GUIDANCE ISSUED ON CHANGES TO TAX RELIEF FOR RESIDENTIAL LANDLORDS
HMRC has issued guidance on the changes to tax relief for residential landlords which are to be phased in from April 2017. The changes will restrict relief for finance costs to the basic rate of income tax. It is vital for advisers to explain the position to any clients which may be affected by these changes.
Despite calls, earlier this week, on new Chancellor Phillip Hammond to review the government’s approach to taxing the buy to let sector; HMRC has released guidance that sets out how the new rules restricting tax relief for residential landlords will operate in practice.
Under the new rules – which were announced at Summer Budget 2015 – finance costs (such as interest on mortgages or loans taken out to furnish the property) will no longer be taken into account to work out taxable property profits. Instead, once the income tax on property profits and any other income sources has been assessed, a landlord’s income tax liability will be reduced by a basic rate ‘tax reduction’.
The rules apply to UK resident individuals that let out residential properties – whether in the UK or overseas – as well as to non-UK resident individuals who let out UK residential property. ‘Individuals’ for these purposes includes individuals who let such properties in partnership as well as trustees or beneficiaries of trusts liable for income tax on residential property profits. The rules do not apply to lettings of commercial properties; or to companies or landlords of furnished holiday lettings.
The restriction will be phased in gradually from 6 April 2017 – at a rate of 25% a year – and will be fully in place from 6 April 2020.
To sit alongside the new guidance, HMRC has also published a series of case studies which demonstrate the potential impact of the changes on individual landlords in a range of specific scenarios.
All individual landlords of residential property will need to consider their position. Existing higher/additional rate taxpaying buy-to-let investors with mortgage interest will be most profoundly affected, however, the changes could also move some basic rate taxpaying landlords into higher rate tax and/or affect entitlement to allowances, such as child benefit, personal allowances, annual allowances for pension plans and whether chargeable event gains suffer higher rate tax or not.
VARIATION OF TRUST CASE RECOGNISES RIGHTS OF SAME-SEX PARTNERS
A landed family has successfully varied an outdated trust to give any future same-sex partners of descendants the same rights as heterosexual spouses.
In what is believed to be the first case of its kind, the High Court has approved a variation of a 51-year old trust to allow same-sex spouses and civil partners to acquire the same inheritance rights over property that are afforded to opposite sex spouses of descendants of the settlor under the terms of the trust.
The terms of the trust as originally drafted were “much in the style of a 19th century dynastic family settlement” which did not include civil partners or spouses under same sex marriages. The Pembertons, who have lived in Trumpington Hall, Cambridgeshire, for three centuries, said they felt they had ‘a moral obligation” to future generations to modify the inheritance arrangements over their ancestral seat.
The variation, which ensures that future same-sex spouses and civil partners will have a life interest in Trumpington Hall following the deaths of their spouses, was approved on the basis that it would ‘be for the benefit of the family as a whole and therefore of benefit to each individual member’ of the trust – the inheritance tax and capital gains tax benefits of which could not be replicated in a new settlement.
It is believed that the Pemberton’s are the first landed gentry to alter the definition of a ‘spouse’ in a pre-existing trust to ensure that it recognises same-sex marriages and civil partnerships.
The trust’s lifespan was also increased for another 125 years, to 2141, and additional investment powers were conferred on the trustees.
The case, which is thought to be the first regarding the recognition of civil partnerships in varying or attempting to vary pre-existing trust arrangements, highlights the progressive attitude of the courts towards outdated family settlements that have not kept pace with changes to the law.
THE COST OF TAX RELIEFS IS PUT UNDER SCRUTINY
Private residence relief comes in for special attention by the National Audit Office.
The National Audit Office (NAO) has called for more scrutiny of tax reliefs generally and specifically the capital gains tax exemption, which is used by people selling their main home and apparently costs the exchequer £18bn a year.
The NAO said that monitoring of tax reliefs was ‘not yet systematic or proportionate to their value or the risks they carry’. ‘Reliefs reduce tax bills and may be exploited or used in ways which parliament did not intend,’ it said.
Altogether, tax reliefs cost more than the budget of any government department and MPs, lawyers and think-tanks have questioned their effectiveness and value for money.
The cost of exempting main residences from capital gains tax rose from £10.5bn to £18bn in the four years to 2015-16 as house prices went up. It was the biggest factor in a 13 per cent rise in the cost of reliefs – to £117bn – during the past four years.
