Dear Accountant… your financial questions answered

Tuesday, March 06, 2012 | Posted by: Mike Hyland
Categories: Business, Personal, Protecting your wealth | Tags: business, tax, tax planning, capital gains tax, inheritance tax, CGT, income tax, IHT, tax relief, trusts, Mike Hyland, money, minimise, main residence, school fees, incorporation, settlor, mortgage interest, trustee

Welcome to a new occasional blog series for high net worth individuals (HNWIs) and high earners in which we answer your burning financial questions. This month, tax manager Mike Hyland is asked about incorporating a business, tax relief on school fees and other money-saving issues.

Q. Should I incorporate my business?

A. Incorporation is the formation of a new company. Where certain conditions are fulfilled, an existing business can often be transferred to the new company without triggering any tax charges. There are advantages and disadvantages of incorporating a business depending on the particular circumstances of each sole trader or partnership.

However, incorporation has certainly become an attractive option for many, with the continuing 50% top rate of income tax much higher than current corporation tax rates (26% at present, falling to 24% by April 2013). You can read more on the tax advantages in my colleague’s post, Tax planning with companies is back in fashion.

Q. Will I pay inheritance tax on my home?

A. In short, yes, if the total value of your estate (including your main home and the value of any gifts made in the seven years prior to your death) exceeds the inheritance tax (IHT) nil rate band, currently £325,000.

There is sometimes a misconception that IHT doesn’t apply to your main home, probably arising from confusion with the capital gains tax rules, which ensure that you do not usually pay capital gains tax when selling your main residence. However, the value of your home, less any outstanding mortgage, will be included in your estate when calculating the IHT bill arising on your death.

I know that many people find the IHT system confusing. In our recent survey of 400 homeowners, 62% with properties valued at over £250,000 believed they were liable when, in fact, just three per cent of UK estates were subject to IHT in 2010/11. Grant Thornton has called for an overhaul of the IHT system to make it simpler and fairer, but until then the value of your main home will be counted for IHT purposes.

Q. Can I be a trustee of my own trust?

A.There are generally no restrictions on who can be a trustee of a private trust, therefore there is no obstacle to you being a trustee of a trust that you settle or which you can benefit from. You can be the sole trustee of a trust or can be one of several trustees.

But there are certain circumstances, for example where you are likely to be transacting with the trust on commercial terms (eg, renting a property from the trustees), where we would not recommend that you act as sole trustee. There are also tax implications of acting as a trustee so I would recommend that you seek professional advice in advance.

Q. What relief can I claim for mortgage interest paid?

A. Tax relief is not normally available for interest paid on a loan to acquire your main home. However, interest paid on a loan taken out for the purposes of a rental business is generally allowed as a deduction against the rental income received.

It is clearly inefficient from a tax point of view – but common in reality – to see clients with large mortgages on their main home, and little or no debt on their rental properties. This can often be easily tweaked by refinancing the debt on the properties to improve the tax position considerably, although the tax relief potentially available needs to be weighed against the interest rates obtainable and any costs of refinancing. I recommend that you seek advice before undertaking such a refinancing to determine the extent to which your position could be improved.

Q. Can I get tax relief for paying my grandchildren’s school fees?

A. There is no tax relief for payment of school fees, but there are ways to fund the fees that are often much more tax-efficient than paying fee money directly from your after-tax income.

By way of an illustration, in order to fund school fees of £10,000, a 50% taxpayer must receive pre-tax income of £20,000.

Contrast this with payments for school fees made directly from a discretionary trust for the benefit of the grandchildren.

The trust could potentially be funded in cash without crystallising any tax liabilities (using the IHT nil rate band(s) of the grandparents). Where set up correctly, income of the trust – which is used to pay grandchildren’s school fees – can effectively be taxed as the income of the grandchildren (using their tax-free income tax personal allowance, with any excess only taxable at 20%). This means that significant income tax savings are possible.

This type of planning is covered in more detail in Rising school fees? Setting up a trust fund could be more than just educational. 

Do you have a question?

These are just some of the issues that private clients have asked me about this month. If you have a question, then please do leave a comment or email me at .(JavaScript must be enabled to view this email address).

Image: (CC) Valerie Everett

You might also find these posts useful:

* SEIS the day? Potentially up to £103,000 of tax relief for a £100,000 seed investment
* Best of Bespoke – our top wealth management posts for high earners and HNWIs
* Read more posts by Mike Hyland