Taxation of the Family

Married couples are subject to a system of independent taxation which means that husbands and wives are taxed separately on their income and capital gains. The effect is that both have their own allowances, tax bands for income and capital gains tax (CGT) purposes and are responsible for their own tax affairs.

2005/06 Income Tax Rates

£	%
0 - 2,090	10
2,091 - 32,400	22*
Over 32,400	40**

*10% on dividends - 20% on other savings income
**32.5% on dividends

Children are independent people for tax purposes and are therefore entitled to their own allowances and tax bands. It may be possible to save tax by generating income or capital gains in the children’s hands.

Separation and divorce can have significant tax implications. In particular, the following areas warrant careful consideration:

current and future tax allowances
transfers of assets between spouses.

Married couples

Everyone is entitled to a basic personal allowance. This allowance cannot be transferred between spouses. Where one spouse was born before 6 April 1935, a married couple’s allowance is available. This is given to the husband although it is possible, by election, to transfer it to the wife.

In general, married couples should try to arrange their ownership of income producing assets so as to ensure that personal allowances are fully utilised and any higher rate liabilities minimised. Generally, when husband and wife jointly own assets, any income arising is assumed to be shared equally for tax purposes. This applies even where the asset is owned in unequal shares unless an election is made to split the income in proportion to the ownership of the asset.

The one exception is dividends from jointly owned shares in ‘close’ companies which are taxed according to the actual ownership of the shares. Close companies are broadly those owned by the directors or five or fewer people. For example if a spouse is entitled to 95% of the income from jointly owned shares they will pay tax on 95% of the dividends from those shares. This measure is designed to close a perceived loophole in the rules and does not apply to income from any other jointly owned assets.

The tax treatment of married couples will extend, from 5 December 2005, to same-sex couples who have entered into a civil partnership under the Civil Partnership Act.

Tax Tip

Review the income split between husband and wife. Consider transferring assets to even up incomes. If the husband or wife is self employed their spouse could be employed or taken into partnership as a means of redistributing income. The Revenue may however look closely at such situations to ensure that they amount to a commercial arrangement.

Each spouse’s CGT liability is computed by reference to their own disposals of assets and each is entitled to their own annual exemption, currently £8,500 per annum. Gains above this level are charged to tax by treating them as the top slice of income and using the rates applicable to savings income. Considerable CGT savings may be made by ensuring that maximum advantage is taken of annual exemptions together with the 10% and 20% tax bands.

This can often be achieved by transferring assets between spouses before sale - a course of action generally having no adverse CGT or inheritance tax (IHT) implications. Advance planning is vital and the possible income tax effects of transferring assets should not be overlooked.

Children

It may be possible for tax savings to be achieved by the transfer of income producing assets to a child so as to take advantage of the child’s personal allowance, starting rate (10%) and basic rate (22%) tax bands.

This cannot be done by the parent if the annual income arising is above £100. The income will still be taxed on the parent. However, transfers of income producing assets by others (eg grandparents) will be effective.

Tax Tip

A parent can allow a child to use any entitlement to the CGT annual exemption by using a ‘bare trust’, ie an arrangement whereby a beneficiary has an absolute right to property and income, but the trustees are the legal owners.

Children or any other person whose personal allowances exceed their income are not liable to tax. Where income has had tax deducted at source, a repayment claim should be made. Remember that tax credits on dividends are not repayable.

Child Trust Fund

A new Child Trust Fund has been introduced from April 2005 for all children born from 1 September 2002. The government provides an initial endowment of £250 (£500 for low income families). Other features of the fund include:

allowing additional contributions to be made by others (family and friends) of up to £1,200 a year
children not being taxable on the income and gains they make on the investments in their CTF account, but no tax relief for contributions made to a CTF account.
funds accessible at age 18.

Child Tax Credit

The Child Tax Credit is means tested and potentially available to families who have responsibility for one or more children.

It is a tax-free payment made direct to the main carer.

There are several elements to the credit but broadly the maximum is an annual amount of £1,690 per child together with a family element (one per family) of £545 per annum.

Tax Tip

Many families with children, whether or not the adults in the family are in work, are eligible for the Child Tax Credit. Some credit is likely to be payable in 2005/06 if a family’s income is less than £58,175 a year or £66,350 if there is a child under one year old.

Marriage breakdown

Marriage breakdown often involves the transfer of assets between husbands and wives. Unless the timing of any such transfers is carefully planned there can be adverse CGT consequences.

If an asset is transferred between a husband and wife who are living together, the asset is deemed to be transferred at a price that does not give rise to a gain or a loss. This treatment continues up to the end of the tax year in which the separation takes place.

CGT can therefore present a problem where transfers take place after the end of the tax year of separation. IHT on the other hand will not cause a problem if transfers take place before the granting of a decree absolute on divorce. Transfers after this date may still not be a problem as often there is no gratuitous intent.