The NAO said the £1.7bn increase in the cost of principal private residence relief between 2014-15 and 2015-16 had not been explained by HM Revenue & Customs and the costs were not monitored by its policy team.
It said there was scope for the misuse of the relief, given its scale, the complexity of the rules and the lack of reporting requirements.
It noted that the number of buy-to-let landlords had risen significantly in recent years and said the eligibility rules for the relief were not always straightforward.
‘There are several restrictions and related reliefs which allow individuals to claim relief for two homes concurrently. This means more scrutiny may be needed to ensure people are following the rules correctly,’ the NAO said.
HMRC said the rise in the cost of the relief was because house prices had gone up and there have been more sales. It said: ‘We ensure the right capital gains tax is paid through reviewing the data we hold and cross-checking it against third-party information.
We also carry out targeted campaigns … where we use our own analysis to reach people we believe should have declared a gain but did not, and to raise awareness about the rules.’
The NAO said it had found examples of good practice in the way HMRC monitored the cost of reliefs though. It said specialist units checked all claims concerning the ‘patent box’ – a tax relief on profits from intellectual property – creative industry reliefs, including breaks for makers of high-end television shows and venture capital schemes.
HMRC had been able to detect unusual changes in the costs of these reliefs and respond, in cases where it monitored costs over time.
The NAO said the sheer number of tax reliefs meant it would be impractical for HMRC to administer each one individually, adding that in many cases the costs of doing so could outweigh the benefits.
HMRC recognised the need to take a risk-based approach to manage reliefs proportionately and had introduced new guidance that focused on new tax reliefs, which tend to carry greater uncertainty and risk.
But the NAO warned that older tax reliefs could present risks too. It said that ‘changing trends can lead to increased take-up or they can become the focus of tax avoidance schemes’.
Worryingly for business owners the NAO said HMRC was planning an extensive review of entrepreneurs’ relief. The use of so called ‘money boxing’ has already been the subject debate and likely action.
The NAO had previously raised concerns that entrepreneurs’ relief was costing three times more than expected, although the government has since introduced changes to reduce its cost and it is understood that there is no general HMRC concern about the fundamental principle of the relief- some form of which has been available for many years.
The fundamental point underlying the NAO concern is that there should be a very regular ‘cost/benefit’ analysis applied to tax reliefs. It is hard to argue with this principle.
Tax reliefs are generally introduced in order to change taxpayer behaviour. A regular assessment of whether targeted behavioural changes have been secured or not seems essential given the cost of many reliefs.
The cost of pensions tax relief (>£30bn) has had very high publicity over the past year or so. The Centre for Policy Studies clearly had this very much in mind in making their recommendations for an alternative means of pensions saving in their ‘ISA Centric Savings World’ document.
ABSENCE OF FINANCIAL NEED DOES NOT RULE OUT REASONABLE PROVISION CLAIM
The High Court has ruled that a claim for ‘reasonable financial provision’ out of the estate of the deceased can succeed even where the applicant is financially independent.
In the recent ‘reasonable provision’ case of Lewis v Warner 2016 EWHC 1787 Ch, the High Court was required to consider whether a will could have failed to make reasonable provision for an applicant who is in no financial need. The facts of the case were as follows.
Stanley Warner had been living with Audrey Blackwell in her house in the village of Twyning Green in Gloucestershire since 1995, when he was 70 and she was 62. Mrs Blackwell died in May 2014 when Mr Warner was 91, leaving her entire estate to her daughter.
Over the years, Mr Warner’s health had deteriorated and he had grown somewhat reliant on his neighbours (one of whom was a doctor) for friendship and medical support over the 20 years that he had been living in the house owned by Mrs Blackwell. Although Mr Warner was wealthy in his own right, he did not want to leave his home and so when Mrs Blackwell’s daughter, Lynn Lewis, sought to evict him in order to sell the house (that now belonged to her); he responded by making a claim for reasonable provision out of the deceased’s estate under the Inheritance (Provision for Family and Dependants) Act 1975. His claim was founded only on the fact that he would be ‘very unhappy and very stressed’ if he had to move from the property.
In the first instance, the County Court recorder admitted Mr Warner’s claim on the grounds that the maintenance of ‘a roof over the head of an applicant for 20 years clearly came within the definition of ‘maintenance’ and that its removal, by there being no provision for the continuance of the same, meant that the will failed to make reasonable financial provision for Mr Warner. However, in view of Mr Warner’s financial position, the solution put forward was for Mr Warner to buy the house from his former cohabitant’s estate for £385,000 (the highest market value estimate).
