies for gift aid relief but there is no deemed basic rate tax deducted at source, he simply claims a deduction for the value of the shares gifted.  He also invests £50,000 under the Enterprise Investment Scheme.  In calculating liability without capping his taxable income will be reduced by £65,000 and there will be a tax reducer relief of £15,000 to offset against the liability arising because of the EIS investment.  Although legally he has taxable income of £185,000, for the purpose of the cap the full income of £250,000 will be used, 25% of which is £62,500 leaving taxable income of £187,500 after capping.

Until we see the consultation document we will not know whether it is the charitable gift or the interest relief that will be practically reduced.  Taxpayers may be allowed to choose.

The document points out that if the EIS shares are disposed of at a loss there will then be a further potential loss relief claim which will also become subject to capping and in fact in this example Charlie will get no relief at all.

Unfortunately capping can’t be applied until the income for the whole of the year has been ascertained and that will usually be after the year has finished.  Traders with a 30 April year end, or one ending earlier in the year, will have an opportunity to know what their income for the year will be and plan accordingly.  Those with a 31 March year end, or an employee with bonus entitlements arising late in the tax year will not.

Timing of certain claims will also become critical to avoid, perhaps, two claims in a single year where capping might then apply where one claim would not be.

Remember – if you or a client of yours is likely to be adversely affected by this proposal you will only have yourself to blame if you fail to take part in the consultation later this year.

31 May 2012 – update:  George Osborne apparently stated today (although there is as yet no confirmation on either the Treasury of the HMRC websites) this:

Mr Osborne said: “I can confirm that we will proceed next year with a cap on income tax reliefs for wealthy people, but we won’t be capping relief for giving money to charity.  It is clear from our conversations with charities that any kind cap could damage donations, and as I said at the Budget that’s not what we want at all. So we’ve listened.”

The point is that the capping of losses and interest relief will go ahead despite the damage that this is likely to cause to the SME sector – this measure, remember, is supposedly aimed at multi-millionaires but the limit, £50,000 or 25% of income is set so low that it WILL affect many smaller businesses – Consultation is likely to start in June or July and it is still critical that that taxation professionals and their clients make it quite clear how damaging this proposal may be.

Remember – if you or a client of yours is likely to be adversely affected by this proposal you will only have yourself to blame if you fail to take part in the consultation later this year.

 

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