The fickleness of family taxation
The creeping change from independent taxation back towards taxation of the family unit causes much confusion, observes Donald Drysdale.
Husbands and wives
Once upon a time a married couple was treated as one taxpayer for income tax and capital gains tax purposes. Incomes and gains were aggregated and taxed on the husband, although they could opt to have their gains taxed separately.
Then the Finance Act 1988 introduced radical changes, including the separate taxation of each individual’s income and capital gains. The new regime was known as ‘independent taxation’ and applied from 1990/91 onwards.
Independent taxation was not only a major simplification. It also recognised that the archaic approach of treating a wife’s income and gains as her husband’s had no place in our modern society.
Time has moved on. Since 2005 same-sex couples have been able to form civil partnerships, and civil partners are treated on the same basis as spouses for all tax purposes. Same-sex couples have even been able to get married in England and Wales since March 2014 and in Scotland since December 2014.
Many couples live together as though married or in a civil partnership, but without formalising their relationship, and there is an infinite variety of such relationships. For most (but not all) tax purposes such cohabitants are treated as single persons, while for tax credit and universal credit purposes they are treated as a family unit.
Jointly held property
Where a bank account or other property is held jointly by spouses or civil partners, income from it is generally treated as split equally between them for income tax purposes – unless the true income split is different from 50/50 and the couple formally opt to be taxed on their respective entitlement.
Where the joint holding is by individuals other than spouses or civil partners (for example, cohabitants), income is attributed to them strictly on the basis of their entitlement.
The settlements legislation seeks to prevent an individual from gaining a tax advantage by diverting income to another person while still retaining an interest in the settled property or income.
For example, an individual might divert income to their spouse, civil partner or minor child (that is, a child under 18 years of age), while retaining the underlying source of the income; in these circumstances the income remains taxable on the settlor.
The settlement rules impose constraints on the ability of individuals to transfer income to others within their family in order to gain a tax advantage. They may equally apply where income is diverted to cohabitants or third parties, but such cases may present HMRC with compliance challenges.
Main residence for capital gains tax
A married couple or the partners in a civil partnership may have only one main residence exempt from capital gains tax, determined by an election or (failing such election) as a matter of fact.
By contrast, a couple who are simply cohabitants may each have a different main residence – either by separate elections, or without elections if (exceptionally) the circumstances of their lifestyles support the existence of separate main residences.
Stamp taxes on additional residential properties
Since 1 April 2016, higher rates of stamp duty land tax (SDLT) – or land and buildings transaction tax (LBTT) in Scotland – apply on acquisitions of additional residential properties such as buy-to-let investments and second homes.
In Scotland, cohabitants are treated for LBTT as a single unit which can have only one main residence. Elsewhere in the UK, cohabitants are regarded for SDLT as two separate individuals, each of whom may have a different main residence if the facts support this. Main residences for LBTT or SDLT may differ from those for capital gains tax.
Each individual, whether single, married or in a civil partnership, has a nil rate band of £325,000 for inheritance tax purposes.
Those who are married or in a civil partnership enjoy added flexibility unavailable to cohabitants. First, transfers of value between UK-domiciled spouses or civil partners are exempt from IHT – though this is limited where the transferor is UK-domiciled and the transferee is domiciled overseas. Second, any part of the nil rate band unused on the first death may be used on the death of the surviving spouse or civil partner.
Income tax allowances
Where at least one party to a marriage or civil partnership was born before 6 April 1935, a married couple’s allowance may be claimed, and shared or transferred between the couple if desired. For 2016/17 the basic allowance amounts to £3,220, but a higher allowance of up to £8,355 is available subject to income limits. The claimant’s income tax liability is reduced by 10% of the amount of the allowance.
Where married couple’s allowance is not claimed and certain other conditions are met, an individual may transfer part of their personal allowance to their spouse or civil partner who is not liable to tax at above the basic rate. The amount of this transferable tax allowance is equal to 10% of the basic personal allowance and is thus £1,100 for 2016/17. It is given to the transferee at the basic rate of income tax.
No married couple’s allowance or transferable tax allowance is available to a couple who are simply cohabitants.
High income child benefit charge
A tax charge applies where an individual’s adjusted net income exceeds £50,000 and they or their spouse, civil partner or cohabitant receives child benefit. If both parties' adjusted net income exceeds £50,000, the charge falls on the person with the higher income. The charge is 1% of the amount of child benefit for every £100 by which the income exceeds £50,000.
This charge impacts unfairly on families in different circumstances. For example, a couple who each have income not exceeding £50,000 will retain their child benefit in full, while another couple with one earner on £60,000 will have the full child benefit clawed back.
Tax credits and universal credit
The social security system has always treated single claimants differently from those who are living together as a couple.
For tax credit purposes a couple extends beyond individuals who are married or civil partners. It also includes a man and woman not married to each other but living together as husband and wife, or two people of the same sex who are not civil partners of each other but are living together as civil partners.
For this purpose, living together as husband and wife or as civil partners is construed according to its normal meaning in everyday language, and the changing nature of relationships is taken into account. The following indicators are considered – namely, living in the same household, stability of relationship, financial support, dependent children and public acknowledgement.
For universal credit purposes the guidelines on living together as a couple (whether opposite-sex or same-sex) have been rewritten and include two additional indicators – namely sexual relationship and future plans.
The way forward
In spite of the adoption of independent taxation in 1990, the tax and benefit regimes have since become a mishmash of different provisions which now apply to couples in differing relationships. Income tax and capital gains tax rules are based mainly (but not solely) on the circumstances of the individual taxpayer, while rules for other taxes and social security benefits take family circumstances into account to varying degrees.
Perhaps a system based wholly on the individual, or wholly on the family unit, might be easier to administer and fairer in its overall impact.
Article supplied by Taxing Words Ltd
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