Mrs Lewis and her husband appealed this decision on the grounds that the Recorder had both ‘come to ‘utterly wrong conclusions’ and had ‘exceeded his powers’ by making an order that he had no authority to make.
However, the appeal was dismissed by the High Court on the basis that ‘maintenance’ need not necessarily mean a transfer of money from the estate to the claimant and moreover that the Recorder was entitled to decide that Mrs Blackwell’s will failed to make reasonable provision for Mr Warner, notwithstanding his financial means. Accordingly, Mr Warner was entitled to buy the house for £385,000.
WORKPLACE PENSIONS AND THE RISKS OF INADVERTENTLY GIVING REGULATED ADVICE
There is a fine line, for both employers and their business advisers, between supporting auto enrolment of their workforce and a “financial promotion”. Is this an opportunity for advice firms?
Currently, a key issue with the defined contribution (DC) auto enrolment programme is communication and employee engagement in driving good outcomes. The logic is that better engagement by workers with their retirement saving arrangements will require more support from employers and trustees. However, is there a risk that the greater the role the employer has (and their non FCA regulated business advisers), the more carefully they will need to tread to ensure that they do not stray into regulatory difficulties with the Financial Conduct Authority (FCA).
There are many examples of employers and trustees trying very hard to do the right thing in relation to pensions and workplace benefits. However, regulatory rules control what can be said and guidance from the Financial Conduct Authority (FCA) has not always been clear on the boundaries between which activities should and should not be regulated.
FCA regulated pension providers (typically SIPP and life offices) understand this all too well and have been grappling with it for many years, but employers and trustees and the third parties that act for them, need to ensure that they are not straying into providing regulated financial advice to workers/members, or potentially carrying out other regulated activities.
It must be said that there is nothing wrong with helping workers and members. Providing access to financial information will be of great benefit to workers who have until now been accustomed to default pension scheme membership, contribution rates and investment strategies, and there are ways to mitigate the risks. These activities must, however, be undertaken with care in what can be a highly regulated area.
There are a number of areas where employers and trustees could stray into regulatory difficulties:
- promoting non-occupational pension schemes, which could involve financial promotion;
- employers designing and monitoring, or not monitoring the default investment in a Group Personal Pension (GPP);
- trustees’ involvement in the delivery of retirement products such as drawdown; and
- employers and trustees using advice and guidance solutions where the end consumer is the worker or scheme member.
The Impact of the Post April 2015 Pension Freedoms
There has been a seismic change in the way in which we approach pensions over the past few years. For example:
- Workers are now enrolled into pension schemes by default, invest by default and save at minimum levels.
- The traditional concept of ‘retirement’ has been replaced by the attainment of age 55 at which point workers can plump for cash, drawdown or buy an annuity from their DC pension savings – or even a blend of all three.
- The point at which individuals access these savings is also no longer necessarily the end of their working lives – people are now more likely to be working in some form for longer, to make up for shortfalls in retirement income and increasing life expectancy.
Employers have generally used DC schemes for automatic enrolment: whether in the form of FCA-regulated GPPs or master trust or other trust arrangements, which are regulated by The Pensions Regulator. Master trusts and GPPs involve the use of a commercial third party to deliver the savings facility, and maybe the retirement functionality too. Employers are also offering their own trust-based schemes during the savings phase, with a small number also enabling drawdown through their own schemes.
Following the 2016 Budget, there is the proposed introduction of the ‘Lifetime ISA’ (LISA) to contend with, now with lobbying for a workplace version. In addition, there is the outcome of the HMT/FCA’s Financial Advice and Market Review (FAMR). Whilst the former has grabbed most of the headlines, the latter identified a number of areas that are directly relevant to workplace pension schemes.
Impact of the FAMR on Workplace Pensions
FAMR recommended that employers take a more active role in “supporting workers’ financial health. It is further proposed that this should be supported by the FCA, which will work with employers to make sure that they understand the rules and don’t fall into tricky areas despite the best of intentions. There are also moves to increase the ability for employers to offer payment for financial advice as a tax efficient workplace benefit, as per our comments in last year’s ‘Age of Responsibility’ report sponsored by Redington. FAMR recommended increasing the £150 income tax and national insurance exemption on advice arranged by an employer to £500 per person per annum.
Some employers have decided to extend their own DC occupational schemes so that they offer drawdown and cash facilities. This approach can potentially drive lower costs for the members, and all such solutions are generally very well intentioned – looking after the worker’s interests after, and perhaps long after, the worker has retired or left the employer. However, taking this step does fundamentally change the nature of the scheme from a savings vehicle for current workers and deferred members, to a retirement product offering a sophisticated investment to those who happened to have worked for the employer but have now retired.
This ‘retirement’ side of retirement saving is particularly difficult to grapple with. Workplace pension scheme members can now take all of their money as cash from the age of 55; or enter into drawdown arrangements, which were previously the preserve of the relatively wealthy. These now sit alongside annuities as mass market retirement options. The downside with annuities was perceived poor value and a lack of shopping around; but drawdown ultimately might suffer from similar problems, with the added risk that the money might not last as long as the scheme member. Deferred annuities are being used alongside drawdown products to guard against the scenario where an individual runs out of money at the age of 85, with another 10 years to live, but there are risks here too, particularly for those with smaller pension pots.
An alternative could involve trustee boards partnering with particular retirement product providers. This approach too has its risks and needs to be structured appropriately although it could be argued that there are greater risks leaving members to their own devices at such a critical point, especially for workers who have been accustomed to default choices being made for them. Trustees and employers might also logically pair with independent financial advisers to help members and workers decide whether to go with the partner provider, or whether to go elsewhere.
This is very different to the average workplace proposition at the moment. The regulatory environment outside of occupational schemes means that this must be approached in the right way but the effect of FAMR should make the appropriate direction easier to find.
Even if the workplace offering does not lead to FCA regulatory issues, employers and trustees must still be on guard. There is still the law of misrepresentation and misstatement to contend with and a duty of care that accompanies the trustee and employer role, breach of which might lead to action in negligence.
Communications need to be honest and accurate and avoid well-intentioned embellishment which overplays the virtues of what is, ultimately, a complex financial product. If there is a mis-match between retirement reality and member expectations, the first thing members will do is dust off the communications and read them very literally. If the scheme doesn’t live up to the promises made or alluded to, then there could well be trouble.
Comment
It seems that for advisory firms there is still a role for them to play with employers even if it is not with direct responsibility with the AE scheme. However, they could offer to undertake the “decumulation” planning for employees and perhaps offer an employer-supported financial review once every 3-5 years, with a more frequent review at the individual’s request to engage directly with the advisory firm if required.
FOS ORDERS PAY-OUT AFTER FOUR-YEAR DELAY OF RETIREMENT PACK
Financial Ombudsman Service orders pay-out after four-year delay of retirement pack.
The Financial Ombudsman Service (FOS) has ordered a pay-out after there was a four-year delay by The Prudential Assurance Company Limited (“Prudential”) in issuing the required retirement pack.
The case was made more complex as whilst the member agreed that if he had taken benefits in 2011, he would have taken the PCLS and been offered an annuity but given the legislative changes in 2015, he now wanted to take a drawdown pension. He also did not wish for the drawdown plan to be administered by Prudential as he has lost faith in their ability to administer his benefits properly.
Summary of the Case
- The customer was a member of an employer’s pension scheme with a Prudential deferred annuity.
- The company were supposed to send out a retirement pack three months before his retirement date in 2011 but they did not do so.
- In 2015, the client discovered details of his Prudential pension when looking through some past papers and he contacted Prudential.
- Prudential explained to the member that they would back date the annuity payments, but he would have to pay HMRC the arrears of income tax.
- They offered him £100 compensation but would not pay him interest.
- A complaint was made to the FOS and Prudential increased its offer, but the increased offer was not accepted by the member.
- An adjucator considered the complaint. She said that Mr K should receive the missed annuity payments with interest. But she also said that the cost of buying the same annuity now should be compared to the current value of his plan. She also said that Prudential should pay a further £200 for Mr K’s trouble and upset.
- Prudential tried to calculate the redress as set out by the adjucator. When these were checked, this time by a different adjucator, they were found to be incorrect. The new adjucator provided Prudential with his calculations, but Prudential asked the matter to be referred to the Financial Ombudsman (FO).
- The FO’s decision was complicated and it included the requirement for Prudential to pay interest at the standard rate of 8% simple and also pay an additional amount of compensation of £300.
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